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PROSPECTUS -- MAY 1, 1997
LAST SURVIVOR FLEXIBLE PREMIUM ADJUSTABLE VARIABLE LIFE INSURANCE POLICIES
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PENN MUTUAL VARIABLE LIFE ACCOUNT I
THE PENN MUTUAL LIFE INSURANCE COMPANY
PHILADELPHIA, PA 19172 . TELEPHONE (215) 956-8000
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This prospectus describes a last survivor flexible premium adjustable variable
life insurance policy (the "Policy" or "Policies") offered by The Penn Mutual
Life Insurance Company ("Penn Mutual"). The Policy is designed to provide
lifetime insurance protection on two insureds named in the Policy and at the
same time provide flexibility to vary the amount and timing of premiums and to
change the amount of death benefits payable under the Policy on the death of
the last surviving insured. This flexibility allows you to provide for changing
insurance needs under a single insurance policy.
You also have the opportunity to allocate net premiums and Policy Value to
one or more subaccounts of the Penn Mutual Variable Life Account I (the
"Separate Account") and Penn Mutual's general account (the "Fixed Account"),
within limits. The assets of each subaccount are invested in a corresponding
fund (each, a "Fund," and together, the "Funds") of Penn Series Funds, Inc.
("Penn Series"), Neuberger & Berman Advisers Management Trust ("AMT"), American
Century Variable Portfolios, Inc. ("American Century Variable Portfolios"),
Variable Insurance Products Fund ("VIP Fund"), Variable Insurance Products Fund
II ("VIP Fund II") or Morgan Stanley Universal Funds, Inc. ("Morgan Stanley").
Each Fund is managed by the investment adviser shown below:
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FUNDS MANAGERS
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PENN SERIES
Growth Equity Fund Independence Capital Management, Inc.
(a subsidiary of Penn Mutual)
Value Equity Fund OpCap Advisors
Small Capitalization Fund OpCap Advisors
Emerging Growth Fund Independence Capital Management, Inc./
Robertson Stephens Investment Management, Inc.
Flexibly Managed Fund T. Rowe Price Associates, Inc.
International Equity Fund Vontobel USA Inc.
Quality Bond Fund Independence Capital Management, Inc.
High Yield Bond Fund T. Rowe Price Associates, Inc.
Money Market Fund Independence Capital Management, Inc.
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AMT
Limited Maturity Bond Portfo-
lio Neuberger & Berman Management, Inc.
Balanced Portfolio Neuberger & Berman Management, Inc.
Partners Portfolio Neuberger & Berman Management, Inc.
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AMERICAN CENTURY VARIABLE PORT-
FOLIOS
Capital Appreciation Portfolio American Century Investment Management, Inc.
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VIP FUND
Equity-Income Portfolio Fidelity Management & Research Company
Growth Portfolio Fidelity Management & Research Company
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VIP FUND II
Asset Manager Portfolio Fidelity Management & Research Company
Index 500 Portfolio Fidelity Management & Research Company
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MORGAN STANLEY UNIVERSAL FUNDS,
INC.
Emerging Markets Equity (In-
ternational) Portfolio Morgan Stanley Asset Management Inc.
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</TABLE>
The accompanying prospectuses for the Funds describe the Funds, including the
risks of investing in the Funds, and provide other information on the Funds.
This prospectus generally describes only those features of the Policy related
to the Separate Account. For a brief summary of the Fixed Account, see "The
Fixed Account," page 14.
You can select from two death benefit options available under the Policy: a
level death benefit ("Specified Amount" or "Option 1") and an increasing death
benefit ("Specified Amount Plus Policy Value" or "Option 2"). Penn Mutual
guarantees that the death benefit will never be less than the Specified Amount
(less any unrepaid policy loans and past due charges) so long as the Policy is
in force.
The Policy provides for a net cash surrender value that can be obtained by
surrendering the Policy. Because this value is based on the performance of the
Funds, to the extent of allocations to the Separate Account, there is no
guaranteed net cash surrender value.
If the net cash surrender value is insufficient to cover the charges due
under the Policy, the Policy will lapse without value. However, Penn Mutual
guarantees to keep the Policy in force during the first five policy years so
long as the No-Lapse Premium requirement and other conditions have been met.
The Policy also provides for policy loans and permits partial surrenders within
limits.
It may not be advantageous to replace existing insurance with the Policy.
Within certain limits, you may return the Policy or convert it to a life
insurance policy with benefits that do not vary with the investment results of
a separate account.
THIS PROSPECTUS SETS FORTH CONCISELY THE INFORMATION YOU SHOULD KNOW BEFORE
DECIDING TO PURCHASE A POLICY. IT SHOULD BE RETAINED FOR FUTURE REFERENCE. THIS
PROSPECTUS MUST BE ACCOMPANIED OR PRECEDED BY A CURRENT PROSPECTUS FOR EACH
FUND. THE FUND PROSPECTUSES SHOULD BE READ IN CONJUNCTION WITH THIS PROSPECTUS.
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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PROSPECTUS CONTENTS
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DEFINITIONS OF TERMS....................................................... 4
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SUMMARY AND DIAGRAM OF THE POLICY.......................................... 5
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GENERAL INFORMATION ABOUT PENN MUTUAL, THE SEPARATE ACCOUNT AND THE FUNDS.. 8
The Penn Mutual Life Insurance Company................................... 8
Penn Mutual Variable Life Account I...................................... 8
The Funds................................................................ 8
Substitution of Securities............................................... 10
Voting Rights............................................................ 10
PREMIUMS AND ALLOCATIONS................................................... 11
Applying for a Policy.................................................... 11
Free Look Right to Cancel Policy......................................... 11
Premiums................................................................. 11
Premiums to Prevent Lapse................................................ 12
Net Premium Allocations.................................................. 12
Crediting Premiums....................................................... 12
Transfers................................................................ 13
Dollar Cost Averaging Program............................................ 13
Asset Rebalancing........................................................ 14
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FIXED ACCOUNT.............................................................. 14
Fixed Account............................................................ 14
Interest Credited on Policy Value in the Fixed Account................... 14
Calculating Fixed Account Value.......................................... 15
Deductions, Surrenders and Transfers from the Fixed Account.............. 15
Payments from the Fixed Account.......................................... 15
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CHARGES AND DEDUCTIONS..................................................... 15
Premium Charge........................................................... 15
Daily Mortality and Expense Risk Charge.................................. 15
Monthly Deduction........................................................ 16
Transfer Charge.......................................................... 17
Surrender Charge......................................................... 17
Partial Surrender Charge................................................. 18
Fund Expenses............................................................ 18
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HOW YOUR POLICY VALUES VARY................................................ 18
Determining the Policy Value............................................. 18
Net Policy Value......................................................... 19
Cash Surrender Value..................................................... 19
Net Cash Surrender Value................................................. 19
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DEATH BENEFIT AND CHANGES IN SPECIFIED AMOUNT.............................. 19
Amount of Death Benefit.................................................. 19
Basic Death Benefit and Specified Amount Options......................... 19
Specified Amount......................................................... 20
Changes in Specified Amount Option....................................... 20
Changes in Specified Amount.............................................. 20
Selecting and Changing the Beneficiary................................... 20
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CASH BENEFITS.............................................................. 20
Policy Loans............................................................. 20
Surrendering the Policy for Net Cash Surrender Value..................... 21
Partial Surrenders....................................................... 21
Maturity Benefit......................................................... 22
Payment Options.......................................................... 22
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ILLUSTRATIONS OF POLICY VALUES, NET CASH SURRENDER VALUES, DEATH BENEFITS
AND ACCUMULATED PREMIUMS.................................................. 22
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OTHER POLICY BENEFITS AND PROVISIONS...................................... 25
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Right to Convert to a Fixed Benefit Policy.............................. 25
Dividends............................................................... 25
Inconstestability....................................................... 25
Suicide Exclusion....................................................... 25
Misstatement of Age or Sex.............................................. 25
When Proceeds Are Paid.................................................. 25
Reports to Policy Owners................................................ 25
Assignment.............................................................. 26
Reinstatement........................................................... 26
Supplemental Benefits................................................... 26
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FEDERAL INCOME TAX CONSIDERATIONS......................................... 26
Introduction............................................................ 26
Tax Status of the Policy................................................ 27
Tax Treatment of Policy Benefits........................................ 27
Charge for Penn Mutual's Taxes.......................................... 29
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OTHER INFORMATION ABOUT THE POLICIES AND PENN MUTUAL...................... 29
Sale of the Policies.................................................... 29
Penn Mutual Trustees and Officers....................................... 30
State Regulation........................................................ 31
Additional Information.................................................. 31
Experts................................................................. 32
Litigation.............................................................. 32
Legal Matters........................................................... 32
Financial Statements.................................................... 32
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APPENDICES
A--Minimum Initial Annual Premiums...................................... A-1
B--Administrative Surrender Charges per $1,000 of Initial Specified
Amount and Sample Charges Premiums for $1,000,000 Specified Amount... B-1
C--Illustrative Net Single Premium Factors.............................. C-1
D--Policies Issued to New York Residents................................ D-1
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THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFERING IN ANY JURISDICTION IN WHICH
SUCH OFFERING MAY NOT BE LAWFULLY MADE. NO PERSON IS AUTHORIZED TO MAKE ANY
REPRESENTATIONS IN CONNECTION WITH THE OFFERING OTHER THAN THOSE CONTAINED IN
THIS PROSPECTUS AND THE ACCOMPANYING PROSPECTUSES OF THE FUNDS OR THEIR
RESPECTIVE STATEMENTS OF ADDITIONAL INFORMATION.
3
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DEFINITIONS OF TERMS
ATTAINED AGE: An Insured's age on the Policy Date, plus the number of full
years since the Policy Date.
BASIC DEATH BENEFIT: Specified Amount or Specified Amount Plus Policy
Value, depending on the option selected. See page 19.
BENEFICIARY: The person to whom the Death Benefit is paid.
CASH SURRENDER VALUE: Policy Value less any surrender charges that would be
deducted if the Policy were surrendered. See page 19.
DEATH BENEFIT: The amount of money payable to the Beneficiary upon the
death of the last surviving Insured if the Policy is then still in force.
The calculation of the Death Benefit is described on page 19.
FIXED ACCOUNT: An account consisting of assets owned by Penn Mutual with
respect to the Policies, other than those in the Separate Account.
INDEBTEDNESS: The total amount owed Penn Mutual as a result of Policy
loans, including both principal and accrued interest.
INITIAL SPECIFIED AMOUNT: The Specified Amount on the Policy Date.
INSURED: A person whose life is covered by the Policy.
ISSUE DATE: The date the Policy is issued. A Policy is issued after
completion of underwriting. If the initial premium is received at our
Office and invested before underwriting has been completed, the Issue Date
will be later than the Policy Date. In that case, once issued, Policy
coverage is retroactive to the Policy Date. The Issue Date is used to
measure contestability periods. See page 25.
MATURITY DATE: The Policy Anniversary nearest the younger Insured's 100th
birthday.
MONTHLY ANNIVERSARY: The same day as the Policy Date for each succeeding
month, except that, if the Policy Date is the 29th, 30th or 31st of a
month, the Monthly Anniversary is deemed to be the first of the following
month. The Monthly Deduction is deducted on each Monthly Anniversary.
NET CASH SURRENDER VALUE: Net Policy Value less any applicable surrender
charge that would be deducted upon surrender. See page 19.
NET POLICY VALUE: Policy Value less any Indebtedness.
NET PREMIUM: A premium minus the premium charge. See page 15.
NO-LAPSE PREMIUM: An amount used to measure premiums paid during the first
five Policy Years for purposes of the Five-Year Guarantee. See page 11.
OFFICE: Operations Offices, 600 Dresher Road, Horsham, PA 19044
OWNER, YOU: The person who purchases a Policy.
PENN MUTUAL, WE, US: The Penn Mutual Life Insurance Company.
POLICY ANNIVERSARY: An anniversary of the Policy Date.
POLICY DATE: The date from which Policy Years and Monthly Anniversaries are
measured.
POLICY LOAN ACCOUNT: A portion of the Policy Value held in the Fixed
Account as collateral for policy loans. See page 20.
POLICY VALUE: The total amount in the Fixed Account and Subaccounts
credited to a Policy. Calculation of the Policy Value is described on page
18.
POLICY YEAR: The year commencing with the Policy Date and ending on the day
before the first Policy Anniversary, or any following year commencing with
a Policy Anniversary and ending on the day before the next Policy
Anniversary.
SEPARATE ACCOUNT: Penn Mutual Variable Life Account I, a separate
investment account of The Penn Mutual Life Insurance Company.
SPECIFIED AMOUNT: A dollar amount used to determine the death benefit under
a Policy. See page 19.
SUBACCOUNT: A division of the Separate Account established to invest in a
particular Fund and available for investment under the Policies.
SURRENDER CHARGE PREMIUM: An amount used to determine the sales charge
deducted on surrender of the Policy. See page 17 and Appendix B.
VALUATION DATE: Each day the New York Stock Exchange and our Office are
open for business.
VALUATION PERIOD: A period commencing with the close of business on the New
York Stock Exchange and ending at the close of business on the New York
Stock Exchange for the next succeeding Valuation Date.
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SUMMARY AND DIAGRAM OF THE POLICY
THE FOLLOWING SUMMARY OF PROSPECTUS INFORMATION AND DIAGRAM OF THE POLICY
SHOULD BE READ IN CONJUNCTION WITH THE DETAILED INFORMATION APPEARING ELSEWHERE
IN THIS PROSPECTUS. UNLESS OTHERWISE INDICATED, THE DESCRIPTION OF THE POLICY
IN THIS PROSPECTUS ASSUMES THAT THE POLICY IS IN FORCE AND THERE IS NO
OUTSTANDING INDEBTEDNESS.
The Policy is similar in many ways to fixed-benefit life insurance. As with
fixed-benefit life insurance, the Owner of a Policy pays premiums for insurance
coverage on the persons insured. Also like fixed-benefit life insurance, the
Policy provides for accumulation of Net Premiums and a Net Cash Surrender Value
which is payable if the Policy is surrendered during an Insured's lifetime. As
with fixed-benefit life insurance, the Net Cash Surrender Value during the
early Policy Years is likely to be substantially lower than the premiums paid.
However, the Policy differs from fixed-benefit life insurance in several
important respects. Unlike fixed-benefit life insurance, the Death Benefit of a
Policy may and Policy Value will increase or decrease to reflect the investment
performance of the Subaccounts to which the Policy Value is allocated. Also,
there is no guaranteed minimum Net Cash Surrender Value. Nonetheless, Penn
Mutual guarantees to keep the Policy in force during the first five Policy
Years so long as the No-Lapse Premium requirement has been met and Indebtedness
is not excessive. See "Five-Year Guarantee," page 12. Otherwise, if the Net
Cash Surrender Value is insufficient to pay charges due, the Policy will lapse
without value after a grace period. See "Premiums to Prevent Lapse," page 12.
The Policy is called "last survivor" because no death benefit is payable
until the death of the second of the two named Insureds (the "last surviving
Insured"). The Policy continues in force without any adjustment after the death
of the first Insured.
The most important features of the Policy, such as charges, cash benefits,
death benefits, and calculation of Policy values, are summarized in the diagram
on the following pages.
PURPOSE OF THE POLICY. The Policy is designed to be a long-term investment
providing significant insurance benefits. The Policy should be considered in
conjunction with other insurance policies owned by the Owner. It may not be
advantageous to replace existing insurance with the Policy.
TAX CONSIDERATIONS. Penn Mutual intends for the Policy to satisfy the
definition of a life insurance contract under section 7702 of the Internal
Revenue Code. Under certain circumstances, a Policy could be treated as a
"modified endowment contract." Penn Mutual will monitor Policies and will
attempt to notify an Owner on a timely basis if his or her Policy is in
jeopardy of becoming a modified endowment contract. For further discussion of
the tax status of a Policy and the tax consequences of being treated as a life
insurance contract or a modified endowment contract, see page 26.
FREE LOOK RIGHT TO CANCEL AND CONVERSION RIGHT. For a limited time after the
Policy is issued, you have the right to cancel your Policy and receive a full
refund of the initial premium paid. See "Free Look Right to Cancel Policy,"
page 11. Until the end of this limited period, Net Premiums paid will be
invested in the Subaccount investing in the Penn Series Money Market Fund. (See
"Net Premium Allocations," page 12.) At any time within the first 24 Policy
Months, you may transfer all funds held in the Separate Account to the Fixed
Account, and thereby convert your Policy to a fixed-benefit (non-variable)
policy. See "Right to Convert to a Fixed Benefit Policy," page 25.
OWNER INQUIRIES. If you have any questions, you may write to us (The Penn
Mutual Life Insurance Company, Philadelphia, PA 19172) or call us (1-800-523-
0650).
5
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DIAGRAM OF POLICY
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PREMIUM PAYMENTS
. You select a payment plan but are not
required to pay premiums according to
the plan. You can vary the amount and
frequency and can skip planned premiums.
See page 15 for rules and limits.
. Minimum initial premium and planned
premium depend on the Insureds' age, sex
and underwriting class, Specified Amount
selected, and any supplemental riders.
See Appendix A for sample minimum
initial premiums.
. Unplanned premiums may be made, within
limits. See page 11.
. Under certain circumstances, extra
premiums may be required to prevent
lapse. See page 12.
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DEDUCTIONS FROM PREMIUMS
. For sales load (5.0% of premiums; the Company's
current intention is to reduce this charge to 3.0%
of premiums paid after the first 15 Policy Years).
. For state premium tax (2.5% of premiums). See page
15.
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NET PREMIUMS
. You direct the allocation of Net Premiums among 14 Subaccounts of the
Separate Account and the Fixed Account (the "Accounts"). See page 12 for
rules and limits on Net Premium allocations.
. The Subaccounts invest in corresponding portfolios ("Funds") of Penn
Series Funds, Inc. ("Penn Series"), Neuberger & Berman Advisers
Management Trust ("AMT"), American Century Variable Portfolios, Inc.
("American Century Variable Portfolios"), Variable Insurance Products
Fund ("VIP Fund") , Variable Insurance Products Fund II ("VIP Fund II")
and Morgan Stanley Universal Funds, Inc. ("Morgan Stanley"). See page 8.
Funds available are:
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Penn Series -- Growth Equity Fund AMT -- Limited Maturity Bond
Penn Series -- Value Equity Fund Portfolio
Penn Series -- Small Capitalization AMT -- Balanced Portfolio
Fund AMT -- Partners Portfolio
Penn Series -- Emerging Growth Fund American Century Variable
Penn Series -- Flexibly Managed Fund Portfolio--Capital Appreciation
Penn Series -- International Equity VIP Fund -- Equity-Income
Fund Portfolio
Penn Series -- Quality Bond Fund VIP Fund -- Growth Portfolio
Penn Series -- High Yield Bond Fund VIP Fund II -- Asset Manager
Penn Series -- Money Market Fund Portfolio
VIP Fund II -- Index 500 Portfolio
Morgan Stanley -- Emerging Markets
Equity (International) Portfolio
</TABLE>
. Interest is credited on amounts allocated to the Fixed Account at a
minimum guaranteed rate of 4%. See page 14 for rules and limits on Fixed
Account allocations.
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DEDUCTIONS FROM ASSETS
. Monthly Deduction for cost of insurance, administrative expenses, and
charges for any supplemental benefits. Administrative expenses are
currently $15.00 per month the first Policy Year, $5.00 per month
thereafter, plus for the first 12 months after the Policy Date, a charge
calculated as $.20 for each $1,000 of the Initial Specified Amount. See
page 16.
. Daily charge at an annual rate of 0.90% (currently declining to 0.60%
after the first 15 Policy Years) from the Subaccounts for mortality and
expense risks. See page 15. This charge is not deducted from Fixed
Account Value.
. Investment advisory fees and other fund expenses are deducted from the
assets of each Fund. See page 18.
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6
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POLICY VALUE
. Is the amount in the Subaccounts and the Fixed Account credited to your
Policy. It is equal to Net Premiums, as adjusted each Valuation Date to
reflect Subaccount investment experience, interest credited on Fixed
Account Value, charges deducted and other policy transactions (such as
transfers and partial surrenders). See pages 17 and 18.
. Varies from day to day. There is no minimum guaranteed Policy Value. The
Policy may lapse if the Net Cash Surrender Value is insufficient to
cover the Monthly Deduction then due. See page 18.
. Policy Value can be transferred among the Accounts. See page 13 for
rules and limits. Policy loans reduce the amount available for
allocations and transfers.
. Dollar cost averaging and asset rebalancing programs are available. See
page 13.
. Policy Value is the starting point for calculating certain values under
a Policy, such as the Cash Surrender Value, Net Cash Surrender Value,
Net Policy Value and the Basic Death Benefit used to determine benefits.
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CASH BENEFITS DEATH BENEFITS
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. Loans may be taken for . Available as lump sum or
amounts up to 90% of Cash under a variety of payment
Surrender Value, at a net options.
interest rate of 1.0%, . Minimum Basic Death Benefit
currently declining to 0.25% ("Specified Amount") of
after the first 10 Policy $200,000.
Years. See page 20 for rules
and limits.
. Two Specified Amount options
available: Option 1 (which
. Partial surrenders generally provides a level Basic Death
can be made up to four times Benefit equal to the
a Policy Year provided there Specified Amount) and Option
is sufficient remaining Net 2 (which is the Specified
Cash Surrender Value. An Amount plus Policy Value and
administrative charge of the thereby provides a
lesser of $25 or 2% of the potentially increasing Basic
surrender amount requested Death Benefit). See page 19.
will apply. See page 21 for
rules and limits.
. Income tax free to Beneficiary.
. The Policy may be
surrendered in full at any . Flexibility to change
time for its Net Cash Specified Amount option and
Surrender Value. A declining decrease Specified Amount.
sales load charge of up to See page 20 for rules and
25% of the Surrender Charge limits.
Premium (an amount calculated
separately for each Policy) . Supplemental benefits
as well as a declining available by rider. See page
administrative charge will 26.
apply to a full surrender
made during the first 16
Policy Years. See page 21.
See Appendix D for special
rules for Policies issued to
New York residents.
. Payment options available.
See page 22.
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7
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GENERAL INFORMATION ABOUT PENN MUTUAL, THE SEPARATE ACCOUNT AND THE FUNDS
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THE PENN MUTUAL LIFE INSURANCE COMPANY
Penn Mutual is a Pennsylvania mutual life insurance company. We were
chartered in 1847 and have been continuously engaged in the life insurance
business since that date. We are authorized to sell insurance in all 50 states
and the District of Columbia. Our corporate headquarters are located at The
Penn Mutual Life Insurance Company, Philadelphia, Pennsylvania, 19172, and our
operations offices are located at 600 Dresher Road, Horsham, Pennsylvania,
19044.
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PENN MUTUAL VARIABLE LIFE ACCOUNT I
We established Penn Mutual Variable Life Account I (the "Separate Account")
as a separate investment account under Pennsylvania law on January 27, 1987. It
is used to support the Policies as well as other variable life insurance
policies, and for other purposes permitted by law. The Separate Account is
registered with the Securities and Exchange Commission (the "SEC") as a unit
investment trust under the Investment Company Act of 1940 (the "1940 Act") and
qualifies as a "separate account" within the meaning of the federal securities
laws. We have established other separate investment accounts, of which Penn
Mutual Variable Life Account I is registered with the SEC.
We own the assets in the Separate Account. The Separate Account is divided
into Subaccounts. The Subaccounts available under the Policies invest in shares
of a specific Fund of Penn Series Funds, Inc. ("Penn Series"), Neuberger &
Berman Advisers Management Trust ("AMT"), American Century Variable Portfolios,
Inc. ("American Century Variable Portfolios") (formerly TCI Portfolios, Inc.),
Variable Insurance Products Fund ("VIP Fund"), Variable Insurance Products Fund
II ("VIP Fund II") and Morgan Stanley Universal Funds, Inc. ("Morgan Stanley").
The Separate Account includes other Subaccounts which are not available under
the Policy and are not otherwise discussed in this prospectus.
Income, gains and losses, realized or unrealized, of a Subaccount are
credited to or charged against the Subaccount without regard to any other
income, gains or losses of Penn Mutual. Assets equal to the reserves and other
contract liabilities with respect to each Subaccount are not chargeable with
liabilities arising out of any other business or account of Penn Mutual. If the
assets exceed the required reserves and other liabilities, we may transfer the
excess to our general account. We are obligated to pay all benefits provided
under the Policies.
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THE FUNDS
Penn Series, AMT, American Century Variable Portfolios, VIP Fund, VIP Fund II
and Morgan Stanley are each registered with the SEC as a diversified open-end
management investment company under the 1940 Act. Each is a series-type mutual
fund made up of different series or funds ("Funds").
The investment objectives of each of the Funds in which Subaccounts invest is
set forth below. There is, of course, no assurance that these objectives will
be met.
PENN SERIES - GROWTH EQUITY FUND - seeks long-term growth of capital and
increase of future income by investing primarily in common stocks of well-
established growth companies.
PENN SERIES - VALUE EQUITY FUND - seeks to maximize total return (capital
appreciation and income) primarily by investing in equity securities of
companies believed to be undervalued considering such factors as assets,
earnings, growth potential and cash flows.
PENN SERIES - SMALL CAPITALIZATION FUND - seeks capital appreciation through
investment in a diversified portfolio of securities consisting primarily of
equity securities of companies with market capitalization of under $1 billion.
PENN SERIES - EMERGING GROWTH FUND - seeks capital appreciation by investing
primarily in common stocks of emerging growth companies with above-average
growth prospects.
PENN SERIES - FLEXIBLY MANAGED FUND - seeks to maximize total return (capital
appreciation and income) by investing in common stocks, other equity
securities, corporate debt securities, and/or short-term reserves, in
proportions considered appropriate in light of the availability of attractively
valued individual securities and current and expected economic and market
conditions.
PENN SERIES - INTERNATIONAL EQUITY FUND - seeks to maximize capital
appreciation by investing in a carefully selected diversified portfolio
consisting primarily of equity securities. The investments will consist
principally of equity securities of European and Pacific Basin countries.
8
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PENN SERIES - QUALITY BOND FUND - seeks the highest income over the long term
consistent with the preservation of principal by investing primarily in
marketable investment-grade debt securities.
PENN SERIES - HIGH YIELD BOND FUND - seeks high current income by investing
primarily in a diversified portfolio of long term high-yield fixed income
securities in the medium to lower quality ranges; capital appreciation is a
secondary objective; such securities, which are commonly referred to as "junk"
bonds, generally involve greater risks of loss of income and principal than
higher rated securities.
PENN SERIES - MONEY MARKET FUND - seeks to preserve capital, maintain
liquidity and achieve the highest possible level of current income consistent
therewith, by investing in high quality money market instruments; an investment
in the Fund is neither insured nor guaranteed by the U.S. Government and there
can be no assurance that the Fund will be able to maintain a stable net asset
value of $1.00 per share.
AMT - LIMITED MATURITY BOND PORTFOLIO - seeks the highest current income
consistent with low risk to principal and liquidity; as a secondary objective,
seeks to enhance its total return through capital appreciation when market
factors, such as falling interest rates and rising bond prices, indicate that
capital appreciation may be available without significant risk to principal;
investments are made by investing net investable assets in a series of Advisers
Managers Trust (a diversified open-end management investment company) with
identical investment objective, policies and limitations; the underlying series
pursues objectives primarily by investing in a diversified portfolio of limited
maturity debt securities.
AMT - BALANCED PORTFOLIO - seeks long-term capital growth and reasonable
current income without undue risk to principal through investment in common
stocks and debt securities; investments are made by investing net investable
assets in a series of Advisers Managers Trust (a diversified open-end
management investment company) with identical investment objective, policies
and limitations; as to the underlying series, it is anticipated that normally
60% of total assets will be invested in common stocks and remaining assets will
be invested in debt securities; at least 25% of the Series' assets will be
invested in fixed income senior securities.
AMT - PARTNERS PORTFOLIO - seeks capital growth by investing primarily in
common stocks of established companies, using the value oriented investment
approach. Neuberger & Berman reserves the right to make changes in the
investment objectives, but will notify shareholders thirty days in advance of
any proposed material change.
AMERICAN CENTURY VARIABLE PORTFOLIOS - CAPITAL APPRECIATION PORTFOLIO
(FORMERLY GROWTH PORTFOLIO) - seeks capital growth by investing in common
stocks (including securities convertible into common stocks) and other
securities that meet certain fundamental and technical standards of selection
and, in the opinion of the Fund's management, have better than average
potential for appreciation; the Fund intends to stay fully invested in such
securities.
VIP FUND - EQUITY-INCOME PORTFOLIO - seeks reasonable income by investing
primarily in income-producing equity securities; in choosing these securities,
the Fund will also consider the potential for capital appreciation; the Fund's
goal is to achieve a yield which exceeds the composite yield on the securities
comprising the Standard & Poor's 500 Composite Stock Price Index.
VIP FUND - GROWTH PORTFOLIO - seeks to achieve capital appreciation; the Fund
normally purchases common stocks, although its investments are not restricted
to any one type of security; capital appreciation may also be found in other
types of securities, including bonds and preferred stocks.
VIP FUND II - ASSET MANAGER PORTFOLIO - seeks high total return with reduced
risk over the long-term by allocating its assets among domestic and foreign
stocks, bonds and short-term fixed-income instruments.
VIP FUND II - INDEX 500 PORTFOLIO - seeks to match the total return of the
S&P 500 while keeping expenses low. The S&P 500 is an index of 500 common
stocks, most of which trade on the New York Stock Exchange.
MORGAN STANLEY UNIVERSAL FUNDS, INC. - EMERGING MARKETS EQUITY
(INTERNATIONAL) PORTFOLIO - seeks long term capital appreciation by investing
primarily in equity securities of emerging market countries issuers. The
Portfolio will focus on economies which are developing strongly and in which
the markets are becoming more sophisticated.
Each Fund sells and redeems its shares at net asset value without any sales
charge. Any dividend from net investment income or distribution from realized
gains from security transactions of a Fund is reinvested at net asset value in
shares of the same Fund.
INDEPENDENCE CAPITAL MANAGEMENT, INC. ("Independence Capital Management"), of
Horsham, Pennsylvania, serves as investment adviser to the Penn Series Growth
Equity, Emerging Growth, Quality Bond and Money Market Funds.
T. ROWE PRICE ASSOCIATES, INC. ("Price Associates"), of Baltimore, Maryland,
serves as investment adviser to the Penn Series Flexibly Managed Fund and Penn
Series High Yield Bond Fund.
9
<PAGE>
OPCAP ADVISORS ("OpCap") (formerly Quest for Value Advisors), of New York,
New York, serves as investment adviser to the Penn Series Value Equity Fund and
the Penn Series Small Capitalization Fund.
VONTOBEL USA INC. ("Vontobel"), of New York, New York, is the investment
adviser to the Penn Series International Equity Fund.
ROBERTSON STEPHENS INVESTMENT MANAGEMENT INC., San Francisco, California, is
investment sub-adviser to the Penn Series Emerging Growth Fund.
NEUBERGER & BERMAN MANAGEMENT INCORPORATED ("N&B Management"), of New York,
New York, is the investment adviser to each series of Advisers Managers Trust
underlying the AMT Limited Maturity Bond Portfolio, the AMT Balanced Portfolio
and the AMT Partner Portfolio.
AMERICAN CENTURY INVESTMENT MANAGEMENT, INC. ("American Century"), of Kansas
City, Missouri, is the investment adviser to American Century Variable
Portfolios Capital Appreciation Portfolio.
FIDELITY MANAGEMENT & RESEARCH CORPORATION ("FMR"), of Boston, Massachusetts,
is the investment adviser to VIP Fund's Equity Income Portfolio and Growth
Portfolio and VIP Fund II's Asset Manager Portfolio and Index 500 Portfolio.
FMR utilizes the services of two subsidiaries on a sub-advisory basis for
foreign securities investments for the Asset Manager Portfolio. These
subsidiaries are Fidelity Management & Research (U.K.) Inc. and Fidelity
Management & Research (Far East) Inc.
MORGAN STANLEY ASSET MANAGEMENT INC. ("Morgan Stanley"), of New York, New
York, is the investment adviser to Morgan Stanley Universal Funds' Emerging
Markets Equity (International) Portfolio.
Further information about the Funds is contained in the accompanying
prospectuses, which you should read in conjunction with this prospectus.
We have entered into agreements with Penn Series, AMT, American Century
Variable Portfolios, VIP Fund, VIP Fund II and Morgan Stanley governing the
Separate Account's investment in those Funds. Under the agreement with American
Century Variable Portfolios, the adviser to the American Century Variable
Portfolios compensates Penn Mutual for certain administrative services provided
by Penn Mutual.
The shares of Penn Series, AMT, American Century Variable Portfolios, VIP
Fund, VIP Fund II and Morgan Stanley are sold not only to the Separate Account,
but to other separate accounts of Penn Mutual that fund benefits under variable
annuity policies. The shares of AMT, American Century Variable Portfolios, VIP
Fund, VIP Fund II and Morgan Stanley are also sold to separate accounts of
other insurance companies and, in the case of AMT, also directly to qualified
pension and retirement plans. It is conceivable that in the future it may
become disadvantageous for both variable life and variable annuity policy
separate accounts (and also qualified pension and retirement plans with respect
to AMT) to invest in the same underlying mutual fund. Although neither we nor
Penn Series, AMT, American Century Variable Portfolios, VIP Fund, VIP Fund II
or Morgan Stanley currently perceives or anticipates any such disadvantage, the
Boards of Directors of Penn Series, American Century Variable Portfolios and
Morgan Stanley, respectively, and the Boards of Trustees of AMT, VIP Fund and
VIP Fund II, respectively, will monitor events to determine whether any
material conflict between variable annuity policyowners and variable life
policyowners (and also qualified pension and retirement plans with respect to
AMT) arises.
Material conflicts could result from such things as: (1) changes in state
insurance laws; (2) changes in federal income tax law; (3) changes in the
investment management of any Fund or of Penn Series, AMT, American Century
Variable Portfolios, VIP Fund or VIP Fund II, respectively; or (4) differences
between voting instructions given by variable annuity policyowners and those
given by variable life policyowners. In the event of a material irreconcilable
conflict, we will take the steps necessary to protect our variable annuity and
variable life policyowners. This could include discontinuance of investment in
a Fund.
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SUBSTITUTION OF SECURITIES
If investment in a Subaccount should no longer be possible or, if in our
judgment, becomes inappropriate to the purposes of the Policies, or, if in our
judgment, investment in another subaccount or insurance company separate
account is in the interest of Owners, we may substitute another subaccount or
insurance company separate account. No substitution may take place without
notice to Owners and prior approval of the SEC and insurance regulatory
authorities, to the extent required by the 1940 Act and applicable law.
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VOTING RIGHTS
We are the legal owner of shares held by the Subaccounts and as such have the
right to vote on all matters submitted to shareholders of the Funds. However,
as required by law, we will vote shares held in the Subaccounts at regular and
special meetings of shareholders of the Funds in accordance with instructions
received from Owners with Policy Value in the Subaccounts. Should the
applicable federal securities laws, regulations or interpretations thereof
change so as to permit us to vote shares of the Funds in our own right, we may
elect to do so.
10
<PAGE>
To obtain voting instructions from Owners, before a meeting we will send
Owners voting instruction material, a voting instruction form and any other
related material. The number of shares held by each Subaccount for which an
Owner may give voting instructions is currently determined by dividing the
portion of the Owner's Policy Value in the Subaccount by the net asset value of
one share of the applicable Fund. Fractional votes will be counted. The number
of votes for which an Owner may give instructions will be determined as of a
date chosen by Penn Mutual but not more than 90 days prior to the meeting of
shareholders. Shares held by a Subaccount for which no timely instructions are
received will be voted by Penn Mutual in the same proportion as those shares
for which voting instructions are received.
We may, if required by state insurance officials, disregard Owner voting
instructions if such instructions would require shares to be voted so as to
cause a change in sub-classification or investment objectives of one or more of
the Funds, or to approve or disapprove an investment advisory agreement. In
addition, we may under certain circumstances disregard voting instructions that
would require changes in the investment policy or investment adviser of one or
more of the Funds, provided that we reasonably disapprove of such changes in
accordance with applicable federal regulations. If we ever disregard voting
instructions, we will advise Owners of that action and of our reasons for such
action in the next semiannual report. Finally, we reserve the right to modify
the manner in which we calculate the weight to be given to pass-through voting
instructions where such a change is necessary to comply with current federal
regulations or the current interpretation thereof.
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PREMIUMS AND ALLOCATIONS
- --------------------------------------------------------------------------------
APPLYING FOR A POLICY
If you want to purchase a Policy, you must complete an application and submit
it to one of our authorized agents. You also must pay an initial premium at
least equal to the minimum required. See "Premiums," below. Policy coverage
will not become effective until the initial premium in good order is received
at our Office.
We require satisfactory evidence of the insurability of both Insureds, which
may include a medical examination of each or one of the Insureds. Generally, we
will issue a Policy covering two proposed Insureds if neither is less than 20
years old nor more than 80 years old, and if there is no more than 30 years
difference in their ages, provided that evidence of insurability satisfies our
underwriting rules. Acceptance of an application depends on our underwriting
rules, and we reserve the right to reject an application for any reason.
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FREE LOOK RIGHT TO CANCEL POLICY
You may cancel your Policy for a refund of premium during your "free-look"
period. This period expires 10 days after you receive your Policy, 45 days
after your application is signed, or 10 days after we mail or deliver a Notice
of Right of Withdrawal, whichever is latest. If you decide to cancel the
Policy, you must return it by mail or delivery to us or to our authorized agent
who sold it. Immediately after mailing or delivery, the Policy will be deemed
void from the beginning. We will refund premiums paid within seven days after
we receive the Policy.
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PREMIUMS
The minimum initial premium required depends on a number of factors, such as
the ages, sexes and rate classes of the proposed Insureds, the desired
Specified Amount, any supplemental benefits and the planned premiums you
propose to make. The initial premium must be at least equal to two No-Lapse
Premiums. See "Planned Premiums," below. Sample minimum initial premiums are
shown in Appendix A.
Additional premiums may be paid in any amount and at any time, subject to the
following limits. First, a premium must be at least $25 and must be sent to our
Office. We may require satisfactory evidence of insurability before accepting
any premium which results in an increase in the net amount at risk (defined on
page 16).
Second, we reserve the right to limit total premiums paid in a Policy Year to
the planned premiums selected (see "Planned Premiums," below). We will refund
any portion of any premium which is determined to be in excess of the premium
limit established by law to qualify a Policy as a policy for life insurance.
(The amount refunded will be the excess premium plus any gain attributable to
the excess premium.) In addition, we will monitor Policies and will attempt to
notify the Owner on a timely basis if his or her Policy is in jeopardy of
becoming a modified endowment contract under the Internal Revenue Code. See
"Tax Considerations," page 26.
Lastly, no premium will be accepted after the Maturity Date.
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<PAGE>
PLANNED PREMIUMS. When applying for a Policy, you select a plan for paying
level premiums at specified intervals, e.g., monthly, semi-annually or
annually, until the Maturity Date. You are not required to pay premiums in
accordance with this plan; rather, you can pay more or less than planned or
skip a planned premium entirely. You can change the amount and frequency of
planned premiums whenever you want by sending written notice to our Office.
However, we reserve the right to limit the amount of a premium or the total
premiums paid, as discussed above. We will send you reminder notices for
planned premiums, unless you have arranged to pay planned premiums by pre-
authorized check.
FIVE-YEAR GUARANTEE. We guarantee that a Policy will remain in force during
the first five Policy Years, regardless of the sufficiency of the Net Cash
Surrender Value, if the total premiums paid less any partial surrenders is
greater than or equal to the amount determined by multiplying the No-Lapse
Premium for the Policy by the number of months the Policy has been in force.
The No-Lapse Premium is a benchmark monthly premium calculated for each Policy
based on the ages, sexes and rate class of the Insureds, the requested
Specified Amount and any supplemental benefits. The No-Lapse Premium for your
Policy generally will be less than the monthly amount of planned premiums you
select to pay. The Five-Year guarantee will not apply if the Net Cash Surrender
Value becomes insufficient because of excessive Indebtedness. See "Loan
Repayment; Effect if Not Repaid," page 21.
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PREMIUMS TO PREVENT LAPSE
Failure to pay planned premiums will not necessarily cause a Policy to lapse.
Conversely, paying all planned premiums will not necessarily guarantee that a
Policy will not lapse (except when the Five-Year Guarantee is in effect).
Rather, whether a Policy lapses depends on whether its Net Cash Surrender Value
is insufficient to cover the Monthly Deduction (see page 16) when due.
If the Net Cash Surrender Value on a Monthly Anniversary is less than the
amount of the Monthly Deduction to be deducted on that date and the Five-Year
Guarantee is not in effect, the Policy will be in default and a grace period
will begin. This could happen if investment experience has been sufficiently
unfavorable that it has resulted in a decrease in the Net Cash Surrender Value
or the Net Cash Surrender Value has decreased because insufficient premiums
have been paid to offset the Monthly Deduction.
GRACE PERIOD. If your Policy goes into default, you will be allowed a 61-day
grace period to pay a premium sufficient to cover the Monthly Deduction. We
will send notice of the amount required to be paid during the grace period
("grace period premium") to your last known address and to any assignee of
record. The grace period will begin when the notice is sent. Your Policy will
remain in effect during the grace period. If the last surviving Insured (or
both Insureds) should die during the grace period before the grace period
premium is paid, the Death Benefit will still be payable to the Beneficiary,
although the amount paid will reflect a reduction for the Monthly Deductions
due on or before the date of the last surviving Insured's death. See "Amount of
Death Benefit," page 19. If the grace period premium has not been paid before
the grace period ends, your Policy will lapse. It will have no value and no
benefits will be payable. See "Reinstatement," page 26.
A grace period also may begin if Indebtedness becomes excessive. See "Loan
Repayment; Effect if not Repaid," page 21.
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NET PREMIUM ALLOCATIONS
In the application, you specify the percentage of a Net Premium to be
allocated to each Subaccount and the Fixed Account. The sum of your allocations
must equal 100% and each allocation percentage must be a whole number. However,
until the free look period expires, all Net Premiums received are invested in
the Subaccount investing in the Penn Series Money Market Fund (the "Money
Market Subaccount"). At the end of this period (which for this purpose is
assumed to begin 3 days after we issue your Policy), the Policy Value in the
Money Market Subaccount is transferred to and allocated to the Accounts based
on the premium allocation percentages in the application. See "Determining the
Policy Value," page 18.
The Net Premium allocation percentages specified in the application will
apply to subsequent premiums until you change them. You can change the
allocation percentages at any time, provided they equal 100% and each is a
whole number, by sending written notice to our Office. The change will apply to
all premiums received with or after our receipt of your notice.
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CREDITING PREMIUMS
The initial Net Premium will be credited to the Policy as of the Policy Date,
or as of the Valuation Date the first premium is received at our office if
later. A planned premium or unplanned premium not requiring additional
underwriting will be credited to the Policy and the resulting Net Premium will
be invested as requested on the Valuation Date the premium was
12
<PAGE>
received by our Office. However, any premium requiring additional underwriting
will be allocated to the Money Market Subaccount until underwriting has been
completed and the premium has been accepted. When accepted, the Policy Value in
the Money Market Subaccount attributable to the resulting Net Premium will be
credited to the Policy and allocated to the Subaccounts and Fixed Account as
requested. If an additional premium is rejected, we will return the premium,
without any adjustment for investment experience.
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TRANSFERS
You may transfer Policy Value among the Subaccounts and Fixed Account subject
to the following rules, some of which depend on whether Policy Value is to be
transferred from a Subaccount or the Fixed Account. You may request transfers
by calling our Office if you have applied for telephone transfer authorization.
Otherwise, transfer requests must be in writing. The Company will not be liable
for following transfer instructions communicated by telephone that we
reasonably believe to be genuine. We require certain identifying information to
process a telephone transfer.
Transfers may not be requested until the end of the free-look period (see
page 11). A transfer will take effect on the date the request is received at
our Office. We may, however, defer transfers under the same conditions that we
may delay payment of proceeds. See "When Proceeds are Paid," page 25. There is
no limit on the number of transfers that may be made. However, after 12
transfers have been made during a Policy Year, we reserve the right to impose a
$10 transfer charge on subsequent transfers. No transfer charge will be made if
the Specified Amount exceeds $4,999,999. See "Transfer Charge," page 17.
SUBACCOUNT TRANSFER RULES. Transfers among Subaccounts and from
Subaccounts to the Fixed Account may be made at any time. The minimum
amount of Policy Value that may be transferred from a Subaccount is $250
or, if less, the full amount held in the Subaccount. If less than the full
amount of Policy Value in a Subaccount is being transferred from the
Subaccount, the amount remaining must be at least $250.
FIXED ACCOUNT TRANSFER RULES. Policy Value held in the Fixed Account may
be transferred to a Subaccount or Subaccounts only during the 30-day period
following the end of each Policy Year. The amount transferred must be at
least $250, or if less, the Policy Value held in the Fixed Account. If the
amount transferred is less than the Policy Value then held in the Fixed
Account, at least $250 must remain in the Fixed Account. See "Deductions,
Surrenders and Transfers from the Fixed Account," page 15, for additional
rules and limits for the Fixed Account.
The transfer rules described above do not apply to transfers made under a
dollar cost averaging or asset rebalancing program.
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DOLLAR COST AVERAGING PROGRAM
You may elect a dollar cost averaging program for the allocation of your
Policy Value among the Subaccounts and the Fixed Account ("accounts"). A dollar
cost averaging program allows you to authorize in advance monthly transfers of
set dollar amounts from the Money Market Subaccount to one or more other
accounts.
The main objective of dollar cost averaging is to shield investments from
short term price fluctuations. Since the same dollar amount is transferred to
selected accounts each month, more accumulation units are purchased in a
Subaccount when their value is low, and fewer accumulation units are purchased
when their value is high. As a result, a lower than average cost of purchasing
accumulation units may be achieved over the long term. This plan of investing
allows Owners to take advantage of investment fluctuations, but does not assure
a profit or protect against a loss in declining markets.
SELECTING DOLLAR COST AVERAGING. You may select a dollar cost averaging
program when you apply for the Policy or at a later date by contacting our Home
Office. You specify the accounts to which amounts will be transferred and the
percentage to be allocated to each Account. To begin a program, the planned
premium for that year must be $600 and the amount to be transferred each month
must be at least $50.
OPERATION OF THE PROGRAM. Transfers will be made on the 15th of each month.
Transfers will continue until the earliest of the following:
. We receive a written or telephone request to stop making transfers.
. There no longer is sufficient Policy Value in the Money Market Subaccount
to make the specified transfer.
. The Policy is in a grace period.
. We receive notice that the last surviving Insured has died.
Transfers under a dollar cost averaging program are not counted for purposes
of the transfer rules discussed above.
13
<PAGE>
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ASSET REBALANCING
You may elect an asset rebalancing program for your Policy Value. Policy
Value allocated to the accounts can be expected to increase or decrease at
different rates. An asset rebalancing program automatically reallocates your
Policy Value among the accounts each quarter to return the allocation to the
original allocation percentages you specify. Asset rebalancing is intended to
transfer Policy Value from those accounts that have increased in value to those
that have declined, or not increased as much, in value. Over time, this method
of investing may help an Owner "buy low and sell high," although there can be
no assurance that this objective will be achieved. Asset rebalancing does not
guarantee profits, nor does it assure that an Owner will not have losses.
SELECTING ASSET REBALANCING. You may select an asset rebalancing program when
you apply for the Policy or at a later date by contacting our Home Office. You
specify the accounts to be included in the program, and the percentage of
Policy Value to be allocated to each specified account. Each allocation
percentage must be a whole number. You can elect to have your entire Policy
Value rebalanced among the specified accounts each quarter, or limit the
program to the Policy Value in specified accounts on each rebalancing date
(e.g., to restore a 60/40 ratio for Policy Value in the Value Equity Subaccount
and Quality Bond Subaccount on each rebalancing date). The minimum Policy Value
to start an asset rebalancing program is $1,000. If a dollar cost averaging
program is in effect, Policy Value in the Money Market Subaccount may not be
included in an asset rebalancing program.
OPERATION OF THE PROGRAM. Effective on the last day of each calendar quarter,
we will transfer Policy Value among the accounts to the extent necessary to
return the allocation to your specifications. Asset rebalancing will continue
until we receive a written or telephone request at our Home Office to
terminate.
Transfers made under an asset rebalancing program are not counted for
purposes of the transfer rules described above.
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FIXED ACCOUNT
BECAUSE OF EXEMPTIVE AND EXCLUSIONARY PROVISIONS, INTERESTS IN THE FIXED
ACCOUNT HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 NOR HAS THE
FIXED ACCOUNT BEEN REGISTERED AS AN INVESTMENT COMPANY UNDER THE INVESTMENT
COMPANY ACT OF 1940. ACCORDINGLY, NEITHER THE FIXED ACCOUNT NOR ANY INTERESTS
THEREIN ARE SUBJECT TO THE PROVISIONS OF THESE ACTS AND, AS A RESULT, THE STAFF
OF THE SECURITIES AND EXCHANGE COMMISSION HAS NOT REVIEWED THE DISCLOSURE IN
THIS PROSPECTUS RELATING TO THE FIXED ACCOUNT. THE DISCLOSURE REGARDING THE
FIXED ACCOUNT MAY, HOWEVER, BE SUBJECT TO CERTAIN GENERALLY APPLICABLE
PROVISIONS OF THE FEDERAL SECURITIES LAWS RELATING TO THE ACCURACY AND
COMPLETENESS OF STATEMENTS MADE IN PROSPECTUSES.
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FIXED ACCOUNT
The Fixed Account consists of assets owned by Penn Mutual with respect to the
Policies, other than those held in the Separate Account. It is part of our
general account assets. Our general account assets are used to support our
insurance and annuity obligations other than those funded by separate accounts.
Subject to applicable law, we have sole discretion over the investment of the
assets of the Fixed Account. The Policy Loan Account is part of the Fixed
Account.
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INTEREST CREDITED ON POLICY VALUE IN THE FIXED ACCOUNT
Net Premiums allocated to the Fixed Account and Policy Value transferred from
the Subaccounts to the Fixed Account are credited to the Fixed Account Value.
The Fixed Account Value also includes the portion of Policy Value transferred
to the Policy Loan Account as collateral for policy loans. We will credit
interest on these amounts at rates we determine in our sole discretion, but in
no event will interest credited on these amounts be less than an effective rate
of at least 4% per year, compounded annually.
However, if at the time of an allocation or transfer to the Fixed Account, we
are crediting a rate of interest higher than 4%, the higher rate will apply to
the amount from the date of its allocation or transfer to the Fixed Account
through to the end of the twelve-month period beginning on the first day of the
calendar month in which the allocation or transfer was made. If a higher rate
of interest is credited, different rates of interest may apply to amounts
allocated or transferred at different times, and different rates of interest
may apply to amounts held in a Policy Loan Account than to the remaining
portion of Policy Value
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<PAGE>
held in the Fixed Account. ANY INTEREST CREDITED ON POLICY VALUE IN THE FIXED
ACCOUNT IN EXCESS OF THE GUARANTEED MINIMUM RATE OF 4% PER YEAR WILL BE
DETERMINED IN OUR SOLE DISCRETION.
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CALCULATING FIXED ACCOUNT VALUE
The Fixed Account Value is calculated daily. See "Fixed Account Value," page
18.
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DEDUCTIONS, SURRENDERS AND TRANSFERS FROM THE FIXED ACCOUNT
Amounts allocated to the Fixed Account at different times, whether from Net
Premiums or transfers, may be credited with different rates of interest.
Whenever a charge is deducted from Policy Value in the Fixed Account, or an
amount is withdrawn from the Policy Value in the Fixed Account to satisfy a
partial surrender, transfer or policy loan request, the charge or withdrawal
will be taken first from the amount most recently allocated to the Fixed
Account, then the amount next most recently allocated, and so forth. See page
13 for limits and restrictions on transfers of Policy Value from the Fixed
Account.
If there is any Policy Value in the Policy Loan Account, it is not available
for transfers, partial surrenders or policy loans, nor are any charges deducted
from this portion of Policy Value. Amounts are transferred to or from the
Policy Loan Account only when policy loans are taken or repayments made. If an
amount is transferred from the Policy Loan Account to the remaining portion of
the Fixed Account Value, it will be treated as a new allocation to the Fixed
Account and will be credited with interest at the rate then in effect for Fixed
Account allocations. See "Policy Loan Account," page 21.
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PAYMENTS FROM THE FIXED ACCOUNT
We may defer payment of proceeds from the Fixed Account for a partial
surrender, full surrender or policy loan request for up to six months from the
date we receive the written request. However, we will not defer payment of a
partial surrender or policy loan requested to pay a premium due on a Penn
Mutual policy. If a payment from the Fixed Account is deferred for 30 days or
more, it will bear interest at a rate of 3% per year compounded annually while
it is deferred.
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CHARGES AND DEDUCTIONS
- --------------------------------------------------------------------------------
PREMIUM CHARGE
We deduct a charge from each premium. This charge is 7.5% of premiums and is
deducted from a premium before allocating the resulting Net Premium to the
Policy Value. It consists of a 2.5% charge for premium taxes, with the
remaining 5.0% a sales charge. An additional sales charge is deducted on
surrender of a Policy during the first 16 Policy Years. See "Surrender Charge,"
page 17.
The 2.5% premium tax charge reimburses us for state premium taxes associated
with the Policies. We expect to pay state premium taxes at an average rate for
all states of approximately 2.5% of premiums.
The 5.0% sales charge partially compensates us for the expenses of selling
and distributing the Policies, including paying sales commissions, printing
prospectuses, preparing sales literature and paying for other promotional
activities. We may reduce the sales charge portion of the premium charge, and
currently, the sales charge is reduced to 3.0% (corresponding to a total
premium charge of 5.5%) of premiums received after the first 15 Policy Years.
We will notify you before your fifteenth Policy Year if the sales charge on
your Policy will remain at 5.0% after your fifteenth Policy Year.
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DAILY MORTALITY AND EXPENSE RISK CHARGE
We deduct a daily charge from assets in the Subaccounts attributable to the
Policies. This charge does not apply to Fixed Account Value. The charge is at
an annual rate of 0.90% of assets. Currently, we reduce the charge to 0.60%
after the fifteenth Policy Year. We will notify you if we change our intention
to reduce the charge after the fifteenth Policy Year. We may realize a profit
from this charge.
The mortality risk we assume is that the Insureds on the Policies may die
sooner than anticipated and that therefore Penn Mutual will pay an aggregate
amount of death benefits greater than anticipated. The expense risk we assume
is that expenses
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<PAGE>
incurred in issuing and administering the Policies and the Separate Account
will exceed the amounts realized from the administrative charges assessed
against the Policies.
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MONTHLY DEDUCTION
On the Issue Date and each Monthly Anniversary, we deduct the Monthly
Deduction from the Policy Value. The amount deducted on the Issue Date is for
the number of policy months that have elapsed since the Policy Date. The
Monthly Deduction consists of (1) insurance charges ("Cost of Insurance
Charge"), (2) administrative charges (the "Monthly Expense Charge"), and (3)
any charges for additional benefits added by supplemental agreement to a Policy
("Supplemental Benefit Charges"), as described below. The Monthly Deduction is
deducted from the Subaccounts and the Fixed Account pro rata on the basis of
the portion of Policy Value in each account. See "Deductions, Surrenders and
Transfers from the Fixed Account," page 15, for applicable rules.
COST OF INSURANCE CHARGE. This charge compensates us for providing insurance
coverage. The charge depends on a number of variables and therefore will vary
from Policy to Policy and from Monthly Anniversary to Monthly Anniversary. For
any Policy the cost of insurance on a Monthly Anniversary is calculated by
multiplying (a) the base cost of insurance rate for the Insureds by (b) the net
amount at risk under the Policy for that Monthly Anniversary.
The net amount at risk for a Monthly Anniversary is the difference between
the Basic Death Benefit (see page 19) for a Policy (as adjusted to take into
account assumed monthly earnings at an annual rate of 4%) and the Policy Value,
as calculated on that Monthly Anniversary before the Monthly Deduction is
taken.
The base cost of insurance rate for a Policy is based on the Policy Year and
on the Attained Ages, sexes and rate class of the Insureds, and therefore
varies from time to time. We place the Insureds in a rate class when we issue
the Policy, based on our underwriting of the application. We currently place
Insureds in the following rate classes, based on our underwriting: a smoker or
nonsmoker standard rate class, a preferred underwriting class, or a rate class
involving a higher mortality risk (a "substandard class").
We guarantee that the cost of insurance rates used to calculate the monthly
cost of insurance charge will not exceed the maximum cost of insurance rates
set forth in the Policies. The guaranteed rates for standard classes are based
on the 1980 Commissioner's Standard Ordinary Mortality Tables, Age Nearest
Birthday ("1980 CSO Tables"). The guaranteed rates for substandard classes are
based on multiples or additives of the 1980 CSO Tables. Our current cost of
insurance rates may be less than the guaranteed rates. Our current cost of
insurance rates will be determined based on our expectations as to future
mortality, investment, expense and persistency experience, and may change from
time to time. Cost of insurance rates (whether guaranteed or current) for
Insureds in a nonsmoker standard class are lower than guaranteed rates for
Insureds of the same age and sex in a smoker standard class. Cost of insurance
rates (whether guaranteed or current) for Insureds in a nonsmoker or smoker
standard class are generally lower than guaranteed rates for Insureds of the
same age and sex and smoking status in a substandard class.
LEGAL CONSIDERATIONS RELATING TO SEX-DISTINCT PREMIUMS AND BENEFITS.
Mortality tables for the Policies generally distinguish between males and
females. Thus, premiums and benefits under Policies covering males and females
of the same age will generally differ. We do, however, also offer Policies
based on unisex mortality tables if required by state law. Employers and
employee organizations considering purchase of a Policy should consult their
legal advisors to determine whether purchase of a Policy based on sex-distinct
actuarial tables is consistent with Title VII of the Civil Rights Act of 1964
or other applicable law. Upon request, we may offer Policies with unisex
mortality tables to such prospective purchasers.
MONTHLY EXPENSE CHARGE. This charge compensates us for administrative
expenses associated with the Policies and the Separate Account. These expenses
relate to premium billing and collection, recordkeeping, processing of death
benefit claims, Policy loans and Policy changes, reporting and overhead costs,
processing applications and establishing Policy records. The Monthly Expense
Charge is the aggregate of the following:
. a flat charge of $15.00 per month (currently only $5.00 per month after
the first Policy Year; we will notify you before it is increased); and
. for the first 12 policy months after the Policy Date, a charge based on
the Initial Specified Amount ($0.20 per $1,000 of Initial Specified
Amount per month).
Except for the monthly charge (which is reduced after the first Policy Year
but may be later increased to $15.00), these charges are guaranteed not to
increase over the life of the Policy. We do not anticipate making any profit on
the Monthly Expense Charge.
SUPPLEMENTAL BENEFIT CHARGES. See "Supplemental Benefits," page 26.
16
<PAGE>
- --------------------------------------------------------------------------------
TRANSFER CHARGE
We reserve the right to impose a $10 transfer charge on any transfer of
Policy Value among the Subaccounts and/or Fixed Account in excess of the 12
free transfers permitted each Policy Year. We will notify you before imposing
the charge. No transfer charge will be made if the Specified Amount exceeds
$4,999,999. If the charge is imposed, it will be deducted from the amount
requested to be transferred before allocation to the new account(s). If an
amount is being transferred from more than one account, the transfer charge
will be deducted proportionately from the amount being transferred from each
account. This charge, if imposed, will reimburse us for administrative expenses
incurred in effecting transfers. We do not anticipate making any profit on this
charge.
- --------------------------------------------------------------------------------
SURRENDER CHARGE
If the Policy is surrendered during the first 16 Policy Years, we will deduct
a surrender charge in calculating the surrender proceeds payable. The surrender
charge consists of a sales charge component and administrative charge
component. The surrender charge is determined by the following formula:
the sum of (a) plus (b), multiplied by (c) where:
(a) = 25% of premiums paid on the Policy, up to the Surrender Charge
Premium (described below);
(b) = an administrative charge based on the Initial Specified Amount and
the younger Insured's Attained Age on the Policy Date (ranging from
$6 at Attained Age 20 to $14 at Attained Age 60 and over, per $1,000
of Initial Specified Amount--see Appendix B); and
(c) = the applicable surrender factor for the Policy Year during which the
surrender is made (see table below).
<TABLE>
<CAPTION>
SURRENDER FACTOR
SURRENDER DURING POLICY YEAR APPLIED TO (C) IN FORMULA
----------------------------------------------------------------------------
<S> <C>
1st through 7th 1.00
----------------------------------------------------------------------------
8th .90
----------------------------------------------------------------------------
9th .80
----------------------------------------------------------------------------
10th .70
----------------------------------------------------------------------------
11th .60
----------------------------------------------------------------------------
12th .50
----------------------------------------------------------------------------
13th .40
----------------------------------------------------------------------------
14th .30
----------------------------------------------------------------------------
15th .20
----------------------------------------------------------------------------
16th .10
----------------------------------------------------------------------------
17th and later 0
----------------------------------------------------------------------------
</TABLE>
Under this formula, the surrender charge declines by 10% each Policy Year
after the seventh, to $0 by the 17th Policy Year so that, after the 16th Policy
Year, there is no surrender charge. For Policies issued to New York residents,
see Appendix D. The Surrender Charge Premium is calculated separately for each
Policy. Sample surrender charge premiums are set forth in Appendix B.
The surrender charge consists of a sales charge component and an
administrative charge component. The sales charge component is to reimburse us
for some of the expenses incurred in the distribution of the Policies. We also
deduct a sales charge from each premium. See "Premium Charge," page 15. The
sales charge component of the surrender charge, together with the sales charge
included in the premium charge, may be insufficient to recover distribution
expenses related to the sale of the Policies. Unrecovered expenses are borne by
our general assets which may include profits, if any, from the mortality and
expense risk charge. See "Daily Mortality and Expense Risk Charge," page 15.
The administrative charge component of the surrender charge is designed to
cover the administrative expenses associated with underwriting and issuing the
Policy, including the costs of processing applications, conducting medical
exams, determining insurability and the Insureds' rate class, and establishing
Policy records, as well as the administrative costs of processing surrender
requests. We do not anticipate making any profit on the administrative charge
component of the surrender charge.
17
<PAGE>
- --------------------------------------------------------------------------------
PARTIAL SURRENDER CHARGE
We will deduct an administrative charge upon a partial surrender. This charge
is the lesser of 2% of the amount surrendered or $25. This charge will be
deducted from the Policy Value in addition to the amount requested to be
surrendered and will be considered to be part of the partial surrender amount.
See page 12 for rules for allocating the deduction. We do not anticipate making
a profit on this charge.
- --------------------------------------------------------------------------------
FUND EXPENSES
The value of the net assets of the Separate Account reflect the investment
advisory fees and other expenses incurred by the Funds. See the prospectuses
for Penn Series, AMT, American Century Variable Portfolios, VIP Fund, VIP Fund
II and Morgan Stanley Universal Funds, Inc.
- --------------------------------------------------------------------------------
HOW YOUR POLICY VALUES VARY
There is no guaranteed minimum Policy Value or Net Cash Surrender Value.
These values will vary with the investment experience of the Subaccounts and/or
the daily crediting of interest in the Fixed Account, and will depend on the
allocation of Policy Value. If the Net Cash Surrender Value on a Monthly
Anniversary is less than the amount of the Monthly Deduction to be deducted on
that date (see page 15) and the Five-Year Guarantee is not then in effect, the
Policy will be in default and a grace period will begin. See "Five-Year
Guarantee," page 12, and "Grace Period," page 12.
- --------------------------------------------------------------------------------
DETERMINING THE POLICY VALUE
On the Policy Date the Policy Value is equal to the initial Net Premium. If
the Policy Date and the Issue Date are the same day, the Policy Value is equal
to the initial Net Premium, less the Monthly Deduction. On each Valuation Date
thereafter, the Policy Value is the aggregate of the Variable Accumulation
Values in the Subaccounts and the Fixed Account Value credited to the Policy.
The Policy Value will vary to reflect the performance of the Subaccounts to
which amounts have been allocated, interest credited on amounts allocated to
the Fixed Account, charges, transfers, withdrawals, policy loans and policy
loan repayments.
VARIABLE ACCUMULATION VALUES. When you allocate an amount to a Subaccount,
either by Net Premium allocation or transfer of Policy Value, your Policy is
credited with accumulation units in that Subaccount. The number of accumulation
units is determined by dividing the amount allocated to the Subaccount by the
Subaccount's accumulation unit value for the Valuation Date when the allocation
is effected.
The number of Subaccount accumulation units credited to your Policy will
increase when Net Premiums are allocated to the Subaccount, amounts are
transferred to the Subaccount and loan repayments are credited to the
Subaccount. The number of Subaccount accumulation units credited to a Policy
will decrease when the allocated portion of the Monthly Deduction is taken from
the Subaccount, a policy loan is taken from the Subaccount, an amount is
transferred from the Subaccount, or a partial surrender, including the partial
surrender charge, is taken from the Subaccount.
ACCUMULATION UNIT VALUES. A Subaccount's accumulation unit value varies to
reflect the investment experience of the underlying Fund, and may increase or
decrease from one Valuation Date to the next. The accumulation unit value for
each Subaccount was arbitrarily set at $10 when the Subaccount was established.
For each Valuation Period after the date of establishment, the accumulation
unit value is determined by multiplying the value of an accumulation unit for a
Subaccount for the prior valuation period by the net investment factor for the
Subaccount for the current valuation period.
NET INVESTMENT FACTOR. The net investment factor is an index used to measure
the investment performance of a Subaccount from one Valuation Period to the
next. It is based on the change in net asset value of the Fund shares held by
the Subaccount, and reflects any dividend or capital gain distributions on Fund
shares and the deduction of the daily mortality and expense risk charge (see
page 15).
FIXED ACCOUNT VALUE. On any Valuation Date, the Fixed Account Value of a
Policy is the total of all Net Premiums allocated to the Fixed Account, plus
any amounts transferred to the Fixed Account, plus interest credited on such
Net Premiums and transferred amounts, less the amount of any transfers from the
Fixed Account, less the amount of any partial surrenders, including the partial
surrender charges, taken from the Fixed Account, and less the pro rata portion
of the Monthly Deduction
18
<PAGE>
deducted from the Fixed Account. If there have been any policy loans, the Fixed
Account Value is further adjusted to reflect the amount in the Policy Loan
Account held in the Fixed Account, including transfers to and from the Policy
Loan Account as loans are taken and repayments are made, and interest credited
on the Policy Loan Account.
- --------------------------------------------------------------------------------
NET POLICY VALUE
The Net Policy Value on a Valuation Date is the Policy Value less
Indebtedness on that date.
- --------------------------------------------------------------------------------
CASH SURRENDER VALUE
The Cash Surrender Value on a Valuation Date is the Policy Value reduced by
any surrender charge that would be assessed if the Policy were surrendered on
that date. The Cash Surrender Value is used to calculate the Loan Value and to
determine whether Indebtedness is excessive (see page 21). The Loan Value is
90% of the Cash Surrender Value.
- --------------------------------------------------------------------------------
NET CASH SURRENDER VALUE
The Net Cash Surrender Value on a Valuation Date is equal to the Net Policy
Value reduced by any surrender charge that would be imposed if the Policy were
surrendered on that date. The Net Cash Surrender Value is used to calculate the
amount available for partial surrenders. It is the amount received upon a full
surrender of the Policy.
- --------------------------------------------------------------------------------
DEATH BENEFIT AND CHANGES IN SPECIFIED AMOUNT
As long as the Policy remains in force, we will pay the Death Benefit upon
receipt at our Office of satisfactory proof of the deaths of both Insureds. The
Death Benefit will be paid in a lump sum generally within seven days after
receipt of such proof (see "When Proceeds Are Paid," page 25) or, if elected,
under a payment option (see "Payment Options," page 22). The Death Benefit will
be paid to the Beneficiary. See "Selecting and Changing the Beneficiary," page
20.
- --------------------------------------------------------------------------------
AMOUNT OF DEATH BENEFIT
The Death Benefit is equal to the sum of the Basic Death Benefit on the date
of the last surviving Insured's death, plus any dividend payable on that date
(see "Dividends," page 25), plus any supplemental benefits provided by rider,
minus any Indebtedness on that date and, if the date of death occurred during a
grace period, minus the past due Monthly Deductions. Under certain
circumstances, the amount of the Death Benefit may be further adjusted. See
"Incontestability," "Suicide Exclusion" and "Misstatement of Age or Sex," page
25.
If part or all of the Death Benefit is paid in one sum, Penn Mutual will pay
interest on this sum from the date of the last surviving Insured's death to the
date of payment. We determine the interest rate, but it will not be less than a
rate of 3% per year compounded annually.
- --------------------------------------------------------------------------------
BASIC DEATH BENEFIT AND SPECIFIED AMOUNT OPTIONS
The Owner may choose one of two Specified Amount Options, which will
determine the Basic Death Benefit. Under Option 1, the Basic Death Benefit is
the greater of (a) the Specified Amount or (b) the Policy Value on the date of
the last surviving Insured's death, multiplied by the applicable net single
premium factor (described below). Under Option 2, the Basic Death Benefit is
the greater of (a) the Specified Amount plus the Policy Value on the date of
the last surviving Insured's death, or (b) the Policy Value on that date
multiplied by the applicable net single premium factor.
If investment performance is favorable the amount of the Basic Death Benefit
may increase. However, under Option 1, the Basic Death Benefit ordinarily will
not change for several years to reflect any favorable investment performance
and may not change at all, whereas under Option 2, the Basic Death Benefit will
vary directly with the investment performance of the Policy Value. To see how
and when investment performance may begin to affect the Basic Death Benefit,
please see the illustrations beginning on page 22.
19
<PAGE>
Net single premium factors are based on the Insureds' sexes and rate classes
and the attained ages on the date of calculation. The factor decreases each
Policy Anniversary as the Insureds' ages increase. A table of net single
premium factors as of each Policy Anniversary is included in the Policy. A
table showing illustrative net single premium factors is included in Appendix
C.
- --------------------------------------------------------------------------------
SPECIFIED AMOUNT
The Initial Specified Amount is set at the time the Policy is issued. You may
decrease the Initial Specified Amount from time to time, as discussed below.
You also may change the Specified Amount Option, as discussed below.
- --------------------------------------------------------------------------------
CHANGES IN SPECIFIED AMOUNT OPTION
You may change the Specified Amount Option on your Policy subject to the
following rules. After any change, the Specified Amount must be at least
$200,000. No more than one change in the Specified Amount Option may be made in
any Policy Year and no change may be made during the first Policy Year. The
effective date of the change will be the Monthly Anniversary that coincides
with or next follows the Valuation Date when we receive the request for the
change. If you request a change from Option 1 to Option 2, we may require
satisfactory evidence of insurability. If the evidence of insurability
indicates a different rate class for the Insureds, the requested change will
not be allowed.
When a change from Option 1 to Option 2 is made, the Specified Amount after
the change is effected will be equal to the Specified Amount before the change
less the Policy Value on the effective date of the change. When a change from
Option 2 to Option 1 is made, the Specified Amount after the change will be
equal to the Specified Amount before the change is effected plus the Policy
Value on the effective date of the change.
- --------------------------------------------------------------------------------
CHANGES IN SPECIFIED AMOUNT
After the first Policy Year, you may request a decrease in the Specified
Amount, subject to the following conditions. No change will be permitted that
would result in your Policy's Death Benefit not being excludable from gross
income due to not satisfying the requirements of Section 7702 of the Internal
Revenue Code.
Any decrease in the Specified Amount must be at least $10,000, and the
Specified Amount after the decrease must be at least $200,000. A decrease in
Specified Amount will become effective on the Monthly Anniversary that
coincides with or next follows our receipt of a request at our Office.
The Specified Amount may increase as a result of a change in Specified Amount
Option. See "Change in Specified Amount Option," above for applicable rules.
- --------------------------------------------------------------------------------
SELECTING AND CHANGING THE BENEFICIARY
You select a Beneficiary in your application. You may later change the
Beneficiary in accordance with the terms of the Policy. If there is no
surviving Beneficiary when a death benefit is payable, the Owner (or the
Owner's estate) will be the Beneficiary.
- --------------------------------------------------------------------------------
CASH BENEFITS
- --------------------------------------------------------------------------------
POLICY LOANS
You may borrow up to the Loan Value of your Policy at any time by submitting
a written request to our Office. Policy loans will be processed as of the date
your written request is received and loan proceeds generally will be sent to
you within seven days. See "When Proceeds Are Paid," page 25, and "Payments
from the Fixed Account," page 15. The Loan Value is 90% of your Cash Surrender
Value. Outstanding policy loans reduce the amount of the Loan Value available
for new loans. Loans under a Policy classified as a modified endowment contract
may be subject to adverse tax consequences, including a 10% penalty. See
"Distributions from Policies Classified as Modified Endowment Contracts," page
28.
INTEREST. We will charge interest daily on any outstanding policy loan at an
annual rate of 5.0%. Interest is due and payable at the end of each Policy Year
while a policy loan is outstanding. If interest is not paid when due, the
amount of the interest is added to the loan and becomes part of the outstanding
policy loan.
20
<PAGE>
YY INDEBTEDNESS. Unrepaid policy loans (including unpaid interest added to
the loan) plus accrued interest not yet due equals the Indebtedness.
LOAN REPAYMENT; EFFECT IF NOT REPAID. You may repay all or part of your
Indebtedness at any time while an Insured is living and the Policy is in force.
Loan repayments must be sent to our Office and will be credited as of the date
received. If the Death Benefit becomes payable while a policy loan is
outstanding, the Indebtedness will be deducted in calculating the Death
Benefit. If the Indebtedness exceeds the Cash Surrender Value on any Valuation
Date, the Policy will be in default. We will send you, and any assignee of
record, notice of the default. You will have a 61-day grace period to submit a
sufficient payment to avoid termination. The notice will specify the amount
that must be repaid to prevent termination. If your Policy terminates because
of excessive Indebtedness, it cannot be reinstated.
POLICY LOAN ACCOUNT. When a policy loan is made, an amount equal to the loan
proceeds is withdrawn from the Policy Value in the Subaccounts and Fixed
Account (other than in the Policy Loan Account). This withdrawal is made pro
rata on the basis of Policy Value in each account unless you direct a different
allocation when requesting the loan. The amount withdrawn is then transferred
to the Policy Loan Account in the Fixed Account and will become part of the
Fixed Account Value. Conversely, when a loan is repaid, an amount equal to the
repayment will be transferred from the Policy Loan Account and allocated to the
Subaccounts and Fixed Account as you direct when submitting the repayment. If
you provide no direction, the amount will be allocated in accordance with your
then effective Net Premium allocation percentages. Thus, a loan or loan
repayment will have no immediate effect on the Policy Value, but other Policy
Values, such as the Net Policy Value and Net Cash Surrender Value, will be
reduced or increased immediately by the amount transferred to or from the
Policy Loan Account.
The amount in the Policy Loan Account will be credited with interest at a
minimum guaranteed annual rate of 4.0%. We may in our discretion credit
interest on this amount at a rate greater than 4%. Thus, the maximum net cost
of a loan is 1.0% per year (the difference between the rate of interest we
charge on Policy loans and the amount we credit on the equivalent amount held
in the Policy Loan Account). We currently intend to credit 4.0% on the amount
held in the Policy Loan Account during the first 10 Policy Years (a net loan
cost of 1.0%), and 4.75% after the first 10 Policy Years (a net loan cost of
0.25%).
EFFECT OF POLICY LOAN. A policy loan, whether or not repaid, will have a
permanent effect on the Death Benefit and Policy values because the investment
results of the Subaccounts of the Separate Account and current interest rates
credited on Policy Value in the Fixed Account will apply only to the non-loaned
portion of the Policy Value. The longer the loan is outstanding, the greater
the effect is likely to be. Depending on the investment results of the
Subaccounts or credited interest rates for the Fixed Account while the policy
loan is outstanding, the effect could be favorable or unfavorable. Policy loans
may increase the potential for lapse if investment results of the Subaccounts
are less than anticipated. Also, policy loans could, particularly if not
repaid, make it more likely than otherwise for a Policy to terminate. See "Tax
Considerations," page 26, for a discussion of adverse tax consequences if a
Policy lapses with policy loans outstanding.
- --------------------------------------------------------------------------------
SURRENDERING THE POLICY FOR NET CASH SURRENDER VALUE
You may surrender your Policy at any time for its Net Cash Surrender Value by
submitting a written request to our Office. We may require return of the
Policy. A surrender charge may apply. See "Surrender Charge," page 17. A
surrender request will be processed as of the date your written request and all
required documents are received and generally will be paid within seven days.
See "When Proceeds are Paid," page 25 and "Payment from the Fixed Account, page
15. The Net Cash Surrender Value may be taken in one sum or it may be applied
to a payment option. See "Payment Options," page 22. Your Policy will terminate
and cease to be in force if it is surrendered for one sum. It cannot later be
reinstated.
- --------------------------------------------------------------------------------
PARTIAL SURRENDERS
You may make partial surrenders under your Policy subject to the following
conditions. You must submit a written request to our Office. The Net Cash
Surrender Value must exceed $1,000 after the partial surrender is deducted from
the Policy Value. No more than four partial surrenders may be made during a
Policy Year, and each partial surrender must be at least $250. During the first
five Policy Years, no partial surrender may be made that would reduce the
Specified Amount to less than $200,000. An administrative charge will be
assessed on a partial surrender. See "Partial Surrender Charge," page 18. This
charge will be deducted from your Policy Value along with the amount requested
to be withdrawn and will be considered part of the partial surrender (together,
the "partial surrender amount"). Policy values will be reduced by the partial
surrender amount.
When you request a partial surrender, you can direct how the partial
surrender amount will be deducted from your Policy Value in the Subaccounts and
the Fixed Account, provided that the minimum amount remaining in an account as
a result of the
21
<PAGE>
deduction is $250. If you provide no directions, the partial surrender amount
will be deducted from your Policy Value in the accounts on a pro rata basis.
See "Deductions, Surrenders and Transfers from the Fixed Account," page 15. If
Specified Amount Option 1 is in effect, the Specified Amount will also be
reduced by the partial surrender amount.
Partial surrender requests will be processed as of the date your written
request is received, and generally will be paid within seven days. See "When
Proceeds Are Paid," page 25, and "Payments from the Fixed Account," page 15.
- --------------------------------------------------------------------------------
MATURITY BENEFIT
The Maturity Date is the Policy Anniversary nearest the younger Insured's
100th birthday. If the Policy is still in force on the Maturity Date, the
Maturity Benefit will be paid to you. The Maturity Benefit is equal to the Net
Policy Value on the Maturity Date. Upon the written request of the Owner, this
policy will continue in force beyond the Maturity Date. Thereafter, the Death
Benefit will be the Net Policy Value.
- --------------------------------------------------------------------------------
PAYMENT OPTIONS
The Policy offers a wide variety of optional ways of receiving proceeds
payable under the Policy, such as on surrender, death or maturity, other than
in a lump sum. Any agent authorized to sell this Policy can explain these
options upon request. None of these options vary with the investment
performance of a separate account because they are all forms of fixed-benefit
annuities.
- --------------------------------------------------------------------------------
ILLUSTRATIONS OF POLICY VALUES, NET CASH SURRENDER VALUES, DEATH BENEFITS AND
ACCUMULATED PREMIUMS
The following tables have been prepared to show how certain values under a
hypothetical Policy change with investment performance over an extended period
of time. The tables illustrate how Policy Values, Net Cash Surrender Values and
Death Benefits under a Policy covering two Insureds of given ages on the Issue
Date, would vary over time if planned premiums were paid annually and the
return on the assets in the selected Funds were a uniform gross annual rate of
0%, 6% and 12%. The values would be different from those shown if the returns
averaged 0%, 6% or 12% but fluctuated over and under those averages throughout
the years shown. The tables also show planned premiums accumulated at 5%
interest. The hypothetical investment rates of return are illustrative only and
should not be deemed a representation of past or future investment rates of
return. Actual rates of return for a particular Policy may be more or less than
the hypothetical investment rates of return and will depend on a number of
factors including the investment allocations made by an Owner, prevailing rates
and rates of inflation.
The tables reflect the fact that the net investment return on the assets held
in the Subaccounts is lower than the gross after tax return of the selected
Funds. The tables assume an average annual expense ratio of 0.88% of the
average daily net assets of the Funds available under the Policies. This
average annual expense ratio is based on the expense ratios of each of the
Funds for the last fiscal year. For information on Fund expenses, see the
prospectuses for the Funds accompanying this prospectus.
In addition, the tables also reflect the daily charge against Separate
Account assets attributable to the Policies for Penn Mutual's assumption of
mortality and expense risks, which is equivalent to an effective annual charge
of 0.90% of assets and currently is reduced to 0.60% of assets after the
fifteenth Policy Year. After deduction of Fund expenses and the mortality and
expense risk charge, the illustrated gross annual investment rates of return of
0%, 6% and 12% would correspond to approximate net annual rates of -1.78%,
4.22% and 10.22%, respectively, and -1.48%, 4.52% and 10.52%, respectively, at
current rates after the fifteenth Policy Year.
The tables also reflect the deduction of the Monthly Expense Charge and the
Monthly Cost of Insurance Charge for the hypothetical Insureds. Our current
cost of insurance charges and the higher guaranteed maximum cost of insurance
charges we have the contractual right to charge are reflected in separate
tables on each of the following pages. All the tables reflect the fact that no
charges for Federal or state income taxes are currently made against the
Separate Account and assume no Indebtedness or charges for supplemental
benefits.
The illustrations are based on our sex distinct rates for standard
nonsmokers. Upon request, we will furnish a comparable illustration based upon
the proposed Insureds' individual circumstances. Such illustrations may assume
different hypothetical rates of return than those illustrated in the following
tables.
22
<PAGE>
- -------------------------------------------------------------------------------
ILLUSTRATION OF POLICY VALUES
PENN MUTUAL LIFE INSURANCE COMPANY
MALE ISSUE AGE: 56 NON-SMOKER
FEMALE ISSUE AGE: 53 NON-SMOKER
$4,000 ANNUAL PREMIUM
$300,000 SPECIFIED AMOUNT
DEATH BENEFIT OPTION 1
USING GUARANTEED COST OF INSURANCE RATES
<TABLE>
<CAPTION>
0% HYPOTHETICAL 6% HYPOTHETICAL 12% HYPOTHETICAL
PREMIUMS GROSS INVESTMENT RETURN GROSS INVESTMENT RETURN GROSS INVESTMENT RETURN
ACCUMULATED ------------------------ ------------------------ -------------------------
END OF AT NET CASH NET CASH NET CASH
POLICY 5% INTEREST POLICY SURRENDER DEATH POLICY SURRENDER DEATH POLICY SURRENDER DEATH
YEAR PER YEAR VALUE VALUE BENEFIT VALUE VALUE BENEFIT VALUE VALUE BENEFIT
- ------ ----------- ------ --------- ------- ------ --------- ------- ------ --------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1 4,200 2,730 0 300,000 2,922 0 300,000 3,115 0 300,000
2 8,610 6,093 1,499 300,000 6,672 2,078 300,000 7,275 2,681 300,000
3 13,241 9,359 4,765 300,000 10,542 5,948 300,000 11,821 7,227 300,000
4 18,103 12,522 7,928 300,000 14,530 9,936 300,000 16,785 12,191 300,000
5 23,208 15,576 10,982 300,000 18,631 14,037 300,000 22,202 17,607 300,000
6 28,568 18,512 13,918 300,000 22,843 18,249 300,000 28,109 23,514 300,000
7 34,196 21,323 16,728 300,000 27,158 22,564 300,000 34,547 29,952 300,000
8 40,106 23,994 19,859 300,000 31,568 27,434 300,000 41,558 37,424 300,000
9 46,312 26,511 22,835 300,000 36,061 32,385 300,000 49,189 45,514 300,000
10 52,827 28,852 25,636 300,000 40,617 37,401 300,000 57,485 54,269 300,000
15 90,630 36,917 35,998 300,000 63,463 62,544 300,000 110,951 110,032 300,000
20 138,877 34,821 34,821 300,000 82,809 82,809 300,000 192,896 192,896 313,358
25 200,454 9,307 9,307 300,000 87,516 87,516 300,000 314,840 314,840 447,810
30 279,043 0 0 0 49,778 49,778 300,000 484,808 484,808 621,663
</TABLE>
(1) Assumes that no policy loans have been made.
(2) Guaranteed values reflect guaranteed cost of insurance rates, a monthly
administrative charge of $15.00 per month, and a mortality and expense
risk charge of 0.90% of assets.
(3) Net investment returns are calculated as the hypothetical gross
investment returns less all charges and deductions shown in the
prospectus.
(4) Assumes that the premium is paid at the beginning of each policy year.
Values would be different if the premiums are paid with a different
frequency or in different amounts.
- -------------------------------------------------------------------------------
ILLUSTRATION OF POLICY VALUES
PENN MUTUAL LIFE INSURANCE COMPANY
MALE ISSUE AGE: 61 NON-SMOKER
FEMALE ISSUE AGE: 57 NON-SMOKER
$7,000 ANNUAL PREMIUM
$300,000 SPECIFIED AMOUNT
DEATH BENEFIT OPTION 1
USING GUARANTEED COST OF INSURANCE RATES
<TABLE>
<CAPTION>
0% HYPOTHETICAL 6% HYPOTHETICAL 12% HYPOTHETICAL
PREMIUMS GROSS INVESTMENT RETURN GROSS INVESTMENT RETURN GROSS INVESTMENT RETURN
ACCUMULATED ------------------------ ------------------------- ---------------------------
END OF AT NET CASH NET CASH NET CASH
POLICY 5% INTEREST POLICY SURRENDER DEATH POLICY SURRENDER DEATH POLICY SURRENDER DEATH
YEAR PER YEAR VALUE VALUE BENEFIT VALUE VALUE BENEFIT VALUE VALUE BENEFIT
- ------ ----------- ------ --------- ------- ------ --------- ------- ------ --------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1 7,350 5,440 594 300,000 5,799 952 300,000 6,158 1,311 300,000
2 15,068 11,432 6,586 300,000 12,512 7,666 300,000 13,636 8,790 300,000
3 23,171 17,243 12,397 300,000 19,433 14,587 300,000 21,801 16,955 300,000
4 31,679 22,862 18,015 300,000 26,556 21,709 300,000 30,709 25,863 300,000
5 40,613 28,274 23,428 300,000 33,873 29,027 300,000 40,424 35,578 300,000
6 49,994 33,464 28,618 300,000 41,375 36,529 300,000 51,011 46,165 300,000
7 59,844 38,409 33,562 300,000 49,047 44,200 300,000 62,542 57,696 300,000
8 70,186 43,082 38,720 300,000 56,869 52,507 300,000 75,098 70,737 300,000
9 81,045 47,455 43,578 300,000 64,824 60,947 300,000 88,772 84,895 300,000
10 92,448 51,496 48,104 300,000 72,891 69,498 300,000 103,671 100,279 300,000
15 158,602 65,272 64,303 300,000 114,088 113,118 300,000 201,734 200,765 336,257
20 243,035 60,914 60,914 300,000 153,427 153,427 300,000 347,909 347,909 505,056
25 350,794 16,504 16,504 300,000 185,854 185,854 300,000 553,240 553,240 720,963
30 488,326 0 0 0 205,201 205,201 300,000 831,871 831,871 1,001,943
</TABLE>
(1) Assumes that no policy loans have been made.
(2) Guaranteed values reflect guaranteed cost of insurance rates, a monthly
administrative charge of $15.00 per month, and a mortality and expense
risk charge of 0.90% of assets.
(3) Net investment returns are calculated as the hypothetical gross
investment returns less all charges and deductions shown in the
prospectus.
(4) Assumes that the premium is paid at the beginning of each policy year.
Values would be different if the premiums are paid with a different
frequency or in different amounts.
- -------------------------------------------------------------------------------
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, PREVAILING RATES AND RATES OF
INFLATION. THE DEATH BENEFIT AND CASH VALUE FOR A POLICY WOULD BE DIFFERENT
FROM THOSE SHOWN IF THE ACTUAL RATES OF RETURN AVERAGED 0%, 6% OR 12% OVER A
PERIOD OF YEARS BUT ALSO FLUCTUATED ABOVE OR BELOW THOSE AVERAGES FOR
INDIVIDUAL POLICY YEARS. NO REPRESENTATION CAN BE MADE BY THE COMPANY OR THE
FUND THAT THESE HYPOTHETICAL RATES OF RETURN CAN BE ACHIEVED FOR ANY ONE YEAR
OR SUSTAINED OVER ANY PERIOD OF TIME.
23
<PAGE>
- -------------------------------------------------------------------------------
ILLUSTRATION OF POLICY VALUES
PENN MUTUAL LIFE INSURANCE COMPANY
MALE ISSUE AGE: 61 NON-SMOKER
FEMALE ISSUE AGE:57 NON-SMOKER
$7,000 ANNUAL PREMIUM
$300,000 SPECIFIED AMOUNT
DEATH BENEFIT OPTION 1
USING CURRENT COST OF INSURANCE RATES
<TABLE>
<CAPTION>
0% HYPOTHETICAL 6% HYPOTHETICAL 12% HYPOTHETICAL
PREMIUMS GROSS INVESTMENT RETURN GROSS INVESTMENT RETURN GROSS INVESTMENT RETURN
ACCUMULATED ------------------------ ------------------------- -----------------------------
END OF AT NET CASH NET CASH NET CASH
POLICY 5% INTEREST POLICY SURRENDER DEATH POLICY SURRENDER DEATH POLICY SURRENDER DEATH
YEAR PER YEAR VALUE VALUE BENEFIT VALUE VALUE BENEFIT VALUE VALUE BENEFIT
- ------ ----------- ------ --------- ------- ------ --------- ------- ------ --------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1 7,350 5,444 598 300,000 5,803 957 300,000 6,162 1,316 300,000
2 15,068 11,571 6,724 300,000 12,655 7,809 300,000 13,784 8,938 300,000
3 23,171 17,528 12,681 300,000 19,735 14,889 300,000 22,122 17,275 300,000
4 31,679 23,310 18,464 300,000 27,045 22,198 300,000 31,242 26,395 300,000
5 40,613 28,911 24,065 300,000 34,584 29,738 300,000 41,216 36,370 300,000
6 49,994 34,320 29,474 300,000 42,352 37,505 300,000 52,124 47,277 300,000
7 59,844 39,527 34,680 300,000 50,345 45,499 300,000 64,052 59,205 300,000
8 70,186 44,523 40,162 300,000 58,567 54,205 300,000 77,103 72,741 300,000
9 81,045 49,301 45,424 300,000 67,019 63,142 300,000 91,395 87,518 300,000
10 92,448 53,850 50,457 300,000 75,704 72,312 300,000 107,057 103,665 300,000
15 158,602 73,565 72,595 300,000 123,567 122,598 300,000 212,372 211,403 353,989
20 243,035 89,376 89,376 300,000 183,820 183,820 300,000 385,237 385,237 559,245
25 350,794 93,335 93,335 300,000 256,878 256,878 334,754 655,860 655,860 854,695
30 488,326 68,702 68,702 300,000 339,341 339,341 408,717 1,066,268 1,066,268 1,284,261
</TABLE>
(1) Assumes that no policy loans have been made.
(2) Current values reflect current cost of insurance rates, a monthly
administrative charge of $15.00 in year 1 and $5.00 thereafter, and a
mortality and expense risk charge of 0.90% of assets in years 1-15 and
0.60% thereafter.
(3) Net investment returns are calculated as the hypothetical gross
investment returns less all charges and deductions shown in the
prospectus.
(4) Assumes that the premium is paid at the beginning of each policy year.
Values would be different if the premiums are paid with a different
frequency or in different amounts.
- -------------------------------------------------------------------------------
ILLUSTRATION OF POLICY VALUES
PENN MUTUAL LIFE INSURANCE COMPANY
MALE ISSUE AGE: 56 NON-SMOKER
FEMALE ISSUE AGE: 53 NON-SMOKER
$4,000 ANNUAL PREMIUM
$300,000 SPECIFIED AMOUNT
DEATH BENEFIT OPTION 1
USING CURRENT COST OF INSURANCE RATES
<TABLE>
<CAPTION>
0% HYPOTHETICAL 6% HYPOTHETICAL 12% HYPOTHETICAL
PREMIUMS GROSS INVESTMENT RETURN GROSS INVESTMENT RETURN GROSS INVESTMENT RETURN
ACCUMULATED ------------------------ ------------------------- -------------------------
END OF AT NET CASH NET CASH NET CASH
POLICY 5% INTEREST POLICY SURRENDER DEATH POLICY SURRENDER DEATH POLICY SURRENDER DEATH
YEAR PER YEAR VALUE VALUE BENEFIT VALUE VALUE BENEFIT VALUE VALUE BENEFIT
- ------ ----------- ------ --------- ------- ------- --------- ------- ------- --------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1 4,200 2,731 0 300,000 2,924 0 300,000 3,117 0 300,000
2 8,610 6,220 1,626 300,000 6,804 2,209 300,000 7,411 2,817 300,000
3 13,241 9,617 5,022 300,000 10,816 6,222 300,000 12,112 7,518 300,000
4 18,103 12,916 8,322 300,000 14,960 10,366 300,000 17,255 12,661 300,000
5 23,208 16,113 11,519 300,000 19,235 14,641 300,000 22,879 18,285 300,000
6 28,568 19,203 14,608 300,000 23,640 19,045 300,000 29,027 24,433 300,000
7 34,196 22,179 17,585 300,000 28,172 23,578 300,000 35,747 31,153 300,000
8 40,106 25,037 20,902 300,000 32,832 28,697 300,000 43,092 38,957 300,000
9 46,312 27,768 24,093 300,000 37,614 33,939 300,000 51,119 47,444 300,000
10 52,827 30,362 27,146 300,000 42,514 39,298 300,000 59,891 56,675 300,000
15 90,630 40,814 39,895 300,000 68,506 67,588 300,000 117,672 116,753 300,000
20 138,877 47,852 47,852 300,000 99,140 99,140 300,000 213,556 213,556 346,921
25 200,454 49,021 49,021 300,000 133,966 133,966 300,000 367,836 367,836 523,189
30 279,043 34,330 34,330 300,000 169,723 169,723 300,000 608,792 608,792 780,646
</TABLE>
(1) Assumes that no policy loans have been made.
(2) Current values reflect current cost of insurance rates, a monthly
administrative charge of $15.00 in year 1 and $5.00 thereafter, and a
mortality and expense risk charge of 0.90% of assets in years 1-15 and
0.60% thereafter.
(3) Net investment returns are calculated as the hypothetical gross
investment returns less all charges and deductions shown in the
prospectus.
(4) Assumes that the premium is paid at the beginning of each policy year.
Values would be different if the premiums are paid with a different
frequency or in different amounts.
- -------------------------------------------------------------------------------
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, PREVAILING RATES AND RATES OF
INFLATION. THE DEATH BENEFIT AND CASH VALUE FOR A POLICY WOULD BE DIFFERENT
FROM THOSE SHOWN IF THE ACTUAL RATES OF RETURN AVERAGED 0%, 6% OR 12% OVER A
PERIOD OF YEARS BUT ALSO FLUCTUATED ABOVE OR BELOW THOSE AVERAGES FOR
INDIVIDUAL POLICY YEARS. NO REPRESENTATION CAN BE MADE BY THE COMPANY OR THE
FUND THAT THESE HYPOTHETICAL RATES OF RETURN CAN BE ACHIEVED FOR ANY ONE YEAR
OR SUSTAINED OVER ANY PERIOD OF TIME.
24
<PAGE>
- --------------------------------------------------------------------------------
OTHER POLICY BENEFITS AND PROVISIONS
- --------------------------------------------------------------------------------
RIGHT TO CONVERT TO A FIXED BENEFIT POLICY
At any time within the first 24 policy months, you may transfer Policy Value
in the Subaccounts to the Fixed Account and thereby convert your Policy to a
last survivor flexible premium adjustable non-variable life insurance policy.
Thereafter the benefits for your Policy will not vary with the investment
experience of a separate account. Premiums paid thereafter will be allocated
automatically to the Fixed Account. The conversion must be elected within 24
months from the Policy Date. No evidence of insurability will be required. The
Policy will provide the same amount of death benefit or the same net amount at
risk, whichever you elect, as was in effect immediately prior to the
conversion. All Indebtedness must be paid prior to the conversion.
- --------------------------------------------------------------------------------
DIVIDENDS
The Policies are participating policies in that they are eligible to
participate in Penn Mutual's surplus. However, we do not anticipate that any
dividends will be paid on the Policies. If dividends are paid, you will have
the option of having them added to your Policy Value or paid to you in cash.
- --------------------------------------------------------------------------------
INCONTESTABILITY
We will not contest the Policy with respect to each Insured after it has been
in force during that Insured's lifetime for two years from the Issue Date. Any
increase in the Death Benefit will be incontestable with respect to statements
made in the evidence of insurability for that change in Specified Amount Option
after the increase has been in force during the life of an Insured for two
years after the effective date of the increase.
- --------------------------------------------------------------------------------
SUICIDE EXCLUSION
If either Insured dies by suicide within two years after the Issue Date,
while sane or insane, the Death Benefit will be limited to the premiums paid
less any Indebtedness and any partial surrenders.
- --------------------------------------------------------------------------------
MISSTATEMENT OF AGE OR SEX
If either Insured's age or sex has been misstated in the Policy, the Death
Benefit under the Policy will be the amount which would have been provided by
the most recent Cost of Insurance Charge at the correct ages and sexes.
- --------------------------------------------------------------------------------
WHEN PROCEEDS ARE PAID
We will ordinarily pay any Death Benefit, loan proceeds or partial or full
surrender proceeds within seven days after receipt at our Office of all the
documents required for such a payment. Other than the Death Benefit, which is
determined as of the date of death, the amount will be determined as of the
date of receipt of required documents. However, we may delay making a payment
or processing a transfer request if (1) the disposal or valuation of the
Separate Account's assets is not reasonably practicable because the New York
Stock Exchange is closed for other than a regular holiday or weekend, trading
is restricted by the SEC, or the SEC declares that an emergency exists; or (2)
the SEC by order permits postponement of payment to protect Penn Mutual's
policy owners. See also "Payments from the Fixed Account," page 15.
- --------------------------------------------------------------------------------
REPORTS TO POLICY OWNERS
Each year you will be sent a report showing the current Policy values,
premiums paid and deductions made since the last report, any outstanding policy
loans, and any additional premiums permitted under your Policy. You will also
be sent an annual and a semi-annual report for the Separate Account and for
each Fund underlying a Subaccount to which you have allocated Policy Value, as
required by the 1940 Act. In addition, when you pay premiums (other than by
pre-authorized check), or if you
25
<PAGE>
take out a policy loan, transfer amounts among the Accounts or make partial
surrenders, you will receive a written confirmation of these transactions.
- --------------------------------------------------------------------------------
ASSIGNMENT
The Policy may be assigned in accordance with its terms on a form provided by
us. We will not be deemed to know of an assignment unless we receive a copy of
it at our Office. We assume no responsibility for the validity or sufficiency
of any assignment.
- --------------------------------------------------------------------------------
REINSTATEMENT
The Policy may be reinstated within five years after lapse, subject to
compliance with certain conditions, including the payment of a necessary
premium and submission of satisfactory evidence of insurability. See your
Policy for further information.
- --------------------------------------------------------------------------------
SUPPLEMENTAL BENEFITS
The following supplemental benefits are available and may be added to your
Policy. There are monthly charges for these benefits that are in addition to
the Cost of Insurance and Monthly Expense Charges described above. (See
"Monthly Deduction," page 16). If any of these benefits are added to your
Policy, monthly charges for the supplemental benefits will be deducted from
your Policy Value as part of the Monthly Deduction.
FLEXIBLE PERIOD SINGLE LIFE TERM RIDER -- provides term insurance covering
the named insured for the designated period.
POLICY SPLIT OPTION -- permits the policy to be split into two fixed
benefit (nonvariable) policies upon the issuance of a final divorce decree
relating to the two Insureds or a change in federal estate tax law that
results in the inability to defer estate taxes until the death of the last
surviving Insured.
ESTATE GROWTH BENEFIT -- provides for automatic annual increase of 3% or 6%
of the Initial Specified Amount.
CHANGE OF INSURED -- permits a change in one insured so long as the new
insured has the same insurable relationship to the remaining insured as did
the insured being replaced.
SUPPLEMENTAL TERM INSURANCE -- provides additional death benefit payable on
the death of the last surviving Insured if the death occurs during the term
of the Policy.
GUARANTEED CONTINUATION OF POLICY -- guarantees that the Policy will remain
in force and a death benefit will be payable regardless of the sufficiency
of the net Cash Surrender Value.
Additional rules and limits apply to these supplemental benefits. All
supplemental benefits may not be available in your state. Please ask your
authorized Penn Mutual agent for further information or contact our Office.
- --------------------------------------------------------------------------------
FEDERAL INCOME TAX CONSIDERATIONS
- --------------------------------------------------------------------------------
INTRODUCTION
The following summary provides a general description of the Federal income
tax considerations associated with the Policy and does not purport to be
complete or to cover all situations. This discussion is not intended as tax
advice. Counsel or other competent tax advisors should be consulted for more
complete information. This discussion is based on Penn Mutual's understanding
of the present Federal income tax laws as they are currently interpreted by the
Internal Revenue Service (the "IRS"). No representation is made as to the
likelihood of continuation of the present Federal income tax laws or of the
current interpretations by the IRS.
26
<PAGE>
- --------------------------------------------------------------------------------
TAX STATUS OF THE POLICY
In order to qualify as a life insurance contract for federal tax purposes,
the Policy must meet the definition of a life insurance contract which is set
forth in Section 7702 of the Internal Revenue Code of 1986, as amended (the
"Code"). The manner in which Section 7702 should be applied to certain features
of the Policy offered in this Prospectus is not directly addressed by Section
7702 or any guidance issued to date under Section 7702. Nevertheless, Penn
Mutual believes it is reasonable to conclude that the Policy will meet the
Section 7702 definition of a life insurance contract. In the absence of final
regulations or other pertinent interpretations of Section 7702, however, there
is necessarily some uncertainty as to whether a Policy will meet the statutory
life insurance contract definition, particularly if it insures a substandard
risk. If a Contract were determined not to be a life insurance contract for
purposes of Section 7702, such contract would not provide most of the tax
advantages normally provided by a life insurance contract.
If it is subsequently determined that a Policy does not satisfy Section 7702,
Penn Mutual may take whatever steps are appropriate and reasonable to attempt
to cause such a Policy to comply with Section 7702. For these reasons, Penn
Mutual reserves the right to restrict Policy transactions as necessary to
attempt to qualify it as a life insurance contract under Section 7702.
Section 817(h) of the Code requires that the investments of each Subaccount
of the Separate Account must be "adequately diversified" in accordance with
Treasury regulations in order for the Policy to qualify as a life insurance
contract under Section 7702 of the Code (discussed above). The Separate
Account, through the Funds, intends to comply with the diversification
requirements prescribed in Treas. Reg. (S) 1.817-5, which affect how the Funds'
assets are to be invested. Penn Mutual believes that the Separate Account will
thus meet the diversification requirement, and Penn Mutual will monitor
continued compliance with this requirement.
The IRS has stated in published rulings that a variable contract owner will
be considered the owner of separate account assets if the contract owner
possesses incidents of ownership in those assets, such as the ability to
exercise investment control over the assets. In circumstances where the
variable contract owner is considered the owner of separate account assets,
income and gain from the assets would be includable in the variable contract
owner's gross income. In connection with the issuance of regulations on the
phrase "adequate diversification," the Treasury Department announced that
guidance would be given, by way of regulation or ruling, on the "extent to
which policyholders may direct their investments to particular subaccounts
without being treated as owners of underlying assets." As of the date of this
prospectus, no such guidance had been issued.
The following discussion assumes that the Policy will qualify as a life
insurance contract for Federal income tax purposes.
- --------------------------------------------------------------------------------
TAX TREATMENT OF POLICY BENEFITS
IN GENERAL. Penn Mutual believes that the proceeds and cash value increases
of a Policy should be treated in a manner consistent with a fixed-benefit life
insurance policy for Federal income tax purposes. Thus, the Death Benefit under
the Policy should be excludable from the gross income of the Beneficiary under
Section 101(a)(1) of the Code.
Depending on the circumstances, the exchange of a Policy, the receipt of a
Policy in an exchange, a change in the Policy's Death Benefit Option, a Policy
loan, a partial withdrawal, a surrender, a change in ownership, a change of
insured, an adjustment of face amount, or an assignment of the Policy may have
Federal income tax consequences. A person considering any such transaction
should consult a tax adviser before effecting the transaction. In addition,
Federal, state and local transfer, and other tax consequences of ownership or
receipt of Policy proceeds depend on the circumstances of each Owner or
Beneficiary.
Generally, the Owner will not be deemed to be in constructive receipt of the
Policy Value, including increments thereof, until there is a distribution. The
tax consequences of distributions from, and loans taken from or secured by, a
Policy depend on whether the Policy is classified as a "Modified Endowment
Contract." Upon a complete surrender or lapse of a Policy or when benefits are
paid at a Policy's maturity date, whether a Policy is or is not a Modified
Endowment Contract, if the amount received plus the amount of indebtedness
exceeds the total investment in the Policy, the excess will generally be
treated as ordinary income subject to tax.
MODIFIED ENDOWMENT CONTRACTS. The Internal Revenue Code establishes a class
of life insurance contracts designated as "Modified Endowment Contracts," which
applies to Policies entered into or materially changed after June 20, 1988.
Due to the Policy's flexibility, classification as a Modified Endowment
Contract will depend on the individual circumstances of each Policy. In
general, a Policy will be a Modified Endowment Contract if the accumulated
premiums paid at
27
<PAGE>
any time during the first seven Policy Years exceeds the sum of the net level
premiums which would have been paid on or before such time if the Policy
provided for paid-up future benefits after the payment of seven level annual
premiums. The determination of whether a Policy will be a Modified Endowment
Contact after a material change generally depends upon the relationship of the
Death Benefit and Policy Value at the time of such change and the additional
premiums paid in the seven years following the material change. At the time a
premium is credited which would cause the Policy to become a Modified Endowment
Contract, Penn Mutual will notify the Owner that unless a refund of the excess
premium (with interest) is requested by the Owner, the Policy will become a
Modified Endowment Contract. The Owner will have 30 days after receiving such
notification to request the refund.
The rules relating to whether a Policy will be treated as a Modified
Endowment Contract are extremely complex and cannot be adequately described in
the limited confines of this summary. Therefore, a current or prospective Owner
should consult with a competent advisor to determine whether a policy
transaction will cause the Policy to be treated as a Modified Endowment
Contract.
DISTRIBUTIONS FROM POLICIES CLASSIFIED AS MODIFIED ENDOWMENT CONTRACTS.
Policies classified as Modified Endowment Contract will be subject to the
following tax rules: First, all distributions, including distributions upon
surrender and partial withdrawals from such a Policy are treated as ordinary
income subject to tax up to the amount equal to the excess (if any) of the
Policy Value immediately before the distribution over the investment in the
Policy (described below) at such time. Second, loans taken from or secured by,
such a Policy are treated as distributions from such a Policy and taxed
accordingly. Past due loan interest that is added to the loan amount will be
treated as a loan. Third, a 10 percent additional income tax is imposed on the
portion of any distribution from, or loan taken from or secured by, such a
Policy that is included in income except where the distribution or loan is made
on or after the Owner attains age 59 1/2, is attributable to the Owner's
becoming totally and permanently disabled, or is part of a series of
substantially equal periodic payments for the life (or life expectancy) of the
Owner or the joint lives (or joint life expectancies) of the Owner and the
Owner's Beneficiary.
DISTRIBUTIONS FROM POLICIES NOT CLASSIFIED AS MODIFIED ENDOWMENT CONTRACTS.
Distributions from a Policy that is not a Modified Endowment Contract, are
generally treated as first recovering the investment in the Policy (described
below) and then, only after the return of all such investment in the Policy, as
distributing taxable income. An exception to this general rule occurs in the
case of a decrease in the Policy's Death Benefit or any other change that
reduces benefits under the Policy in the first 15 years after the Policy is
issued and that results in a cash distribution to the Owner in order for the
Policy to continue complying with the Section 7702 definitional limits. Such a
cash distribution will be taxed in whole or in part as ordinary income (to the
extent of any gain in the Policy) under rules prescribed in Section 7702.
Loans from, or secured by, a Policy that is not a Modified Endowment Contract
are not treated as distributions. Instead, such loans are treated as
indebtedness of the Owner.
Finally, neither distributions (including distributions upon surrender) nor
loans from, or secured by, a Policy that is not a Modified Endowment Contract
are subject to the 10 percent additional tax.
POLICY LOAN INTEREST. Generally, personal interest paid on a loan under a
Policy which is owned by an individual is not deductible. In addition, interest
on any loan under a Policy owned by a taxpayer and covering the life of any
individual who is an officer or employee of or is financially interested in the
business carried on by that taxpayer will not be tax deductible to the extent
the aggregate amount of such loans with respect to contracts covering such
individual exceeds $50,000. The deduction of interest on Policy loans may also
be subject to the restrictions of Section 264 of the Code. An Owner should
consult a tax adviser before deducting any interest paid in respect of a policy
loan.
INVESTMENT IN THE POLICY. Investment in the Policy means: (i) the aggregate
amount of any premiums or other consideration paid for a Policy, minus (ii) the
aggregate amount received under the Policy which is excluded from gross income
of the Owner (except that the amount of any loan from, or secured by, a Policy
that is a Modified Endowment Contract, to the extent such amount is excluded
from gross income, will be disregarded), plus (iii) the amount of any loan
from, or secured by, a Policy that is a Modified Endowment Contract to the
extent that such amount is included in the gross income of the Owner.
MULTIPLE POLICIES. All Modified Endowment Contracts that are issued by Penn
Mutual (or its affiliates) to the same Owner during any calendar year are
treated as one Modified Endowment Contract for purposes of determining the
amount
includable in the gross income under Section 72(e) of the Code.
TAXATION OF POLICY SPLIT. The Policy Split Option Rider permits a Policy to
be split into two other life policies upon the occurrence of a divorce of the
joint insureds or certain changes in federal estate tax law. A policy split
could have adverse tax consequences; for example, it is not clear whether a
policy split will be treated as a nontaxable exchange under Section 1031
through 1043 of the Code. If a policy split is not treated as a nontaxable
exchange, a split could result in the recognition of taxable income in an
amount up to any gain in the Policy at the time of the split. In addition, it
is not clear whether, in all circumstances, the individual contracts that
result from a policy split would be treated as life insurance contracts for
federal
28
<PAGE>
income tax purpose and, if so treated, whether the individual contracts would
be classified as modified endowment contracts. Before you exercise rights
provided by the policy split option, it is important that you consult with a
competent tax advisor regarding the possible consequences of a policy split.
OTHER TAX CONSIDERATIONS. The transfer of the Policy or the designation of a
Beneficiary may have federal, state, and/or local transfer and inheritance tax
consequences, including the imposition of gift, estate and generation-skipping
transfer taxes. For example, the transfer of the Policy to, or the designation
as beneficiary of, or the payment of proceeds to, a person who is assigned to a
generation which is two or more generations below the generation of the Owner,
may have generation skipping transfer tax considerations under Section 2601 of
the Code.
The individual situation of each Owner or Beneficiary will determine the
extent, if any, to which federal, state and local transfer taxes may be
imposed. Consult with your tax adviser for specific information in connection
with these taxes.
- --------------------------------------------------------------------------------
CHARGE FOR PENN MUTUAL'S TAXES
At the present time, Penn Mutual makes no charge for any federal, state or
local taxes (other than premium taxes) that it incurs that may be attributable
to the Separate Account or Fixed Account or to the Policies. Penn Mutual,
however, reserves the right to impose a charge in the future for any such tax
or other economic burden resulting from the application of tax laws that it
determines to be properly attributable to the Accounts or to the Policies.
- --------------------------------------------------------------------------------
OTHER INFORMATION ABOUT THE POLICIES AND PENN MUTUAL
- --------------------------------------------------------------------------------
SALE OF THE POLICIES
Hornor, Townsend & Kent, Inc. ("HTK"), a wholly-owned subsidiary of Penn
Mutual, acts as a principal underwriter of the Policies. HTK also acts as
principal underwriter for Penn Mutual Variable Annuity Account III, a separate
account also established by Penn Mutual and for PIA Variable Annuity Account I,
a separate account established by The Penn Insurance and Annuity Company, a
wholly-owned subsidiary of Penn Mutual. HTK is a registered broker-dealer under
the Securities Exchange Act of 1934 and a member of the National Association of
Securities Dealers, Inc. Regulatory approvals are being sought so that the
Policy can be offered in all states. The Policy is sold by certain registered
representatives of HTK who are also appointed and licensed as insurance agents.
The Policy may also be offered through insurance and securities brokers who
have lawfully qualified to sell the Policies. Registered representatives may be
paid commissions on a Policy they sell based on premiums paid in amounts up to
50% of first year premiums, 2% on premiums paid during the second through
fifteenth Policy Years, and 1.2% on premiums paid after the first fifteen
Policy Years. Registered representatives may also be paid commissions of up to
0.25% of Policy Value. Other allowances and overrides also may be paid.
Registered representatives who meet certain productivity and profitability
standards may be eligible for additional compensation.
For 1996 and 1995, Penn Mutual received premium payments on the Policy in the
approximate amount of $4,580,000 and $477,000, respectively, and compensated
HTK in the approximate amount of $34,139 and $3,100, respectively, for its
services as principal underwriter.
29
<PAGE>
- --------------------------------------------------------------------------------
PENN MUTUAL TRUSTEES AND OFFICERS
Penn Mutual is managed by a board of trustees. The following table sets forth
the name, address and principal occupations during the past five years of each
of Penn Mutual's trustees.
BOARD OF TRUSTEES
<TABLE>
<CAPTION>
POSITION WITH PRINCIPAL OCCUPATION
NAME AND ADDRESS PENN MUTUAL DURING PAST FIVE YEARS
- ------------------------------------------------------------------------------
<C> <C> <S>
Robert E. Chappell Chairman of the Chairman of the Board and Chief
The Penn Mutual Life Board and Chief Executive Officer (since
Insurance Company Executive Officer December 1996), President and
Philadelphia, PA 19172 Chief Executive Officer (April
1995-December 1996), President
and Chief Operating Officer, The
Penn Mutual Life Insurance
Company (January 1994 to April
1995); Executive Vice President,
PNC Bank Corp. (January 1992 to
December 1993); Chairman of the
Board (June 1991 to January
1992) and Chairman, President
and Chief Executive Officer,
Provident National Bank (prior
thereto).
- ------------------------------------------------------------------------------
Daniel J. Toran President and Chief President and Chief Operating
The Penn Mutual Life Operating Officer Officer (since January 1997),
Insurance Company Executive Vice President, The
Philadelphia, PA 19172 Penn Mutual Life Insurance
Company (May 1996-January 1997),
Executive Vice President, The
New England Mutual Life
Insurance Company (prior
thereto).
- ------------------------------------------------------------------------------
James A. Hagen Trustee Retired (since May 1996),
2001 Market Street Chairman of the Board, Conrail,
P.O. Box 41417 Inc. (prior thereto).
Philadelphia, PA 19101-
1417
- ------------------------------------------------------------------------------
Philip E. Lippincott Trustee Retired (since April 1994),
3578 Oakwood Drive Chairman and Chief Executive
Park City, UT 84060 Officer, Scott Paper Company
(prior thereto).
- ------------------------------------------------------------------------------
John F. McCaughan Trustee Retired (since April 1996),
Betz Dearborn Foundation President, Betz Dearborn
200 Witmer Road Foundation (since March 1996),
Horsham, PA 19044 Chairman of the Board, Betz
Laboratories, Inc. (prior
thereto).
- ------------------------------------------------------------------------------
Alan B. Miller Trustee Chairman and President,
367 S. Gulph Road Universal Health Services, Inc.
King of Prussia, PA
19406
- ------------------------------------------------------------------------------
Norman T. Wilde, Jr. Trustee President and Chief Executive
1801 Market Street Officer, Janney Montgomery Scott
Philadelphia, PA 19103 Inc. (a securities broker/dealer
and subsidiary of The Penn
Mutual Life Insurance Company).
- ------------------------------------------------------------------------------
Wesley S. Williams, Jr., Trustee Partner, Covington & Burling
Esq. (law firm).
1201 Pennsylvania Ave.,
N.W. P.O. Box 7566
Washington, D.C. 20004
</TABLE>
30
<PAGE>
The following table sets forth the names, addresses and principal occupations
during the past five years of the senior officers of Penn Mutual (other than
officers who are members of Penn Mutual's Board of Trustees).
SENIOR OFFICERS
<TABLE>
<CAPTION>
NAME PRINCIPAL OCCUPATION DURING PAST FIVE YEARS
- -------------------------------------------------------------------------------
<C> <S>
John M. Albanese Vice President, Systems and Service (since July 1995),
The Penn Mutual Life Vice President, Information Systems Application (August
Insurance Company 1992 to July 1995); Manager Price Waterhouse (prior
Philadelphia, PA 19172 thereto).
- -------------------------------------------------------------------------------
Michael A. Biondolillo Vice President, Human Resources, The Penn Mutual Life
The Penn Mutual Life Insurance Company (since October 1996); Corporate Vice
Insurance Company President and General Manager, Human Resources and
Philadelphia, PA 19172 Quality MG Industries, America (prior thereto).
- -------------------------------------------------------------------------------
Nancy S. Brodie Executive Vice President and Chief Financial Officer
The Penn Mutual Life (since December 1995), Senior Vice President and Chief
Insurance Company Financial Officer (January 1994 to December 1995), Vice
Philadelphia, PA 19172 President and Controller (November 1991 to January
1994), General Auditor (October 1989 to November 1991),
Assistant Vice President, Taxation, The Penn Mutual
Life Insurance Company (prior thereto).
- -------------------------------------------------------------------------------
L. Stockton Illoway Senior Vice President, Marketing and Sales Support
The Penn Mutual Life (since June 1996), Senior Vice President, Annuity and
Insurance Company Pension Business (December 1993 to June 1996), Senior
Philadelphia, PA 19172 Vice President, Individual Retirement Investment
Services (September 1993 to December 1993), Regional
Vice President, The Penn Mutual Life Insurance Company
(prior thereto).
- -------------------------------------------------------------------------------
Richard J. Liburdi Senior Vice President, Career Agency System (since June
The Penn Mutual Life 1996), Senior Vice President, Insurance and Life Sales
Insurance Company (January 1991 to June 1996), Vice President and Product
Philadelphia, PA 19172 Manager (November 1988 to January 1991), Assistant Vice
President and Product Manager, The Penn Mutual Life
Insurance Company (prior thereto).
- -------------------------------------------------------------------------------
Nina M. Mulrooney General Auditor (since November 1991), Assistant Vice
The Penn Mutual Life President, Corporate Accounting and Controls (December
Insurance Company 1988 to November 1991), Director, Cost Accounting and
Philadelphia, PA 19172 Budget, The Penn Mutual Life Insurance Company (prior
thereto).
- -------------------------------------------------------------------------------
Harold E. Maude, Jr. Senior Vice President, Independence Financial Network
The Penn Mutual Life (since July 1996), Vice President, Independence
Insurance Company Financial Network (1991 to July 1996), Regional
Philadelphia, PA 19172 Director (1989 to 1991).
- -------------------------------------------------------------------------------
Peter M. Sherman Senior Vice President and Chief Investment Officer
The Penn Mutual Life (since May 1996), Vice President, Investments (January
Insurance Company 1996 to April 1996), Vice President, Fixed Income
Philadelphia, PA 19172 Portfolio Management, The Penn Mutual Life Insurance
Company (prior thereto); President, Independence
Capital Management, Inc. (an investment advisory
organization and subsidiary of Penn Mutual).
</TABLE>
- --------------------------------------------------------------------------------
STATE REGULATION
Penn Mutual is subject to regulation by the Department of Insurance of the
Commonwealth of Pennsylvania, which periodically examines our financial
condition and operations. We are also subject to the insurance laws and
regulations of all jurisdictions where we do business. The Policy described in
this prospectus has been filed with and, where required, approved by, insurance
officials in those jurisdictions where it is sold.
We are required to submit annual statements of our operations, including
financial statements, to the insurance departments of the various jurisdictions
where we do business to determine solvency and compliance with applicable
insurance laws and regulations.
- --------------------------------------------------------------------------------
ADDITIONAL INFORMATION
A registration statement under the Securities Act of 1933 has been filed with
the SEC relating to the offering described in this prospectus. This prospectus
does not include all the information set forth in the registration statement.
The omitted information may be obtained at the SEC's principal office in
Washington, D.C. by paying the SEC's prescribed fees.
31
<PAGE>
- --------------------------------------------------------------------------------
EXPERTS
The statement of assets and liabilities of Penn Mutual Variable Life Account
I--Cornerstone VUL II/Variable EstateMax as of December 31, 1996, and the
related statement of operations for the year then ended and the statements of
changes in net assets for the year then ended and for the period May 1, 1995
(commencement of operations) to December 31, 1995, and the statutory statements
of financial condition of The Penn Mutual Life Insurance Company as of December
31, 1996 and 1995 and the related statutory statements of operations, surplus
and cash flows for the three years in the period ended December 31, 1996,
included in this prospectus, have been audited by Coopers & Lybrand L.L.P.,
independent accountants. The reports and the financial statements have been
included upon authority of said firm as experts in accounting and auditing.
Actuarial matters included in this prospectus have been examined by Peter R.
Schaefer, F.S.A., M.A.A.A., Actuary of Penn Mutual, whose opinion is filed as
an exhibit to the Registration Statement.
- --------------------------------------------------------------------------------
LITIGATION
No litigation is pending that would have a material effect upon the Separate
Account or Penn Series.
- --------------------------------------------------------------------------------
LEGAL MATTERS
Morgan, Lewis & Bockius, LLP of Philadelphia, Pennsylvania, has provided
advice on certain matters relating to the federal securities laws and the
offering of the Policies.
- --------------------------------------------------------------------------------
FINANCIAL STATEMENTS
The financial statements of the Subaccounts and of Penn Mutual appear on the
following pages. The financial statements of Penn Mutual should be
distinguished from any financial statements of the Subaccounts and should be
considered only as bearing upon Penn Mutual's ability to meet its obligations
under the Policies.
32
<PAGE>
- --------------------------------------------------------------------------------
REPORT OF INDEPENDENT ACCOUNTANTS
TO THE PENN MUTUAL LIFE INSURANCE COMPANY AND CONTRACT OWNERS
OF PENN MUTUAL VARIABLE LIFE ACCOUNT I--CORNERSTONE VUL II/VARIABLE ESTATE MAX:
We have audited the accompanying statement of assets and liabilities of Penn
Mutual Variable Life Account I--Cornerstone VUL II/Variable Estate Max (VUL
II/VMAX) [comprising, respectively, Money Market Fund, Quality Bond Fund, High
Yield Bond Fund, Growth Equity Fund, Value Equity Fund, Flexibly Managed Fund,
Small Capitalization Fund, International Equity Fund, Balanced Portfolio,
Limited Maturity Bond Portfolio, Capital Appreciation Portfolio (formerly TCI
Growth Portfolio), Equity Income Portfolio, Growth Portfolio, and Asset Manager
Portfolio] as of December 31, 1996, and the related statement of operations for
the year then ended, and the statements of changes in net assets for the year
then ended and the period from May 1, 1995 (commencement of operations) to
December 31, 1995. These financial statements are the responsibility of the
management of VUL II/VMAX. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. Our
procedures included confirmation of securities owned as of December 31, 1996 by
correspondence with the transfer agents. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Penn Mutual Variable Life
Account I--Cornerstone VUL II/Variable Estate Max as of December 31, 1996, the
results of its operations for the year then ended and its changes in net assets
for the year then ended and the period from May 1, 1995 (commencement of
operations) to December 31, 1995 in conformity with generally accepted
accounting principles.
COOPERS & LYBRAND L.L.P.
2400 Eleven Penn Center
Philadelphia, Pennsylvania
April 7, 1997
33
<PAGE>
- --------------------------------------------------------------------------------
PENN MUTUAL VARIABLE LIFE ACCOUNT I - VUL II/VARIABLE ESTATE MAX
STATEMENT OF ASSETS AND LIABILITIES - DECEMBER 31, 1996
<TABLE>
<CAPTION>
MONEY MARKET MONEY MARKET QUALITY BOND HIGH YIELD BOND
TOTAL FUND+(a) FUND+(b) FUND+ FUND+
----------- ------------ ------------ ------------ ---------------
<S> <C> <C> <C> <C> <C>
INVESTMENT IN COMMON
STOCK:
Number of shares....... 2,721,787 866,474 54,620 56,501
Identified cost........ $32,739,350 $2,721,787 $866,474 $572,212 $510,015
ASSETS:
Investments at value... $33,510,725 $2,721,787 $866,474 $546,197 $503,423
Dividends receivable... 14,523 11,104 3,419 0 0
LIABILITIES:
Due to (from) The Penn
Mutual Life Insurance
Company............... 91,057 82,348 3,892 122 105
----------- ---------- -------- -------- --------
NET ASSETS.............. $33,434,191 $2,650,543 $866,001 $546,075 $503,318
=========== ========== ======== ======== ========
Variable life accumula-
tion units............. 247,647 80,811 47,590 41,747
Accumulation unit val-
ues.................... $ 10.70 $ 10.72 $ 11.47 $ 12.06
- --------------------------------------------------------------------------------------------
PENN MUTUAL VARIABLE LIFE ACCOUNT I - VUL II/VARIABLE ESTATE MAX
STATEMENT OF OPERATIONS - FOR THE YEAR ENDED DECEMBER 31, 1996
<CAPTION>
MONEY MARKET MONEY MARKET QUALITY BOND HIGH YIELD BOND
TOTAL FUND+(A) FUND+(B) FUND+ FUND+
----------- ------------ ------------ ------------ ---------------
<S> <C> <C> <C> <C> <C>
INVESTMENT INCOME:
Dividends.............. $ 612,816 $ 96,731 $ 21,290 $ 34,073 $ 36,843
EXPENSE:
Mortality and expense
risk charges.......... 154,468 18,162 3,982 1,812 2,276
----------- ---------- -------- -------- --------
Net investment income.. 458,348 78,569 17,308 32,261 34,567
----------- ---------- -------- -------- --------
REALIZED AND UNREALIZED
GAINS (LOSSES) ON
INVESTMENTS:
Realized gains (losses)
from redemption of
shares of Penn Series
Funds, Inc............ 2,709 0 0 94 360
Capital gains distribu-
tions................. 917,424 0 0 0 0
----------- ---------- -------- -------- --------
Net realized gains
(losses).............. 920,133 0 0 94 360
Net change in
unrealized
appreciation
(depreciation) of
investments........... 785,327 0 0 (24,231) (2,192)
----------- ---------- -------- -------- --------
Net realized and
unrealized gains
(losses) on
investments........... 1,705,460 0 0 (24,137) (1,832)
----------- ---------- -------- -------- --------
NET INCREASE (DECREASE)
IN NET ASSETS RESULTING
FROM OPERATIONS........ $ 2,163,808 $ 78,569 $ 17,308 $ 8,124 $ 32,735
=========== ========== ======== ======== ========
</TABLE>
- -----------------------
+ Investment in Penn Series Funds, Inc.
++ Investment in Neuberger & Berman Advisers Management Trust.
+++ Investment in American Century Variable Portfolios, Inc. (TCI Growth
Portfolio changed to Capital Appreciation Portfolio as of May 1, 1997).
++++ Investment in Fidelity Investments' Variable Insurance Products Funds I
and II.
(a) Represents only the Cornerstone VUL II product.
(b) Represents only the Variable Estate Max product.
The accompanying notes are an integral part of these financial statements.
34
<PAGE>
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FLEXIBLY SMALL INTERNATIONAL LIMITED
GROWTH EQUITY VALUE EQUITY MANAGED CAPITALIZATION EQUITY BALANCED MATURITY BOND
FUND+ FUND+ FUND+ FUND+ FUND+ PORTFOLIO++ PORTFOLIO++
------------- ------------ ---------- -------------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
17,523 247,116 430,952 103,024 162,866 32,980 15,640
$383,627 $4,510,103 $8,050,766 $1,230,184 $2,521,631 $522,217 $217,956
$376,047 $4,774,282 $8,076,040 $1,290,887 $2,542,333 $525,047 $219,743
0 0 0 0 0 0 0
83 1,035 1,792 (1,489) 552 131 49
-------- ---------- ---------- ---------- ---------- -------- --------
$375,964 $4,773,247 $8,074,248 $1,292,376 $2,541,781 $524,916 $219,694
======== ========== ========== ========== ========== ======== ========
27,281 319,544 621,124 97,253 193,714 43,651 20,059
$ 13.78 $ 14.94 $ 13.00 $ 13.29 $ 13.12 $ 12.03 $ 10.95
- ---------------------------------------------------------------------------------------------
<CAPTION>
FLEXIBLY SMALL INTERNATIONAL LIMITED
GROWTH EQUITY VALUE EQUITY MANAGED CAPITALIZATION EQUITY BALANCED MATURITY BOND
FUND+ FUND+ FUND+ FUND+ FUND+ PORTFOLIO++ PORTFOLIO++
------------- ------------ ---------- -------------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
$ 1,635 $ 51,995 $ 259,738 $ 6,965 $ 83,272 $ 3,556 $ 4,961
1,669 19,807 37,310 5,420 10,480 2,798 1,062
-------- ---------- ---------- ---------- ---------- -------- --------
(34) 32,188 222,428 1,545 72,792 758 3,899
-------- ---------- ---------- ---------- ---------- -------- --------
(39) 1,827 1,306 1,590 (805) 926 (33)
36,293 194,155 338,828 47,534 110,931 19,775 0
-------- ---------- ---------- ---------- ---------- -------- --------
36,254 195,982 340,134 49,124 110,126 20,701 (33)
(2,111) 264,271 61,997 62,662 13,930 2,836 898
-------- ---------- ---------- ---------- ---------- -------- --------
34,143 460,253 402,131 111,786 124,056 23,537 865
-------- ---------- ---------- ---------- ---------- -------- --------
$ 34,109 $ 492,441 $ 624,559 $ 113,331 $ 196,848 $ 24,295 $ 4,764
======== ========== ========== ========== ========== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
35
<PAGE>
- --------------------------------------------------------------------------------
PENN MUTUAL VARIABLE LIFE ACCOUNT I - VUL II/VARIABLE ESTATE MAX
STATEMENT OF ASSETS AND LIABILITIES - DECEMBER 31, 1996 (CONT'D.)
<TABLE>
<CAPTION>
CAPITAL
APPRECIATION EQUITY INCOME GROWTH ASSET MANAGER
PORTFOLIO+++ PORTFOLIO++++ PORTFOLIO++++ PORTFOLIO++++
------------ ------------- ------------- -------------
<S> <C> <C> <C> <C>
INVESTMENT IN COMMON
STOCK:
Number of shares....... 155,575 172,796 164,733 42,038
Identified cost........ $1,728,534 $3,347,783 $4,904,041 $652,020
ASSETS:
Investments at value... 1,593,085 3,633,895 5,129,774 711,711
Dividends receivable... 0 0 0 0
LIABILITIES:
Due to (from) The Penn
Mutual Life Insurance
Company............... 401 799 1,076 161
---------- ---------- ---------- --------
NET ASSETS.............. $1,592,684 $3,633,096 $5,128,698 $711,550
========== ========== ========== ========
Variable life accumula-
tion units............. 139,698 268,476 364,202 56,043
Accumulation unit val-
ues.................... $ 11.40 $ 13.53 $ 14.08 $ 12.70
- --------------------------------------------------------------------------------
PENN MUTUAL VARIABLE LIFE ACCOUNT I - VUL II/VARIABLE ESTATE MAX
STATEMENT OF OPERATIONS - FOR THE YEAR ENDED DECEMBER 31, 1996 (CONT'D.)
<CAPTION>
CAPITAL
APPRECIATION EQUITY INCOME GROWTH ASSET MANAGER
PORTFOLIO+++ PORTFOLIO++++ PORTFOLIO++++ PORTFOLIO++++
------------ ------------- ------------- -------------
<S> <C> <C> <C> <C>
INVESTMENT INCOME:
Dividends.............. $ 0 $ 2,337 $ 2,539 $ 6,881
EXPENSE:
Mortality and expense
risk charges ......... 8,636 16,925 23,494 635
---------- ---------- ---------- --------
Net investment income.. (8,636) (14,588) (20,955) 6,246
---------- ---------- ---------- --------
REALIZED AND UNREALIZED
GAINS (LOSSES) ON
INVESTMENTS:
Realized gains (losses)
from redemption of
shares
of Penn Series Funds,
Inc. ................. (378) (1,148) (1,555) 564
Capital gains distribu-
tions................. 68,944 31,190 64,100 5,674
---------- ---------- ---------- --------
Net realized gains
(losses).............. 68,566 30,042 62,545 6,238
Net change in
unrealized
appreciation
(depreciation) of
investments........... (135,169) 253,509 235,591 53,336
---------- ---------- ---------- --------
Net realized and
unrealized gains
(losses) on
investments........... (66,603) 283,551 298,136 59,574
---------- ---------- ---------- --------
NET INCREASE (DECREASE)
IN NET ASSETS RESULTING
FROM OPERATIONS........ $ (75,239) $ 268,963 $ 277,181 $ 65,820
========== ========== ========== ========
</TABLE>
- -----------------------
+ Investment in Penn Series Funds, Inc.
++ Investment in Neuberger & Berman Advisers Management Trust.
+++ Investment in American Century Variable Portfolios, Inc. (TCI Growth
Portfolio changed to Capital Appreciation Portfolio as of May 1, 1997).
++++ Investment in Fidelity Investments' Variable Insurance Products Funds I
and II.
(a) Represents only the Cornerstone VUL II product.
(b) Represents only the Variable Estate Max product.
The accompanying notes are an integral part of these financial statements.
36
<PAGE>
- --------------------------------------------------------------------------------
PENN MUTUAL VARIABLE LIFE ACCOUNT I - VUL II/VARIABLE ESTATE MAX
STATEMENT OF CHANGES IN NET ASSETS - FOR THE YEAR ENDED DECEMBER 31, 1996, AND
THE PERIOD MAY 1, 1995 (COMMENCEMENT OF OPERATIONS) TO DECEMBER 31, 1995
<TABLE>
<CAPTION>
MONEY MONEY MARKET
TOTAL MARKET FUND+(a) FUND+(b)
----------------------- ------------------------ ----------------------
1996 1995 1996 1995 1996 1995
----------- ---------- ----------- ----------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
OPERATIONS:
Net investment income
(loss)................ $ 458,348 $ 82,891 $ 78,569 $ 15,227 $ 17,308 $ 719
Net realized gain
(loss) from investment
transactions.......... 920,133 107,693 0 0 0 0
Net change in
unrealized
appreciation
(depreciation) of
investments........... 785,327 (13,949) 0 0 0 0
----------- ---------- ----------- ----------- ----------- ---------
Net increase (decrease)
in net assets resulting
from operations........ 2,163,808 176,635 78,569 15,227 17,308 719
----------- ---------- ----------- ----------- ----------- ---------
VARIABLE LIFE
ACTIVITIES:
Purchase payments under
variable life
contracts............. 29,546,396 5,759,715 15,559,938 4,084,747 2,858,896 440,146
Surrender benefits..... (253,954) (34) (13,953) 0 0 0
Net transfers.......... (350,840) 471,816 (13,489,878) (2,833,877) (2,006,542) (364,402)
Contract administration
charges............... (1,438,914) (141,962) (205,795) (45,854) (50,964) (7,862)
Cost of insurance...... (2,256,403) (242,072) (408,772) (89,809) (17,733) (3,565)
----------- ---------- ----------- ----------- ----------- ---------
Net increase in net
assets resulting from
variable life
activities............. 25,246,285 5,847,463 1,441,540 1,115,207 783,657 64,317
----------- ---------- ----------- ----------- ----------- ---------
Total increase in net
assets................. 27,410,093 6,024,098 1,520,109 1,130,434 800,965 65,036
NET ASSETS:
Beginning of period.... 6,024,098 0 1,130,434 0 65,036 0
----------- ---------- ----------- ----------- ----------- ---------
END OF PERIOD.......... $33,434,191 $6,024,098 $ 2,650,543 $ 1,130,434 $ 866,001 $ 65,036
=========== ========== =========== =========== =========== =========
<CAPTION>
QUALITY HIGH YIELD GROWTH
BOND FUND+ BOND FUND+ EQUITY FUND+
----------------------- ------------------------ ----------------------
1996 1995 1996 1995 1996 1995
----------- ---------- ----------- ----------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
OPERATIONS:
Net investment income
(loss)................ $ 32,261 $ 4,811 $ 34,567 $ 7,715 $ (34) $ 74
Net realized gain
(loss) from investment
transactions.......... 94 122 360 2 36,254 6,719
Net change in
unrealized
appreciation
(depreciation) of
investments........... (24,231) (1,784) (2,192) (4,400) (2,111) (5,469)
----------- ---------- ----------- ----------- ----------- ---------
Net increase (decrease)
in net assets resulting
from operations........ 8,124 3,149 32,735 3,317 34,109 1,324
----------- ---------- ----------- ----------- ----------- ---------
VARIABLE LIFE
ACTIVITIES:
Purchase payments under
variable life
contracts............. 154,180 31,077 165,686 10,712 152,803 16,993
Surrender benefits..... (2,649) 0 (2,074) 0 (842) 0
Net transfers.......... 336,072 56,550 262,002 81,913 181,764 36,960
Contract administration
charges............... (13,801) (1,442) (18,004) (1,270) (16,807) (1,346)
Cost of insurance...... (22,987) (2,198) (29,457) (2,242) (26,209) (2,785)
----------- ---------- ----------- ----------- ----------- ---------
Net increase in net
assets resulting from
variable life
activities............. 450,815 83,987 378,153 89,113 290,709 49,822
----------- ---------- ----------- ----------- ----------- ---------
Total increase in net
assets................. 458,939 87,136 410,888 92,430 324,818 51,146
NET ASSETS:
Beginning of period.... 87,136 0 92,430 0 51,146 0
----------- ---------- ----------- ----------- ----------- ---------
END OF PERIOD.......... $ 546,075 $ 87,136 $ 503,318 $ 92,430 $ 375,964 $ 51,146
=========== ========== =========== =========== =========== =========
</TABLE>
- -----------------------
+ Investment in Penn Series Funds, Inc.
++ Investment in Neuberger & Berman Advisers Management Trust
+++ Investment in American Century Variable Portfolios, Inc. (TCI Growth
Portfolio changed to Capital Appreciation Portfolio as of May 1, 1997).
++++ Investment in Fidelity Investments' Variable Insurance Products Funds I
and II.
(a) Represents only the Cornerstone VUL II product
(b) Represents only the Variable Estate Max product
The accompanying notes are an integral part of these financial statements.
37
<PAGE>
- --------------------------------------------------------------------------------
PENN MUTUAL VARIABLE LIFE ACCOUNT I - VUL II/VARIABLE ESTATE MAX
STATEMENT OF CHANGES IN NET ASSETS - FOR THE YEAR ENDED DECEMBER 31, 1996, AND
THE PERIOD MAY 1, 1995 (COMMENCEMENT OF OPERATIONS) TO DECEMBER 31, 1995
(CONT'D.)
<TABLE>
<CAPTION>
VALUE FLEXIBLY SMALL CAPITALIZATION
EQUITY FUND+ MANAGED FUND+ FUND+
-------------------- ---------------------- -----------------------
1996 1995 1996 1995 1996 1995
---------- -------- ---------- ---------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
OPERATIONS:
Net investment income
(loss)................ $ 32,188 $ 10,368 $ 222,428 $ 37,212 $ 1,545 $ 799
Net realized gain
(loss) from investment
transactions.......... 195,982 49,190 340,134 48,262 49,124 3,427
Net change in
unrealized
appreciation
(depreciation) of
investments........... 264,271 (91) 61,997 (36,724) 62,662 (1,959)
---------- -------- ---------- ---------- ----------- ---------
Net increase (decrease)
in net assets resulting
from operations........ 492,441 59,467 624,559 48,750 113,331 2,267
---------- -------- ---------- ---------- ----------- ---------
VARIABLE LIFE
ACTIVITIES:
Purchase payments under
variable life
contracts............. 1,360,144 136,674 2,664,444 361,651 498,674 66,532
Surrender benefits..... (32,419) 0 (74,122) (14) (13,130) (10)
Net transfers.......... 2,385,789 772,784 4,216,930 1,057,640 660,016 106,381
Contract administration
charges............... (141,826) (11,403) (285,785) (26,150) (52,877) (4,603)
Cost of insurance...... (226,508) (21,896) (469,401) (44,254) (78,480) (5,725)
---------- -------- ---------- ---------- ----------- ---------
Net increase in net
assets resulting from
variable life
activities............. 3,345,180 876,159 6,052,066 1,348,873 1,014,203 162,575
---------- -------- ---------- ---------- ----------- ---------
Total increase in net
assets................. 3,837,621 935,626 6,676,625 1,397,623 1,127,534 164,842
NET ASSETS:
Beginning of period.... 935,626 0 1,397,623 0 164,842 0
---------- -------- ---------- ---------- ----------- ---------
END OF PERIOD.......... $4,773,247 $935,626 $8,074,248 $1,397,623 $ 1,292,376 $ 164,842
========== ======== ========== ========== =========== =========
<CAPTION>
INTERNATIONAL BALANCED LIMITED MATURITY
EQUITY FUND+ PORTFOLIO++ BOND PORTFOLIO++
-------------------- ---------------------- -----------------------
1996 1995 1996 1995 1996 1995
---------- -------- ---------- ---------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
OPERATIONS:
Net investment income
(loss)................ $ 72,792 $ 5,449 $ 758 $ (169) $ 3,899 $ (76)
Net realized gain
(loss) from investment
transactions.......... 110,126 25 20,701 28 (33) 4
Net change in
unrealized
appreciation
(depreciation) of
investments........... 13,930 6,773 2,836 (6) 898 889
---------- -------- ---------- ---------- ----------- ---------
Net increase (decrease)
in net assets resulting
from operations........ 196,848 12,247 24,295 (147) 4,764 817
---------- -------- ---------- ---------- ----------- ---------
VARIABLE LIFE
ACTIVITIES:
Purchase payments under
variable life
contracts............. 861,883 124,822 360,163 20,792 89,190 6,858
Surrender benefits..... (17,014) 0 (6,240) 0 (135) 0
Net transfers.......... 1,483,081 143,874 120,901 86,515 103,331 32,606
Contract administration
charges............... (102,391) (6,540) (28,971) (1,898) (5,179) (503)
Cost of insurance...... (144,055) (10,974) (46,800) (3,694) (11,238) (817)
---------- -------- ---------- ---------- ----------- ---------
Net increase in net
assets resulting from
variable life
activities............. 2,081,504 251,182 399,053 101,715 175,969 38,144
---------- -------- ---------- ---------- ----------- ---------
Total increase in net
assets................. 2,278,352 263,429 423,348 101,568 180,733 38,961
NET ASSETS:
Beginning of period.... 263,429 0 101,568 0 38,961 0
---------- -------- ---------- ---------- ----------- ---------
END OF PERIOD.......... $2,541,781 $263,429 $ 524,916 $ 101,568 $ 219,694 $ 38,961
========== ======== ========== ========== =========== =========
</TABLE>
- -----------------------
+ Investment in Penn Series Funds, Inc.
++ Investment in Neuberger & Berman Advisers Management Trust
+++ Investment in American Century Variable Portfolios, Inc. (TCI Growth
Portfolio changed to Capital Appreciation Portfolio as of May 1, 1997).
++++ Investment in Fidelity Investments' Variable Insurance Products Funds I
and II.
(a) Represents only the Cornerstone VUL II product
(b) Represents only the Variable Estate Max product
The accompanying notes are an integral part of these financial statements.
38
<PAGE>
- --------------------------------------------------------------------------------
PENN MUTUAL VARIABLE LIFE ACCOUNT I - VUL II/VARIABLE ESTATE MAX
STATEMENT OF CHANGES IN NET ASSETS - FOR THE YEAR ENDED DECEMBER 31, 1996, AND
THE PERIOD MAY 1, 1995 (COMMENCEMENT OF OPERATIONS) TO DECEMBER 31, 1995
(CONT'D.)
<TABLE>
<CAPTION>
CAPITAL APPRECIATION EQUITY INCOME GROWTH ASSET MANAGER
PORTFOLIO+++ PORTFOLIO++++ PORTFOLIO++++ PORTFOLIO++++
----------------------- -------------------- -------------------- ------------------
1996 1995 1996 1995 1996 1995 1996 1995
----------- ---------- ---------- -------- ---------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
OPERATIONS:
Net investment income
(loss)................ $ (8,636) $ (476) $ (14,588) $ 2,557 $ (20,955) $ (946) $ 6,246 $ (373)
Net realized gain
(loss) from investment
transactions.......... 68,566 469 30,042 (243) 62,545 (309) 6,238 (3)
Net change in
unrealized
appreciation
(depreciation) of
investments........... (135,169) (280) 253,509 32,603 235,591 (9,857) 53,336 6,356
----------- --------- ---------- -------- ---------- -------- -------- --------
Net increase (decrease)
in net assets resulting
from operations........ (75,239) (287) 268,963 34,917 277,181 (11,112) 65,820 5,980
----------- --------- ---------- -------- ---------- -------- -------- --------
VARIABLE LIFE
ACTIVITIES:
Purchase payments under
variable life
contracts............. 840,551 89,544 1,456,967 119,945 2,213,494 219,332 309,383 29,890
Surrender benefits..... (20,881) 0 (31,547) 0 (34,941) (10) (4,007) 0
Net transfers.......... 798,967 213,357 1,764,383 411,297 2,566,211 537,988 266,133 132,230
Contract administration
charges............... (98,540) (6,609) (144,237) (9,829) (246,323) (14,116) (27,414) (2,537)
Cost of insurance...... (137,884) (10,295) (222,108) (15,655) (356,315) (22,691) (58,456) (5,472)
----------- --------- ---------- -------- ---------- -------- -------- --------
Net increase in net
assets resulting from
variable life
activities............. 1,382,213 285,997 2,823,458 505,758 4,142,126 720,503 485,639 154,111
----------- --------- ---------- -------- ---------- -------- -------- --------
Total increase in net
assets................. 1,306,974 285,710 3,092,421 540,675 4,419,307 709,391 551,459 160,091
NET ASSETS:
Beginning of period.... 285,710 0 540,675 0 709,391 0 160,091 0
----------- --------- ---------- -------- ---------- -------- -------- --------
END OF PERIOD.......... $ 1,592,684 $ 285,710 $3,633,096 $540,675 $5,128,698 $709,391 $711,550 $160,091
=========== ========= ========== ======== ========== ======== ======== ========
</TABLE>
- -----------------------
+ Investment in Penn Series Funds, Inc.
++ Investment in Neuberger & Berman Advisers Management Trust
+++ Investment in American Century Variable Portfolios, Inc. (TCI Growth
Portfolio changed to Capital Appreciation Portfolio as of May 1, 1997).
++++ Investment in Fidelity Investments' Variable Insurance Products Funds I
and II.
(a) Represents only the Cornerstone VUL II product
(b) Represents only the Variable Estate Max product
The accompanying notes are an integral part of these financial statements.
39
<PAGE>
- --------------------------------------------------------------------------------
PENN MUTUAL VARIABLE LIFE ACCOUNT I - CORNERSTONE VUL II/VARIABLE ESTATE MAX
NOTES TO FINANCIAL STATEMENTS - DECEMBER 31, 1996
- --------------------------------------------------------------------------------
NOTE 1.
The significant accounting policies of Penn Mutual Variable Life Account
I--Cornerstone VUL II/Variable Estate Max sub-accounts (Cornerstone
II/Estate Max) are as follows:
For presentation purposes the Cornerstone VUL II and Variable Estate Max
products are presented in one financial statement.
GENERAL - Cornerstone II/Estate Max were established by The Penn Mutual
Life Insurance Company (Penn Mutual) under the provisions of the
Pennsylvania Insurance Law. Penn Mutual has structured Cornerstone
II/Estate Max as a unit investment trust registered under the Investment
Company Act of 1940. Cornerstone II/Estate Max offers units to variable
life contract owners to provide for the accumulation of value and for the
payment of benefits. Contract owners may borrow up to a specific amount
depending on policy value at any time by submitting a written request for a
policy loan. The preparation of the accompanying financial statements
requires management to make estimates and assumptions that affect the
reported values of assets and liabilities as of December 31, 1996 and the
reported amounts from operations and contract transactions during 1996 and
1995. Actual results could differ from those estimates.
INVESTMENTS - Assets of Cornerstone II/Estate Max are invested in shares of
Penn Series Funds, Inc. (Penn Series): Money Market, Quality Bond, High
Yield Bond, Growth Equity, Value Equity, Flexibly Managed, International
Equity Fund and Small Capitalization Funds; Neuberger and Berman Advisers
Management Trust (AMT): Limited Maturity Bond and Balanced Portfolios
- --------------------------------------------------------------------------------
NOTE 2.
For the year ended December 31, 1996 and the period May 1, 1995
(commencement of operations) to December 31, 1995 transactions in
Cornerstone II/Estate Max were as follows:
<TABLE>
<CAPTION>
MONEY MARKET QUALITY BOND HIGH YIELD GROWTH EQUITY
FUND+ FUND+ BOND FUND+ FUND +
----------------------- ------------------ ----------------- --------------------
1996 1995 1996 1995 1996 1995 1996 1995
----------- ---------- -------- -------- -------- ------- ---------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Shares purchased........ 12,518,440 3,348,369 56,687 9,741 60,481 10,274 17,079 2,786
Shares received from re-
investment of:
Net investment income.. 118,022 19,306 3,407 486 4,135 952 76 10
Capital gains distribu-
tion.................. 0 0 0 0 0 1,691 337
----------- ---------- -------- -------- -------- ------- ---------- --------
Total shares acquired... 12,636,462 3,367,675 60,094 10,227 64,616 11,226 18,846 3,133
Shares redeemed......... (10,154,039) (2,261,837) (13,985) (1,716) (19,068) (273) (3,881) (575)
----------- ---------- -------- -------- -------- ------- ---------- --------
Net increase in shares
owned.................. 2,482,423 1,105,838 46,109 8,511 45,548 10,953 14,965 2,558
Shares owned beginning
of period.............. 1,105,838 0 8,511 0 10,953 0 2,558 0
----------- ---------- -------- -------- -------- ------- ---------- --------
Shares owned end of pe-
riod................... 3,588,261 1,105,838 54,620 8,511 56,501 10,953 17,523 2,558
=========== ========== ======== ======== ======== ======= ========== ========
Cost of shares acquired. $12,636,462 $3,367,675 $626,412 $106,815 $585,899 $99,320 $ 413,350 $ 69,532
Proceeds from shares re-
deemed................. $10,154,039 $2,261,837 $143,226 $ 18,005 $173,086 $ 2,480 $ 86,303 $ 12,868
<CAPTION>
LIMITED CAPITAL
INTERNATIONAL BALANCED MATURITY BOND APPRECIATION
EQUITY FUND+ PORTFOLIO++ PORTFOLIO++ PORTFOLIO+++
----------------------- ------------------ ----------------- --------------------
1996 1995 1996 1995 1996 1995 1996 1995
----------- ---------- -------- -------- -------- ------- ---------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Shares purchased........ 171,806 18,851 35,598 6,311 23,930 2,748 133,027 28,845
Shares received from re-
investment of:
Net investment income.. 5,335 413 233 0 368 0 0 0
Capital gains distribu-
tion.................. 7,106 0 1,296 0 0 0 6,448 0
----------- ---------- -------- -------- -------- ------- ---------- --------
Total shares acquired... 184,247 19,264 37,127 6,311 24,298 2,748 139,475 28,845
Shares redeemed......... (39,588) (1,057) (9,945) (513) (11,307) (99) (7,594) (5,151)
----------- ---------- -------- -------- -------- ------- ---------- --------
Net increase in shares
owned.................. 144,659 18,207 27,182 5,798 12,991 2,649 131,881 23,694
Shares owned beginning
of period.............. 18,207 0 5,798 0 2,649 0 23,694 0
----------- ---------- -------- -------- -------- ------- ---------- --------
Shares owned end of pe-
riod................... 162,866 18,207 32,980 5,798 15,640 2,649 155,575 23,694
=========== ========== ======== ======== ======== ======= ========== ========
Cost of shares acquired. $ 2,884,014 $ 271,701 $582,671 $110,500 $337,832 $39,519 $1,523,998 $347,755
Proceeds from shares re-
deemed................. $ 618,269 $ 15,037 $162,966 $ 8,942 $157,920 $ 1,446 $ 81,197 $ 62,319
</TABLE>
The cost of shares redeemed is determined on a last-in, first-out basis.
- -----------------------
+ Investment in Penn Series Funds, Inc.
++ Investment in Neuberger & Berman Advisers Management Trust
+++ Investment in American Century Variable Portfolios, Inc. (TCI Growth
Portfolio changed to Capital Appreciation Portfolio as of May 1, 1997).
++++ Investment in Fidelity Investments' Variable Insurance Products Funds I
and II.
40
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NOTE 1., CONT'D.
American Century Variable Portfolios, Inc. (American Century): Capital
Appreciation Portfolio; and Fidelity Investments' Variable Insurance
Products (Fidelity): Equity Income, Growth, and Asset Manager Portfolios.
Penn Series, AMT, American Century, and Fidelity are open-end diversified
investment companies. The shares are carried at market value as determined
by the underlying net asset value of the respective Funds or Portfolios.
Dividend income is recorded on the ex-dividend date. Investment
transactions are accounted for on a trade date basis.
FEDERAL INCOME TAXES - Penn Mutual is taxed under federal law as a life
insurance company. Cornerstone II/Estate Max is part of Penn Mutual's total
operations and is not taxed separately. Under existing federal law, no
taxes are payable on investment income and realized gains of Cornerstone
II/Estate Max.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SMALL
VALUE EQUITY CAPITALIZATION
FUND+ FLEXIBLY MANAGED FUND+ FUND+
- --------------------- ------------------------- -----------------------
1996 1995 1996 1995 1996 1995
- ---------- -------- ---------- ---------- ---------- --------
<S> <C> <C> <C> <C> <C>
192,908 57,004 342,661 81,492 114,111 16,139
2,691 810 13,860 2,328 556 116
10,049 2,944 18,080 2,750 3,801 305
- ---------- -------- ---------- ---------- ---------- --------
205,648 60,758 374,601 86,570 118,468 16,560
(16,010) (3,280) (23,982) (6,237) (30,486) (1,518)
- ---------- -------- ---------- ---------- ---------- --------
189,638 57,478 350,619 80,333 87,982 15,042
57,478 0 80,333 0 15,042 0
- ---------- -------- ---------- ---------- ---------- --------
247,116 57,478 430,952 80,333 103,024 15,042
========== ======== ========== ========== ========== ========
$3,863,030 $991,706 $7,070,311 $1,547,895 $1,430,164 $183,496
$ 290,587 $ 57,139 $ 455,369 $ 113,783 $ 368,391 $ 16,757
<CAPTION>
ASSET
EQUITY INCOME GROWTH MANAGER
PORTFOLIO++++ PORTFOLIO++++ PORTFOLIO++++
- --------------------- ------------------------- -----------------------
1996 1995 1996 1995 1996 1995
- ---------- -------- ---------- ---------- ---------- --------
<S> <C> <C> <C> <C> <C>
167,613 30,938 145,505 27,337 37,160 10,425
56 204 92 0 456 0
1,654 0 2,307 0 376 0
- ---------- -------- ---------- ---------- ---------- --------
169,323 31,142 147,904 27,337 37,992 10,425
(24,588) (3,081) (7,468) (3,040) (6,094) (285)
- ---------- -------- ---------- ---------- ---------- --------
144,735 28,061 140,436 24,297 31,898 10,140
28,061 0 24,297 0 10,140 0
- ---------- -------- ---------- ---------- ---------- --------
172,796 28,061 164,733 24,297 42,038 10,140
========== ======== ========== ========== ========== ========
$3,317,836 $566,137 $4,408,108 $ 810,160 $ 596,147 $158,075
$ 477,046 $ 57,753 $ 221,841 $ 90,521 $ 98,446 $ 4,317
</TABLE>
41
<PAGE>
- --------------------------------------------------------------------------------
PENN MUTUAL VARIABLE LIFE ACCOUNT I - CORNERSTONE VUL II/VARIABLE ESTATE MAX
NOTES TO FINANCIAL STATEMENTS - DECEMBER 31, 1996 (CONT'D)
- --------------------------------------------------------------------------------
NOTE 3.
Operations are charged for mortality and expense risks assumed by Penn
Mutual as determined daily at a current annual rate guaranteed never to
exceed 0.90% of the average value of Cornerstone II/Estate Max.
On the date of issue and on each monthly anniversary a monthly deduction is
made from the policy value. The monthly deduction consists of (1) insurance
charges (2) administrative charges and (3) any charges for additional
benefits added by supplemental agreements to a policy. See original policy
documents for specific charges assessed.
If a policy is surrendered within the first 11 years in Cornerstone VUL II
or the first 13 years for Variable Estate Max, a contingent deferred sales
charge and/or contingent deferred administrative charge will be assessed.
These charges will be deducted before any surrender proceeds are paid. See
original policy document for specific charges assessed.
42
<PAGE>
- --------------------------------------------------------------------------------
REPORT OF INDEPENDENT ACCOUNTANTS
TO THE BOARD OF TRUSTEES OF
THE PENN MUTUAL LIFE INSURANCE COMPANY
PHILADELPHIA, PENNSYLVANIA
We have audited the accompanying statutory statements of financial condition of
The Penn Mutual Life Insurance Company as of December 31, 1996 and 1995, and
the related statutory statements of operations, surplus and cash flows for the
three years in the period ended December 31, 1996. These statutory financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
As described more fully in Note 1 to the financial statements, the Company
prepared these financial statements using accounting practices prescribed or
permitted by the Insurance Department of the Commonwealth of Pennsylvania
(SAP), which practices differ from generally accepted accounting principles
(GAAP). The effects on the financial statements of the variances between SAP
and GAAP are described in Note 1 to the financial statements.
In our report dated January 26, 1996, we expressed our opinion that the 1995
and 1994 financial statements, prepared using SAP, presented fairly, in all
material respects, the financial position of The Penn Mutual Life Insurance
Company as of December 31, 1995, and the results of its operations, and its
cash flows for the two years then ended in conformity with GAAP. As described
in Note 1 to the financial statements, financial statements of mutual life
insurance enterprises issued or reissued after 1996, which are prepared in
accordance with SAP, are no longer considered to be presented in conformity
with GAAP. Accordingly, our present opinion on the 1995 and 1994 financial
statements as presented herein is different from that expressed in our previous
report.
In our opinion, because of the effects of the matter discussed in the second
preceding paragraph, the financial statements referred to above do not present
fairly, in conformity with GAAP, the financial position of The Penn Mutual Life
Insurance Company as of December 31, 1996 and 1995, or the results of its
operations or its cash flows for the three years in the period ended December
31, 1996.
In our opinion, the statutory financial statements referred to above present
fairly, in all material respects, the financial condition of The Penn Mutual
Life Insurance Company as of December 31, 1996 and 1995, and the results of its
operations and its cash flows for the three years in the period ended December
31, 1996, on the basis of accounting described in Note 1.
As discussed in Note 2 to the financial statements, during 1995, the Company
changed its accounting method for certain components of the federal income tax
expense. Also as discussed in Note 2, in 1996 and 1995, the Company changed the
reserve valuation basis for disability income and certain annuity contracts,
respectively.
Coopers & Lybrand L.L.P
2400 Eleven Penn Center
Philadelphia, Pennsylvania
January 28, 1997
43
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY
STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
DECEMBER 31, 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C>
(in thousands of dollars)
ASSETS
Bonds.................................................... $4,541,972 $3,695,516
Stocks
Preferred............................................... 13,042 15,049
Common--affiliated...................................... 205,574 171,193
- --unaffiliated........................................... 160 8,182
Mortgage loans........................................... 117,046 960,692
Real estate.............................................. 99,575 138,329
Policy loans............................................. 409,344 422,865
Cash and short-term investments.......................... 14,532 75,962
Other invested assets.................................... 76,500 59,561
---------- ----------
TOTAL CASH AND INVESTED ASSETS.......................... 5,477,745 5,547,349
Investment income due and accrued........................ 83,573 94,350
Premiums due and deferred................................ 25,297 26,926
Other assets............................................. 36,479 41,082
Separate account assets.................................. 1,225,038 911,683
---------- ----------
TOTAL ASSETS............................................ $6,848,132 $6,621,390
========== ==========
LIABILITIES
Reserves and funds for payment of future life and annuity
benefits................................................ $4,948,254 $5,064,298
Dividends to policyholders payable in the following year. 69,445 72,653
Policy claims in process................................. 25,626 27,241
Interest maintenance reserve............................. 18,716 36,084
Asset valuation reserve.................................. 77,408 83,157
Other liabilities........................................ 103,871 77,063
Separate account liabilities............................. 1,225,038 905,960
---------- ----------
TOTAL LIABILITIES....................................... 6,468,358 6,266,456
---------- ----------
SURPLUS
Special surplus funds.................................... 1,629 1,576
Unassigned surplus....................................... 378,145 353,358
---------- ----------
TOTAL................................................... 379,774 354,934
---------- ----------
TOTAL LIABILITIES AND SURPLUS.......................... $6,848,132 $6,621,390
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
44
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY
STATEMENTS OF OPERATIONS AND SURPLUS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31, 1996 1995 1994
- ---------------------------------------------------------------------------------
(in thousands of dollars)
<S> <C> <C> <C>
INCOME
Premium and annuity considerations.......... $ 641,183 $ 710,442 $ 771,547
Net investment income....................... 455,278 456,108 446,354
Other income................................ 3,340 (5,632) 10,497
---------- ---------- ----------
TOTAL INCOME............................... 1,099,801 1,160,918 1,228,398
---------- ---------- ----------
BENEFITS AND EXPENSES
Benefits paid to policyholders and benefi-
ciaries.................................... 816,583 859,798 766,598
Increase (decrease) in reserves and funds
for payment of future life and annuity
benefits................................... (135,705) (50,775) 54,380
Commissions................................. 37,487 38,044 45,579
Operating expenses.......................... 110,194 116,673 124,920
Net transfers to separate accounts.......... 125,532 86,944 128,773
---------- ---------- ----------
TOTAL BENEFITS AND EXPENSES................ 954,091 1,050,684 1,120,250
---------- ---------- ----------
INCOME FROM OPERATIONS BEFORE DIVIDENDS AND
FEDERAL INCOME TAXES...................... 145,710 110,234 108,148
Dividends to policyholders.................. 65,996 70,057 69,098
---------- ---------- ----------
INCOME FROM OPERATIONS BEFORE FEDERAL IN-
COME TAXES................................ 79,714 40,177 39,050
Federal income tax expense (benefit)........ 13,073 (52,442) 197
---------- ---------- ----------
INCOME FROM OPERATIONS..................... 66,641 92,619 38,853
Net realized capital losses, net of taxes... 40,736 91,890 37,399
---------- ---------- ----------
NET INCOME................................. 25,905 729 1,454
SURPLUS
Change in asset valuation reserve........... 5,749 28,728 29,060
Change in net unrealized capital gains and
losses..................................... 5,433 2,395 (3,376)
Changes in accounting methods, net of taxes. (14,773) 7,984 --
Other....................................... 2,526 (223) 8,618
---------- ---------- ----------
TOTAL CONTRIBUTION TO SURPLUS.............. 24,840 39,613 35,756
Surplus, Beginning of Year................. 354,934 315,321 279,565
---------- ---------- ----------
SURPLUS, END OF YEAR....................... $ 379,774 $ 354,934 $ 315,321
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
45
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31, 1996 1995 1994
- ---------------------------------------------------------------------------------
(in thousands of dollars)
<S> <C> <C> <C>
CASH PROVIDED
Net cash from operations:
Premium and annuity considerations.......... $ 642,997 $ 708,301 $ 767,017
Net investment income....................... 429,532 439,508 420,917
Other income................................ 76,756 (2,511) 15,704
---------- ---------- ----------
1,149,285 1,145,298 1,203,638
Benefits to policyholders................... 816,297 871,983 750,019
Commissions................................. 37,456 38,139 45,540
Operating expenses and taxes................ 107,115 152,907 96,050
Net transfers to separate accounts.......... 165,495 86,944 129,858
Dividends to policyholders.................. 69,204 69,804 70,246
Net decrease in policy loans................ (12,884) (15,202) (22,361)
---------- ---------- ----------
NET CASH FROM OPERATIONS................... (33,398) (59,277) 134,286
---------- ---------- ----------
Investments sold, matured or repaid:
Bonds....................................... 1,079,993 1,410,126 1,038,593
Stocks...................................... 27,131 95,347 197,503
Mortgage loans.............................. 819,237 102,394 45,255
Real estate and other invested assets....... 36,968 10,837 12,701
---------- ---------- ----------
Total investments sold, matured or repaid.. 1,963,329 1,618,704 1,294,052
Taxes on realized investment gains........... (3,694) 3,253 (17,722)
Other cash provided.......................... 5,852 4,275 10,035
---------- ---------- ----------
1,965,487 1,626,232 1,286,365
---------- ---------- ----------
TOTAL CASH PROVIDED........................ 1,932,089 1,566,955 1,420,651
---------- ---------- ----------
CASH APPLIED
Cost of investments acquired:
Bonds....................................... 1,916,791 1,357,008 1,218,880
Stocks...................................... 15,035 26,114 131,248
Mortgage loans.............................. 38,768 100,466 71,427
Real estate and other invested assets....... 17,456 8,970 14,909
---------- ---------- ----------
Total cost of investments acquired......... 1,988,050 1,492,558 1,436,464
Other cash applied........................... 5,469 6,231 24,452
---------- ---------- ----------
TOTAL CASH APPLIED......................... 1,993,519 1,498,789 1,460,916
---------- ---------- ----------
Net change in cash and short-term invest-
ments....................................... (61,430) 68,166 (40,265)
Cash and short-term investments:
Beginning of year........................... 75,962 7,796 48,061
---------- ---------- ----------
END OF YEAR................................. $ 14,532 $ 75,962 $ 7,796
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
46
<PAGE>
- -------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995
(IN THOUSANDS OF DOLLARS)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
NATURE OF OPERATIONS
The Penn Mutual Life Insurance Company (the "Company"), is a mutual life
insurance company which concentrates primarily in the sale of individual life
insurance and annuity products. The primary products that the Company
currently markets are traditional whole life, yearly renewable term, universal
life, variable life, immediate annuities and deferred annuities, both fixed
and variable. The Company markets its products through a network of career
agents, independent agents, and independent marketing organizations. The
Company sells its products in all fifty states and the District of Columbia.
BASIS OF PRESENTATION
The financial statements of the Company have been prepared in conformity with
accounting principles prescribed or permitted by the Insurance Department of
the Commonwealth of Pennsylvania (SAP). Prescribed SAP include state laws,
regulations, and general administrative rules, as well as a variety of
publications of the National Association of Insurance Commissioners (NAIC).
Permitted SAP encompass all accounting practices that are not prescribed.
These principles were considered to be in conformity with generally accepted
accounting principles (GAAP) prior to the issuance of Financial Accounting
Standards Board Interpretation No. 40, "Applicability of Generally Accepted
Accounting Principles to Mutual Life Insurance and other Enterprises," (FIN
No. 40) and Statement of Financial Accounting Standards (SFAS) No. 120,
"Accounting and Reporting by Mutual Life Insurance Enterprises and by
Insurance Enterprises for Certain Long-Duration Participating Contracts".
Effective for fiscal years beginning after December 15, 1995, in accordance
with FIN No. 40, the financial statements of mutual life insurance companies
which are prepared on the basis of SAP can no longer be described as prepared
in conformity GAAP. Therefore, as required by generally accepted auditing
standards, the opinion expressed by our independent accountants on the 1995
and 1994 financial statements is different from that expressed in their
previous report.
In financial statements prepared in conformity with SAP, the accounting
treatment of certain items is different than for financial statements issued
in conformity with GAAP. Significant differences include:
. Policy acquisition costs, such as commissions and other costs incurred in
connection with acquiring new and renewal business, are expensed when
incurred; under GAAP, such costs are deferred and amortized over the
expected premium paying period.
. Premiums for universal life and investment-type products are recognized as
revenue when due; under GAAP, they are accounted for as deposits and
excluded from revenue.
. Policy reserves are based on statutory mortality and interest requirements
and without consideration of withdrawals and are reported net of reinsurance
reserve credits; under GAAP, the reserves are based on expected investment
yield, mortality and withdrawals and are reported gross of reinsurance
reserve credits. Changes in reserves on account of change in valuation basis
during the year are charged directly to surplus rather than reflected in the
net gain from operations, as is the case under GAAP.
. No provision is made for deferred income taxes; under GAAP, deferred taxes
result from temporary differences between the tax basis of assets and
liabilities and their reported amounts in the financial statements.
. An asset valuation reserve (AVR) is established as a liability to offset
potential investment losses and changes in the AVR are charged or credited
to surplus; under GAAP, reserves are established for invested assets based
on evaluation of impairment and are recorded through realized
gains/(losses).
. An interest maintenance reserve (IMR) is established as a liability to
capture gains and losses, net of tax, on the sale of fixed maturities
resulting from changes in the general level of interest rates; no such
reserve is required under GAAP.
. Investments in bonds and preferred stocks are generally carried at amortized
cost; under GAAP, investments in bonds and preferred stocks, other than
those classified as held to maturity, are carried at fair value.
. Certain assets, designated as nonadmitted, are excluded from assets by a
direct charge to surplus; under GAAP, such assets are carried on the
statement of financial condition with appropriate valuation allowances.
47
<PAGE>
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THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
. Pension expense for the qualified noncontributory pension plan (Plan) is
recognized when pension contributions are deductible for federal income tax
purposes, rather than incurred over the service lives of employees
participating in the Plan, as is the case under GAAP.
. Postretirement benefits are recognized for vested employees and current
retirees, rather than accruing an obligation over the service period for all
eligible employees, as is the case under GAAP.
.In accordance with Pennsylvania Insurance Laws and Regulations, the Company's
subsidiaries are not consolidated for statutory filing purposes; under GAAP,
majority-owned subsidiaries are consolidated.
The preparation of financial statements requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
the disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period.
VALUATION OF INVESTMENTS
Bonds and stocks are carried in the accompanying Statements of Financial
Condition at values prescribed by the NAIC. In general, bonds are stated at
amortized cost, preferred stocks at cost and unaffiliated common stocks at
market value. The Company's subsidiaries are carried on the equity basis with
the net income from subsidiaries recorded in net investment income. Real
estate is carried at cost less encumbrances and accumulated depreciation. Real
estate acquired through foreclosure is recorded at the lower of cost or market
value at the time of foreclosure. Real estate is depreciated using the
straight-line method. Mortgage loans are carried at the unpaid principal
amount, less any unamortized discount. Policy loans are stated at the unpaid
principal balance less amounts unsecured by cash surrender and dividend
accumulation values. Cash and short-term investments include cash on deposit
and securities purchased with a maturity date of less than one year. Short-
term investments are valued at cost, which approximates market. Other invested
assets include joint venture real estate partnerships, which are valued on the
equity basis, and venture capital limited partnerships, which are carried at
market value. Certain assets which are considered to be non-admitted for
statutory purposes have been excluded from the Statement of Financial
Condition by a direct charge to surplus.
Financial instruments utilized to hedge the Company's assets are recorded
using a valuation method consistent with the valuation method of the assets
hedged. Gains and losses on financial futures contracts used as hedges against
interest rate fluctuations are deferred and recognized in the Statements of
Operations over the remaining life of the hedged securities. Changes in the
market value of financial futures contracts used as hedges against market
fluctuations of equity securities are reported as unrealized gains or losses.
They are recognized as realized gains or losses when the hedged securities are
sold.
Statutory accounting principles require insurance companies to hold an Asset
Valuation Reserve (AVR) and an Interest Maintenance Reserve (IMR). The purpose
of the AVR is to maintain consistent and prescribed valuation reserves for
invested assets. Changes in the AVR are recorded directly to surplus. The
purpose of the IMR is to defer recognition of realized gains and losses which
result from interest rate movements and to amortize these gains and losses
into income over the original expected life of the investment sold.
Amortization of gains and losses included in the IMR are reflected as a
component of net investment income.
Realized gains and losses are determined on the specific identification method
and presented in the Statements of Operations net of taxes and excluding net
gains and losses transferred to the IMR. Unrealized gains and losses are
accounted for as direct increases or decreases to surplus.
RESERVES AND FUNDS FOR THE PAYMENT OF FUTURE LIFE AND ANNUITY BENEFITS
Reserves and funds for the payment of future life and annuity benefits are
developed using actuarial methods based on statutory mortality and interest
requirements. Reserves for life insurance are computed principally on the net
level, modified preliminary term or CRVM methods using the 1941, 1958 and 1980
Commissioners' Standard Ordinary Mortality and American Experience Tables and
assumed interest rates ranging from 2.25% to 4.5%. Reserves for annuity
contracts are based principally on the 1949, 1971 and 1983 Individual Annuity
Mortality Tables for individual annuities and the 1971 and 1983 Group Annuity
Mortality Tables for group annuities and assumed interest rates ranging from
2.25% to 13.25%. Policy claims in process include provisions for payments to
be made on reported claims and claims incurred but not reported. Any
adjustments
48
<PAGE>
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THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
that are made to the reserve balances are reflected in the Statements of
Operations in the year in which such adjustments are made, with the exception
of changes in valuation bases which are accounted for as a charge or credit to
surplus.
REVENUE AND RELATED EXPENSE RECOGNITION
Premiums are recognized as income over the premium payment period of the
related policies. Annuity considerations are recognized as income as they are
received. Premium and annuity considerations are recorded net of reinsurance
premiums. Benefits are reported net of the amounts received from reinsurers.
Commissions and other expenses related to the acquisition of new policies are
charged to operations as incurred.
FEDERAL INCOME TAXES
The Company files a consolidated federal income tax return with its insurance
and non-insurance subsidiaries. Each subsidiary's tax liability or refund is
accrued on a separate company basis. The Company reimburses subsidiaries for
losses utilized in the consolidated return based on inter-company tax
allocation agreements. In accordance with statutory accounting practices, no
deferred taxes are provided for temporary differences between pre-tax
accounting income and taxable income.
POLICYHOLDER DIVIDENDS
All insurance policies are participating. A liability for the dividends to be
paid or credited to policyholders during the following calendar year is
established at each year end. The amount of dividends to be paid is approved
annually by the Board of Trustees.
SEPARATE ACCOUNTS
Separate Account assets and liabilities represent segregated funds administered
and invested by the Company primarily for the benefit of variable life
insurance policyholders and annuity and pension contractholders, including
certain of the Company's benefit plans. The value of the assets in the Separate
Accounts reflects the actual investment performance of the respective accounts
and is not guaranteed by the Company. The carrying value for Separate Account
assets and liabilities approximates the estimated fair value of the underlying
assets.
RECLASSIFICATIONS
Certain 1995 and 1994 amounts have been reclassified to conform with the 1996
presentation.
NOTE 2 - ACCOUNTING CHANGES:
During 1996, the Company changed its valuation basis for disability income and
certain other contracts. The increase in reserves of $14,773, net of taxes, was
taken as a direct charge to surplus.
The sections of the Internal Revenue Code (IRC) applicable to mutual life
insurance companies require that mutual, but not stock, life insurance
companies include the Differential Earnings Amount (DEA) in each year's taxable
income. This amount is computed by multiplying the Company's average taxable
equity base by a rate that represents the difference between stock and mutual
companies' earnings rates. Under the IRC, the enacted DEA rate for the current
year is an Internal Revenue Service (IRS) estimate and is recomputed in the
following year to reflect the actual industry results.
Prior to 1995, the Company recorded its federal income tax expense for the DEA
based on the enacted IRS rates for the current year along with any adjustment
to the DEA related to the recomputation of the prior year's estimate. The
portion of the Company's federal income tax expense associated with the DEA was
recorded directly to surplus.
In 1995, the Company changed its method of accounting for the DEA to record the
tax based on management's best estimate of the final DEA rates. The impact of
this accounting change resulted in a $16,723 direct charge to surplus in 1995.
In addition, in 1995 the Company began recording the portion of its federal
income tax expense associated with the DEA in the Statement of Operations.
49
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THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
During 1995, the Company changed the reserve valuation bases for certain of its
annuity products. These changes resulted in the release of $24,707 of
policyholder reserves and a corresponding credit directly to surplus.
NOTE 3 - INVESTMENTS:
DEBT SECURITIES
The following summarizes the statement value and estimated fair value of the
Company's investment in debt securities, including redeemable preferred stocks,
as of December 31, 1996 and 1995.
<TABLE>
<CAPTION>
DECEMBER 31, 1996
-------------------------------------------
GROSS GROSS ESTIMATED
STATEMENT UNREALIZED UNREALIZED FAIR
VALUE GAINS LOSSES VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
United States Government........... $ 15,541 $ 549 $ -- $ 16,090
Other governmental units........... 34,451 1,601 -- 36,052
Public utility..................... 415,874 28,379 2,020 442,233
Industrial and other............... 2,102,134 100,466 8,138 2,194,462
Mortgage and other asset-backed se-
curities.......................... 1,973,972 24,969 15,587 1,983,354
---------- -------- ------- ----------
4,541,972 155,964 25,745 4,672,191
Redeemable preferred stocks........ 3,575 -- 266 3,309
---------- -------- ------- ----------
TOTAL............................. $4,545,547 $155,964 $26,011 $4,675,500
========== ======== ======= ==========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1995
-------------------------------------------
GROSS GROSS ESTIMATED
STATEMENT UNREALIZED UNREALIZED FAIR
VALUE GAINS LOSSES VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
United States Government........... $ 63,477 $ 1,875 $ -- $ 65,352
Other governmental units........... 103,090 2,893 -- 105,983
Public utility..................... 509,120 51,946 347 560,719
Industrial and other............... 2,184,414 197,075 13,208 2,368,281
Mortgage and other asset-backed se-
curities.......................... 835,415 32,504 3,951 863,968
---------- -------- ------- ----------
3,695,516 286,293 17,506 3,964,303
Redeemable preferred stocks........ 3,964 -- 237 3,727
---------- -------- ------- ----------
TOTAL............................. $3,699,480 $286,293 $17,743 $3,968,030
========== ======== ======= ==========
</TABLE>
The following summarizes the statement value and estimated fair value of debt
securities as of December 31, 1996 by contractual maturity.
<TABLE>
<CAPTION>
ESTIMATED
STATEMENT FAIR
VALUE VALUE
---------- ----------
<S> <C> <C>
Maturity:
Within one year......................................... $ 211,786 $ 211,591
After one year through five years....................... 621,748 631,662
After five years through ten years...................... 296,615 307,622
After ten years through twenty years.................... 435,475 478,638
After twenty years...................................... 1,002,376 1,059,324
Mortgage and other asset-backed securities.............. 1,973,972 1,983,354
---------- ----------
4,541,972 4,672,191
Redeemable preferred stocks.............................. 3,575 3,309
---------- ----------
TOTAL................................................... $4,545,547 $4,675,500
========== ==========
</TABLE>
50
<PAGE>
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THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
Expected maturities may differ from contractual maturities because certain
borrowers have the right to call or prepay obligations with or without call or
prepayment penalties. Mortgage and other asset-backed securities consist of
commercial and residential mortgage pass-through holdings and securities backed
by credit card receivables, auto loans and home equity and manufactured housing
loans. These securities follow a structured principal repayment schedule and
are of high credit quality. These securities are rated investment grade, other
than $60,547 in commercial mortgage-backed securities retained from the
securitization of the Company's commercial mortgage loan portfolio. The
mortgage and other asset-backed securities portfolio is presented separately in
the maturity schedule due to the potential for prepayment. The weighted average
life of this portfolio is 7.6 years.
During 1996, 1995 and 1994, proceeds from dispositions of investments in debt
securities amounted to $1,079,993, $1,410,126, and $1,038,593, respectively.
The gross gains realized on those dispositions were $13,794, $57,295 and
$5,876, and the gross losses realized on those dispositions were $6,535,
$10,069 and $27,348 during 1996, 1995 and 1994, respectively. Total net
realized losses, net of taxes, transferred to the IMR in 1996 were $16,208.
Total net realized gains, net of taxes, transferred to the IMR in 1995 were
$32,211. Total net realized losses, net of taxes, transferred to the IMR, in
1994 were $14,089. Amortization of the IMR included in net investment income
amounted to $1,160, $1,482 and $1,056 in 1996, 1995 and 1994, respectively.
The Company's investment portfolio of debt securities is comprised
predominantly of investment grade securities. As of December 31, 1996 and 1995,
debt securities totaling $168,313 and $100,013, respectively, were classified
by the NAIC as less than investment grade. The Company did not hold any debt
securities which were non-income producing for the preceding twelve months as
of December 31, 1996 and 1995.
MORTGAGE LOANS
On August 29, 1996, the Company securitized the majority of its mortgage loan
portfolio, by transferring mortgage loans with a principal value of $715,712
and a book value of $715,121 to a trust which qualifies as a REMIC (Real Estate
Mortgage Investment Conduit) under the Internal Revenue Code. The trust issued
sixteen classes of Commercial Mortgage Pass-Through Certificates with a total
par value of $715,912. The certificates evidence the entire beneficial
ownership interest in the trust. The cash flow from the mortgages will be used
to repay the certificates over an average life of 4.28 years. The actual date
on which the principal amount of the notes may be paid in full could be
substantially earlier or later based on performance of the mortgages. The cash
flows of the assets of the trust will be the sole source of payments on the
notes. The Company has not guaranteed these certificates or the mortgage loans
held by the trust. As a result of this transaction, the Company recognized a
loss of $23,029 upon the transfer of the mortgages to the trust, representing
the difference between the fair market value of the certificates and the book
value of the mortgage loans transferred to the trust. This loss was deferred
through the Interest Maintenance Reserve (IMR), net of related taxes, and will
be amortized into income over the remaining life of the mortgages sold.
Included in the Company's bond portfolio are the highest quality classes of
certificates with a par value of $655,055 and a fair market value of $672,643
at the time of the securitization, which the Company retained. The Company sold
the lowest rated classes of certificates with a par value of $60,857 and a fair
market value of $22,752.
The mortgage loans which were not included in the securitization were retained
by the Company and had a book value of $152,480 and an estimated fair value of
$140,691 on the date of the securitization. Loans which the Company intends to
dispose of within a period of 6 to 24 months were written down to their
estimated net realizable value. These loans had a book value of $83,428 and an
estimated net realizable value of $67,642, which resulted in a credit-related
realized loss of $15,786. The Company intends to hold mortgage loans with a
book value of $69,052 on the date of the securitization, through their
remaining terms. The Company has discontinued the origination of commercial
mortgage loans.
51
<PAGE>
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THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
The following summarizes the statement value of mortgage loans, by property
type and geographic concentration, as of December 31, 1996 and 1995.
<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
Property Type
Office buildings.............................................. $ 40,243 $296,976
Retail........................................................ 39,090 230,902
Dwellings..................................................... 33,539 223,192
Other......................................................... 4,174 209,622
-------- --------
Total........................................................ $117,046 $960,692
======== ========
Geographic Concentration
Northeast..................................................... $ 43,552 $328,397
Midwest....................................................... 17,539 358,203
South......................................................... 20,715 132,382
West.......................................................... 35,240 139,979
Canada........................................................ -- 1,731
-------- --------
Total........................................................ $117,046 $960,692
======== ========
</TABLE>
The Company's investments at December 31, 1996 included $12,983 of mortgage
loans delinquent over 60 days and no mortgage loans which were non-income
producing for the preceding twelve months as of December 31, 1996. The
Company's investments at December 31, 1995 included $27,295 of mortgage loans
delinquent over 60 days, including $8,033 of mortgage loans which were non-
income producing for the preceding twelve months as of December 31, 1995. The
mortgage loan portfolio includes $7,110 and $19,928 of restructured mortgage
loans as of December 31, 1996 and 1995, respectively. Restructured mortgage
loans include commercial loans for which the basic terms, such as interest
rate, amortization, maturity date, or collateral have been changed as a result
of actual or anticipated delinquency. Restructures do not include mortgages
refinanced prior to or upon maturity at or above current market terms.
REAL ESTATE
As of December 31, 1996 and 1995, accumulated depreciation on real estate
amounted to $32,592 and $43,069, respectively. Depreciation expense on real
estate totaled $5,769, $10,019 and $8,445 for the years ended December 31,
1996, 1995 and 1994, respectively. The Company's investments include $14,330
and $27,944 of foreclosed real estate as of December 31, 1996 and 1995,
respectively. The statement value of the Company's largest real estate
investment amounted to $49,923 and $54,858 as of December 31, 1996 and 1995,
respectively. During 1996, the Company wrote down the statement value of this
property by $16,000 to its current estimated fair value based on changes in
future valuation assumptions. During 1995, the Company wrote down the statement
value of this property by $76,500 to its estimated fair value at that date.
This write down reflected the Company's determination that the value of the
property was permanently impaired due in part to the notification by the major
tenant that it did not intend to exercise lease extension options. In addition,
as of 1995, the Company no longer intended to hold this property as a long-term
investment.
NOTE 4 - RESERVES AND FUNDS FOR PAYMENT OF FUTURE LIFE AND ANNUITY BENEFITS:
The following summarizes the withdrawal characteristics of the Company's
reserve and deposit funds as of December 31, 1996.
<TABLE>
<CAPTION>
STATEMENT
VALUE
-----------
<S> <C>
Total policyholders' reserves and funds, including separate ac-
count liabilities................................................ $ 6,173,292
Amounts not subject to discretionary withdrawal................... (1,207,000)
-----------
Amounts subject to discretionary withdrawal...................... $ 4,966,292
===========
</TABLE>
52
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THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
Of the total reserves and deposit funds which are subject to discretionary
withdrawal, $1,958,656, which is net of applicable policy loans, may be
withdrawn without the policyholder incurring surrender charges or market value
adjustments to those funds.
NOTE 5 - FAIR VALUE OF FINANCIAL INSTRUMENTS AND OFF-BALANCE-SHEET RISK:
The following table summarizes the statement value and estimated fair value of
the Company's financial instruments as of December 31, 1996 and 1995.
<TABLE>
<CAPTION>
1996 1995
--------------------- ---------------------
STATEMENT ESTIMATED STATEMENT ESTIMATED
VALUE FAIR VALUE VALUE FAIR VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
FINANCIAL ASSETS:
Debt securities
Bonds............................. $4,541,972 $4,672,192 $3,695,516 $3,964,303
Redeemable preferred stocks....... 3,575 3,309 3,964 3,727
Equity securities
Common stock--unaffiliated........ 160 160 8,182 8,182
Non-redeemable preferred stocks... 9,467 12,112 11,085 13,607
Mortgage loans
Commercial........................ 117,046 120,281 958,079 1,000,003
Residential....................... -- -- 2,613 2,930
Policy loans....................... 409,344 387,562 422,865 405,721
Venture capital limited partner-
ships............................. 37,792 37,792 30,325 30,325
Separate account assets............ 1,225,038 1,225,038 911,683 911,683
FINANCIAL LIABILITIES:
Investment-type contracts
Individual annuities.............. 1,216,161 1,246,695 $1,248,138 $1,287,644
Guaranteed investment contracts... 111,276 112,300 222,991 226,255
Other group annuities............. 188,565 189,853 216,686 219,857
Dividends to policyholders payable
in the following year............. 69,445 69,445 72,653 72,653
Separate account liabilities....... 1,225,038 1,225,038 905,960 905,960
</TABLE>
The estimated fair values for the Company's investments in debt and equity
securities are based on quoted market prices, where available. In situations
where market prices are not readily available, primarily private placements,
fair values are estimated using a formula pricing method based on fair values
of securities with similar characteristics. The fair value of currently
performing mortgage loans is estimated by discounting the cash flows associated
with the investments, using an interest rate currently offered for similar
loans to borrowers with similar credit ratings. Loans with similar credit
quality, characteristics and time to maturity are aggregated for purposes of
estimating fair value. Assumptions regarding credit risk, cash flows and
discount rates are determined using the available market and borrower-specific
information. The estimated fair value for non-performing loans is based on the
estimated fair value of the underlying real estate, which is based on recent
appraisals or other estimation techniques. The estimated fair value of policy
loans is calculated by discounting estimated future cash flows using interest
rates currently being offered for similar loans. Loans with similar
characteristics are aggregated for purposes of estimating fair value. The
statement values of cash and short-term investments and separate account assets
approximate their fair values. The estimated fair value for venture capital
limited partnerships is based on values determined by the partnerships'
managing general partners. The resulting estimated fair values may not be
indicative of the value negotiated in an actual sale.
The fair values of the Company's liabilities for individual annuities,
guaranteed investment contracts and other group annuities are estimated by
discounting the cash flows associated with the contracts, using an interest
rate currently offered for similar contracts with maturities similar to those
remaining for the contracts being valued. The statement value for certain of
the other group annuities, totaling $34,803 and $43,490 as of December 31, 1996
and 1995, respectively, approximates the fair value due
53
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THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
to the nature of the contracts. The statement values of dividends to
policyholders payable in the following year and separate account liabilities
approximate their fair values.
Currently, disclosure of estimated fair values is not required for all of the
Company's assets and liabilities. Therefore, presentation of the estimated fair
value of a significant portion of assets without a corresponding valuation of
liabilities associated with insurance contracts can be misinterpreted. The
continuing management of the relationship between the maturities of the
Company's investments and the amounts due under insurance contracts reduces the
Company's exposure to changing interest rates.
The Company is exposed to interest rate risk on its interest sensitive
products. The Company's investment strategy is designed to minimize interest
risk by managing the duration of both assets and liabilities and anticipated
cash flows of the Company's assets and liabilities.
To minimize exposure and reduce risk from exchange and interest rate
fluctuations in the normal course of business, the Company is party to
financial instruments with off-balance-sheet risk. As of December 31, 1996 and
1995, the Company had interest rate swaps with aggregate notional amounts equal
to $115,000, with average unexpired terms of 29 and 39 months, respectively.
Interest rate swap agreements involve the exchange of fixed and floating rate
interest payment obligations without an exchange of the underlying notional
principal amounts. During the term of the swap, the net settlement amount is
accrued as an adjustment to interest income. If the counterparty defaults, the
Company is exposed only to the loss of the interest rate differential. If the
positions were closed as of December 31, 1996 and 1995, the Company would have
recognized gains of $7,605 and $12,880, respectively. The fair values for
interest rate swaps and futures contracts are based on dealers' quotes and
represent the estimated amount the Company would receive to terminate the
contracts taking into account current interest rates and the creditworthiness
of the counterparties, where appropriate.
In the normal course of business, the Company loans securities under
arrangements in which collateral is obtained in amounts greater than the
current market value of loaned securities. This collateral is held in the form
of cash, cash equivalents or securities issued or guaranteed by the United
States Government. The Company is at risk to the extent the value of loaned
securities exceeds the value of the collateral obtained. The Company controls
this risk by requiring collateral of the highest quality and requiring that
additional collateral be deposited when the market value of loaned securities
increases in relation to the collateral held or the value of the collateral
decreases in relation to the value of the loaned securities. The Company had no
loaned securities outstanding as of December 31, 1996 and 1995.
NOTE 6 - BENEFIT PLANS:
The Company maintains both qualified and non-qualified defined benefit plans as
well as qualified defined contribution plans covering substantially all of its
employees and full-time agents. The total pension expense related to these
plans, including amounts allocated to the Company's subsidiaries, amounted to
$8,310, $8,848 and $7,757 in 1996, 1995 and 1994, respectively.
DEFINED BENEFIT PLANS
The Company's expense and funding policy for the qualified defined benefit plan
is to contribute an amount between the minimum required contribution and the
maximum deductible amount in accordance with the Internal Revenue Code. The
benefits for the plan are based on years of service and the employee's
compensation prior to termination of employment.
The following summarizes the accumulated plan benefits, calculated using the
projected unit credit method and plan net assets for the Company's qualified
defined benefit plan as of December 31, 1996 and 1995.
<TABLE>
<CAPTION>
1996 1995
------- -------
<S> <C> <C>
Actuarial present value of accumulated plan benefits:
Vested........................................................ $32,572 $29,744
Non-vested.................................................... 935 763
------- -------
TOTAL........................................................ $33,507 $30,507
======= =======
Net assets available for plan benefits......................... $37,938 $34,067
======= =======
</TABLE>
54
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THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
The actuarial present value of accumulated plan benefits was determined using a
7.5% and a 7.0% assumed discount rate for December 31, 1996 and 1995,
respectively.
The Company also sponsors defined benefit plans for certain employees in excess
of limits for qualified retirement plans. Pension assets are maintained in the
Company's general account. As of December 31, 1996, the plans' total
accumulated benefit obligation, determined in accordance with SFAS No. 87 and
based on a 7.5% assumed discount rate amounted to $16,439. As of December 31,
1995, the plans' total accumulated benefit obligation, determined in accordance
with SFAS No. 87 and based on an 7.0% assumed discount rate amounted to
$17,609. The additional obligation for future salary increases was $1,899 and
$2,539 as of December 31, 1996 and 1995, respectively.
DEFINED CONTRIBUTION PLANS
Defined contribution plan benefits are based on the participant's account
balance. Designated contributions of up to 8% of each employee's annual
compensation are eligible to be matched by the Company. As of December 31, 1996
and 1995, the estimated fair value of the defined contribution plans' assets
was $134,778 and $126,378, respectively.
POSTRETIREMENT BENEFITS
The Company also provides certain health care and life insurance benefits
(postretirement benefits) for retired employees. Substantially all employees
become eligible for these benefits if they reach retirement age eligibility
while working for the Company.
The Company accounts for the costs of postretirement benefits using an accrual
method and is amortizing a transition obligation of $33,744 over 20 years. As
of December 31, 1996 and 1995, the unamortized transition obligation was
$26,996 and $28,683, respectively.
Postretirement benefit expense for the year ended December 31, 1996, 1995 and
1994 was $3,778, $4,426, and $4,346 respectively, which includes the expected
cost of postretirement benefits for vested employees, interest cost, service
cost, and amortization of the transition obligation and the unrecognized
gains/(losses) on the obligation. The interest cost, service cost and
amortization of the unrecognized gain on the obligation were $1,948, $590 and
$447, respectively, for the year ended December 31, 1996. The interest cost and
service cost were $2,471 and $268, respectively, for the year ended December
31, 1995. The interest cost and service cost were $2,366 and $293,
respectively, for the year ended December 31, 1994. There was no unrecognized
gain/(losses) on the obligation in 1995 and 1994. The Company made
contributions to the plans of $2,107, $2,629 and $2,438 in 1996, 1995 and 1994,
respectively, as claims were incurred.
As of December 31, 1996 and 1995, the unfunded postretirement benefit
obligation for retirees and other fully eligible or vested plan participants
was $25,960 and $36,150, respectively. For December 31, 1996 the discount rate
used in determining the accumulated postretirement benefit obligation was 7.5%,
and the health care cost trend rate was 8.5%, graded to 5% over 8 years. For
December 31, 1995, the discount rate used in determining the accumulated
postretirement benefit obligation was 7.0%, and the health care cost trend rate
was 9.0%, graded to 5.0% over 9 years.
The health care cost trend rate assumption has a significant effect on the
amount reported. To illustrate, increasing the assumed health care cost trend
rate by one percentage point in each year would increase the postretirement
benefit obligation as of January 1, 1996 by $1,833 and the estimated
eligibility cost and interest cost components of net periodic postretirement
benefit cost for the year ended December 31, 1996 by $135.
NOTE 7 - FEDERAL INCOME TAXES:
The provision for federal income taxes is computed in accordance with the
sections of the Internal Revenue Code applicable to mutual life insurance
companies.
The taxable income reflected in the Company's federal tax return differs from
statutory income as reflected in the accompanying Statements of Operations.
Significant differences relate to the DEA, treatment of policy acquisition
costs, differences in policy reserve valuation methods, and settled tax issues.
55
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
The IRS has examined the Company's income tax returns through the year 1990 and
is currently examining years 1991 through 1994. Management believes that an
adequate provision has been made for potential assessments.
In 1995, the Company settled various tax issues with the IRS, including an
issue with the tax treatment of certain traditional life insurance policy
updates. As a result of these settlements, the 1995 federal income tax expense
was decreased in the Statement of Operations by approximately $57,000.
NOTE 8 - REINSURANCE:
The Company has assumed and ceded reinsurance on certain life and annuity
contracts under various agreements. The Company remains primarily liable as the
direct insurer on all risks reinsured, and performs due diligence to ensure
that amounts due from reinsurers are collectable. The table below includes the
reinsurance amounts recorded in the accompanying financial statements, which
are presented net of reinsurance activity.
<TABLE>
<CAPTION>
ASSUMED CEDED TO
GROSS FROM OTHER OTHER NET
AMOUNT COMPANIES COMPANIES AMOUNT
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
DECEMBER 31, 1996:
Life Insurance in-force.......... $26,822,820 $7,829,755 $5,517,369 $29,135,206
Premium and annuity considera-
tions........................... 656,437 17,831 33,085 641,183
Reserves and funds for payment of
future life and annuity bene-
fits............................ 5,942,388 3,945 320,167 5,626,166
DECEMBER 31, 1995:
Life Insurance in-force.......... $26,290,414 $7,668,076 $4,982,235 $28,976,255
Premium and annuity considera-
tions........................... 724,188 19,762 33,508 710,442
Reserves and funds for payment of
future life and annuity bene-
fits............................ 5,364,721 3,937 304,360 5,064,298
</TABLE>
During 1994, the Company had gross premiums of $772,461, assumed premiums of
$40,418 and ceded premiums of $41,332.
Under reinsurance agreements with The Penn Insurance and Annuity Company (PIA),
a wholly-owned subsidiary, the Company has assumed and ceded certain risks. As
a result of these reinsurance agreements with PIA, net life insurance in-force
ceded to PIA totaled $327,897 and $342,694 as of December 31, 1996 and 1995,
respectively. The Company reduced its reserves by $243,426 and $242,691 as of
December 31, 1996 and 1995, respectively. Net premium and annuity
considerations ceded to PIA were $11,620 and $11,056, which include an
experience refund paid of $4,461 and $2,257 in 1996 and 1995, respectively. Net
premium and annuity considerations assumed from PIA in 1994 were $10,069.
During 1995, PIA recaptured its single premium immediate annuity business which
it had previously ceded entirely to the Company. The transaction resulted in
the transfer of approximately $31,000 of invested assets and policyholder
liabilities from the Company to PIA.
During 1995, the Company recaptured the portion of its disability income
business that was previously reinsured under a quota share and excess
reinsurance agreement with the Monarch Life Insurance Company ("Monarch"). As a
result of this recapture, approximately $21,200 of cash and policyholder
reserves were transferred to the Company from Monarch.
56
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
NOTE 9 - RELATED PARTIES:
The following summarizes the statement value of the Company's unconsolidated
subsidiaries and affiliates as of December 31, 1996 and 1995:
<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
Independence Square Properties, Inc. ........................ $108,817 $ 88,607
PIA.......................................................... 82,102 65,601
Other affiliates............................................. 14,655 16,985
-------- --------
TOTAL....................................................... $205,574 $171,193
======== ========
</TABLE>
The Company's unconsolidated subsidiaries had combined assets of $1,545,888 and
$1,373,745, and combined liabilities of $1,340,314 and $1,202,552 as of
December 31, 1996 and 1995, respectively. The Company records earnings from
these subsidiaries through investment income. The majority of the earnings of
$37,981, $23,642 and $24,311 for the years ended December 31, 1996, 1995 and
1994, respectively, relate to broker/dealer subsidiaries.
As of December 31, 1996 and 1995, bonds include notes receivable from
subsidiaries of $27,304 and $31,130, respectively. Investment income on notes
receivable from subsidiaries amounted to $1,989, $3,118 and $2,527 for 1996,
1995 and 1994, respectively.
NOTE 10 - COMMITMENTS AND CONTINGENCIES:
The Company and its subsidiaries are respondents in a number of proceedings,
some of which involve extra-contractual damage in addition to other damages. In
addition, insurance companies are subject to assessments, up to statutory
limits, by state guaranty funds for losses of policyholders of insolvent
insurance companies. In the opinion of management, the outcome of the
proceedings and assessments are not likely to have a material adverse effect on
the financial position of the Company.
The Company has undertaken to its wholly-owned subsidiary, PIA, to provide
sufficient financial support so that PIA will have adequate capital and surplus
as required by applicable laws to meet its obligations to its policyholders
under the terms of PIA's policies and contracts.
The Company, in the ordinary course of business, extends commitments relating
to its investment activities. As of December 31, 1996, the Company had
outstanding commitments totaling $13,079 relating to these investment
activities. The fair value of these commitments approximates the face amount.
As of December 31, 1996, unused lines of credit available to the Company
amounted to $40,000.
57
<PAGE>
- --------------------------------------------------------------------------------
APPENDIX A
- --------------------------------------------------------------------------------
MINIMUM INITIAL ANNUAL PREMIUMS
The following table shows for Insureds of varying ages, the minimum initial
annual premium for a Policy with a Basic Death Benefit of $1,000,000. The table
assumes the Insureds will be placed in a nonsmoker class and that no
supplemental benefits will be added to the base Policy.
<TABLE>
<CAPTION>
AGE OF MALE AGE OF FEMALE MINIMUM INITIAL ANNUAL PREMIUM
-----------------------------------------------------------------------------------
<S> <C> <C>
35 35 $2,802
-----------------------------------------------------------------------------------
40 45 $3,224
-----------------------------------------------------------------------------------
45 45 $3,296
-----------------------------------------------------------------------------------
50 45 $3,376
-----------------------------------------------------------------------------------
55 45 $3,462
-----------------------------------------------------------------------------------
55 55 $4,248
-----------------------------------------------------------------------------------
60 58 $4,687
-----------------------------------------------------------------------------------
65 70 $7,146
-----------------------------------------------------------------------------------
70 62 $6,391
-----------------------------------------------------------------------------------
</TABLE>
A-1
<PAGE>
- --------------------------------------------------------------------------------
APPENDIX B
- --------------------------------------------------------------------------------
ADMINISTRATIVE SURRENDER CHARGES PER $1,000 OF INITIAL SPECIFIED AMOUNT
<TABLE>
<CAPTION>
ATTAINED AGE OF YOUNGER CHARGE PER EACH $1,000 OF
INSURED ON POLICY DATE INITIAL SPECIFIED AMOUNT
----------------------------------------------------------------------------
<S> <C>
20-29 $ 6.00
----------------------------------------------------------------------------
30-39 $ 8.00
----------------------------------------------------------------------------
40-49 $10.00
----------------------------------------------------------------------------
50-59 $12.00
----------------------------------------------------------------------------
60-over $14.00
----------------------------------------------------------------------------
</TABLE>
SAMPLE SURRENDER CHARGE PREMIUMS FOR $1,000,000 SPECIFIED AMOUNT
(NS = NONSMOKER; S = SMOKER)
<TABLE>
<CAPTION>
AGE OF SMOKING AGE OF SMOKING MAXIMUM SURRENDER
MALE STATUS FEMALE STATUS CHARGE PREMIUM
---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
50 NS 45 NS $ 9,254
---------------------------------------------------------------------------------------
65 NS 65 NS $29,399
---------------------------------------------------------------------------------------
55 S 55 S $16,280
---------------------------------------------------------------------------------------
55 S 45 NS $10,392
---------------------------------------------------------------------------------------
45 NS 45 S $ 9,040
---------------------------------------------------------------------------------------
35 NS 35 NS $ 5,364
---------------------------------------------------------------------------------------
70 NS 62 S $25,370
---------------------------------------------------------------------------------------
40 S 45 S $ 9,044
---------------------------------------------------------------------------------------
65 S 70 NS $31,204
---------------------------------------------------------------------------------------
60 NS 58 NS $16,885
---------------------------------------------------------------------------------------
</TABLE>
B-1
<PAGE>
- --------------------------------------------------------------------------------
APPENDIX C
- --------------------------------------------------------------------------------
ILLUSTRATIVE NET SINGLE PREMIUM FACTORS
For a Policy Issued to a Male Nonsmoker, age 65, standard underwriting class
and Female, Nonsmoker, age 65, standard underwriting class.
<TABLE>
<S> <C> <C> <C>
65 2.2464 83 1.2787
- --------------------------------------------------------------------------------
66 2.1200 84 1.2557
- --------------------------------------------------------------------------------
67 2.0406 85 1.2348
- --------------------------------------------------------------------------------
68 1.9656 86 1.2159
- --------------------------------------------------------------------------------
69 1.8949 87 1.1987
- --------------------------------------------------------------------------------
70 1.8283 88 1.1831
- --------------------------------------------------------------------------------
71 1.7657 89 1.1686
- --------------------------------------------------------------------------------
72 1.7068 90 1.1550
- --------------------------------------------------------------------------------
73 1.6517 91 1.1421
- --------------------------------------------------------------------------------
74 1.6002 92 1.1295
- --------------------------------------------------------------------------------
75 1.5523 93 1.1171
- --------------------------------------------------------------------------------
76 1.5080 94 1.1044
- --------------------------------------------------------------------------------
77 1.4670 95 1.0913
- --------------------------------------------------------------------------------
78 1.4290 96 1.0778
- --------------------------------------------------------------------------------
79 1.3940 97 1.0643
- --------------------------------------------------------------------------------
80 1.3615 98 1.0520
- --------------------------------------------------------------------------------
81 1.3316 99 1.0321
- --------------------------------------------------------------------------------
82 1.3040
- --------------------------------------------------------------------------------
</TABLE>
C-1
<PAGE>
- --------------------------------------------------------------------------------
APPENDIX D
- --------------------------------------------------------------------------------
POLICIES ISSUED TO NEW YORK RESIDENTS
For Policies issued to New York residents, the surrender charge declines
during the 6th through the 14th Policy Years so that no surrender charge is
deductible during the 15th and later Policy Years. The surrender factors used
to calculate the surrender charge for such Policies are as follows:
<TABLE>
<CAPTION>
SURRENDER FACTOR
SURRENDER DURING APPLIED TO (C) IN
POLICY YEAR FORMULA ON PAGE
-----------------------------------------------------------------------------
<S> <C>
1st through 5th 1.00
-----------------------------------------------------------------------------
6th .90
-----------------------------------------------------------------------------
7th .80
-----------------------------------------------------------------------------
8th .70
-----------------------------------------------------------------------------
9th .60
-----------------------------------------------------------------------------
10th .50
-----------------------------------------------------------------------------
11th .40
-----------------------------------------------------------------------------
12th .30
-----------------------------------------------------------------------------
13th .20
-----------------------------------------------------------------------------
14th .10
-----------------------------------------------------------------------------
15th 0
-----------------------------------------------------------------------------
</TABLE>
D-1
