<PAGE>
PROSPECTUS
MAY 1, 1998
(as revised
August 7, 1998)
DELAWARE GROUP PREMIUM FUND, INC.
1818 Market Street, Philadelphia, PA 19103
This Prospectus describes the Small Cap Value Series and the Delaware
Series ("Series") of Delaware Group Premium Fund, Inc. (the "Fund").
Small Cap Value Series' objective is to seek capital appreciation by
investing primarily in small cap common stocks whose market value appears low
relative to their underlying value or future earnings and growth potential.
Emphasis will also be placed on securities of companies that may be temporarily
out of favor or whose value is not yet recognized by the market. This Series has
the same objective and investment disciplines as Small Cap Value Fund of
Delaware Group Equity Funds V, Inc., a separate fund in the Delaware Investments
family.
Delaware Series' objective is to seek a balance of capital appreciation,
income and preservation of capital. It uses a dividend-oriented valuation
strategy to select securities issued by established companies that are believed
to demonstrate potential for income and capital growth. This Series has the same
objective and investment disciplines as Delaware Fund of Delaware Group Equity
Funds I, Inc., a separate fund in the Delaware Investments family, in that, as a
"balanced" fund, the Series, consistent with its objective, invests at least 25%
of its assets in fixed-income securities and the remainder primarily in equity
securities.
The shares of the Fund are sold only to separate accounts of life insurance
companies ("life companies"). The separate accounts are used in conjunction with
variable annuity contracts and variable life insurance policies ("variable
contracts"). The separate accounts invest in shares of the various series in
accordance with allocation instructions received from contract owners. The
investment objective and principal policies of each Series are described below.
See Investment Objectives and Policies. Although each Series will constantly
strive to attain its objective, there can be no assurance that it will be
attained.
This Prospectus sets forth information that you should read and consider
before you invest. Please retain it for future reference. A Statement of
Additional Information ("Part B" of the Fund's registration statement), dated
May 1, 1998, as revised August 7, 1998, and as it may be amended from time to
time, contains additional information about the Fund and has been filed with the
Securities and Exchange Commission ("SEC"). Part B is incorporated by reference
into this Prospectus and is available, without charge, by writing to Delaware
Distributors, L.P. at the above address or by calling 1-800-523-1918. The SEC
also maintains a Web site (http://www.sec.gov) that contains Part B, material
incorporated by reference into the Fund's registration statement, and other
information regarding registrants that electronically file with the SEC. The
Series' financial statements appear in the Fund's Annual Report, which will
accompany any response to requests for Part B.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
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BE SURE TO CONSULT YOUR FINANCIAL ADVISER WHEN MAKING INVESTMENTS. MUTUAL
FUNDS CAN BE A VALUABLE PART OF YOUR FINANCIAL PLAN; HOWEVER, SHARES OF THE
SERIES ARE NOT FDIC OR NCUSIF INSURED, ARE NOT GUARANTEED BY ANY BANK OR ANY
CREDIT UNION, ARE NOT OBLIGATIONS OF ANY BANK OR ANY CREDIT UNION, AND INVOLVE
INVESTMENT RISK, INCLUDING THE POSSIBLE LOSS OF THE PRINCIPAL AMOUNT INVESTED.
SHARES OF THE SERIES ARE NOT BANK OR CREDIT UNION DEPOSITS.
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1
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TABLE OF CONTENTS
Cover Page................................................................1
Summary Information.......................................................3
Financial Highlights......................................................4
Investment Objectives and Policies........................................6
Introduction..........................................................6
Small Cap Value Series................................................6
Delaware Series.......................................................7
Purchase and Redemption...................................................8
Dividends and Distributions...............................................8
Taxes.....................................................................8
Calculation of Offering Price and Net Asset Value Per Share...............8
Management of the Fund....................................................9
Performance Information..............................................10
Distribution and Service.............................................10
Expenses.............................................................11
Description of Fund Shares...........................................11
Other Considerations.....................................................12
Appendix A-Ratings.......................................................21
2
<PAGE>
SUMMARY INFORMATION
INVESTMENT OBJECTIVES AND POLICIES
The Small Cap Value Series' objective is to seek capital appreciation by
investing primarily in small cap common stocks whose market value appears low
relative to their underlying value or future earnings and growth potential.
Emphasis will also be placed on securities of companies that may be temporarily
out of favor or whose value is not yet recognized by the market. This Series has
the same objective and investment disciplines as Small Cap Value Fund of
Delaware Group Equity Funds V, Inc., a separate fund in the Delaware Investments
family.
Delaware Series' objective is to seek a balance of capital appreciation,
income and preservation of capital. It uses a dividend-oriented valuation
strategy to select securities issued by established companies that are believed
to demonstrate potential for income and capital growth. This Series has the same
objective and investment disciplines as Delaware Fund of Delaware Group Equity
Funds I, Inc., a separate fund in the Delaware Investments family, in that, as a
"balanced" fund, the Series, consistent with its objective, invests at least 25%
of its assets in fixed-income securities and the remainder primarily in equity
securities.
See Investment Objectives and Policies.
SPECIAL CONSIDERATIONS AND RISK FACTORS
Prospective investors should consider a number of factors before investing
in the Series:
1. Small Cap Value Series invests primarily in small cap common stocks. As a
general matter, small cap companies may have more limited product lines, markets
and financial resources than large cap companies. In addition, securities of
small cap companies, generally, may trade less frequently (and with a lesser
volume), may be more volatile and may be somewhat less liquid than securities
issued by larger capitalization companies. See Small Cap Value Series under
Investment Objectives and Policies.
2. Each Series may invest a portion of its assets in securities issued by
non-United States companies. Investing in securities of non-United States
companies which are generally denominated in foreign currencies, and utilization
of forward foreign currency exchange contracts in connection with transactions
in such securities involve certain risk and opportunity considerations not
typically associated with investing in the securities of United States companies
and issuers. See Foreign Currency Transactions, Foreign Securities and Foreign
Currency Transactions and Special Risk Considerations under Other
Considerations.
<PAGE>
3. Each Series has the right to engage in certain options transactions for
hedging purposes to counterbalance portfolio volatility. The Series do not
engage in such activities for speculative purposes, but there are certain risks
associated with the use of options which a prospective investor should consider.
See Options under Other Considerations.
4. Small Cap Value Series also may engage in certain hedging transactions
involving futures contracts and options on such contracts, and in connection
with such activities will maintain certain collateral in special accounts
established with or on behalf of futures commission merchants. While the Series
does not engage in such transactions for speculative purposes, there are risks
which result from the use of these instruments which an investor should
consider. The Fund is not registered as a commodity pool operator nor is
Delaware Management Company registered as commodities trading advisers in
reliance upon various exemptive rules. See Futures Contracts and Options on
Futures Contracts under Other Considerations.
INVESTMENT MANAGER
Delaware Management Company ("Delaware Management") furnishes investment
management services to each Series, subject to the supervision and direction of
the Fund's Board of Directors. See Management of the Fund for information about
Delaware Management and the fees payable under each Series' Investment
Management Agreement.
PURCHASE AND REDEMPTION
Shares of the Series are sold only to separate accounts of life insurance
companies. Purchases and redemptions are made at the net asset value
calculated after receipt of the purchase or redemption order. Neither the
Series nor Delaware Distributors, L.P. (the "Distributor"), assesses a charge
for purchases or redemptions. See Purchase and Redemption.
OPEN-END INVESTMENT COMPANY
The Fund, which was organized as a Maryland corporation in 1987, is an
open-end registered management investment company. Each Series operates as a
diversified fund as defined by the Investment Company Act of 1940 (the "1940
Act").
3
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FINANCIAL HIGHLIGHTS
The following financial highlights are derived from the financial statements of
Delaware Group Premium Fund, Inc. and have been audited by Ernst & Young LLP,
independent auditors. The data should be read in conjunction with the financial
statements, related notes, and the report of Ernst & Young LLP, all of which are
incorporated by reference into Part B. Further information about each Series'
performance is contained in the Fund's Annual Report to shareholders. A copy of
the Fund's Annual Report (including the report of Ernst & Young LLP) may be
obtained from the Fund upon request at no charge.
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<TABLE>
<CAPTION>
Small Cap Value Series
----------------------------------------------------------------------
12/27/93(1)
Year Ended through
12/31/97 12/31/96 12/31/95 12/31/94 12/31/93
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of period......... $ 14.500 $ 12.470 $10.290 $10.210 $10.000
Income From Investment Operations:
- ----------------------------------
Net investment income........................ 0.122 0.112 0.192 0.148 none
Net realized and unrealized gain (loss) on
investments.................................. 4.338 2.548 2.208 (0.068) 0.210
-------- -------- ------- ------- ------
Total from investment operations............. 4.460 2.660 2.400 0.080 0.210
-------- -------- ------- ------- ------
Less Dividends and Distributions:
- ---------------------------------
Dividends from net investment income......... (0.110) (0.180) (0.150) none none
Distributions from net realized gain
on investment transactions................. (0.930) (0.450) (0.070) none none
Total dividends and distributions............ (1.040) (0.630) (0.220) none none
-------- -------- ------- ------- ------
Net asset value, end of period............... $17.920 $ 14.500 $12.470 $10.290 $10.210
======== ======== ======= ======= =======
- -----------------------------------------------------------------------------------------------------------------------------
Total return(2).............................. 32.91%(3) 22.55%(3) 23.85%(3) 0.78%(3) 2.10%(3)
- ------------
- -----------------------------------------------------------------------------------------------------------------------------
Ratios and Supplemental Data:
- -----------------------------
Net assets, end of period (000 omitted)...... $ 84,071 $ 23,683 $11,929 $6,291 $ 210
Ratio of expenses to average net assets...... 0.80% 0.80% 0.80 0.80% (4)
Ratio of expenses to average net assets
prior to expense limitation................ 0.90% 0.99% 0.96% 1.41% (4)
Ratio of net investment income to
average net assets......................... 1.24% 1.28% 2.13% 2.62% (4)
Ratio of net investment income to average
net assets prior to expense limitation..... 1.14% 1.09% 1.97% 2.01% (4)
Portfolio turnover........................... 41% 84% 71% 26% (4)
Average commission rate paid(5).............. $ 0.0600 $ 0.0600 N/A N/A N/A
</TABLE>
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(1) Date of initial public offering; total return has not been annualized. Total
return for this short of a time period may not be representative of longer term
results.
(2) Total return does not reflect expenses that apply to the Separate Accounts
or to the related insurance policies and inclusion of these charges would reduce
total return figures for all periods shown.
(3) Total return reflects the expense limitation referenced in Expenses under
Management of the Fund.
(4) The ratios of expenses and net investment income to average net assets and
portfolio turnover have been omitted as management believes that such ratios are
not meaningful due to the limited net assets of this Series.
(5) Computed by dividing the total amount of commissions paid by the total
number of shares purchased and sold during the period for which there was a
commission charged.
4
<PAGE>
<TABLE>
<CAPTION>
Delaware Series
-----------------------------------------------------------------
Year Ended
12/31/97 12/31/96 12/31/95 12/31/94 12/31/93
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of period.................... $16.640 $15.500 $12.680 $13.330 $13.550
Income From Investment Operations:
- ----------------------------------
Net investment income................................... 0.435 0.530 0.509 0.437 0.328
Net realized and unrealized gain (loss) on investments.. 3.575 1.765 2.761 (0.447) 0.692
------- ------- ------- ------ -------
Total from investment operations........................ 4.010 2.295 3.270 (0.010) 1.020
------- ------- ------- ------ -------
Less Dividends and Distributions:
- ---------------------------------
Dividends from net investment income.................... (0.530) (0.500) (0.450) (0.340) (0.460)
Distributions from net realized gain
on investment transactions............................ (1.070) (0.655) none (0.300) (0.780)
------ ------ ------- ------ ------
Total dividends and distributions....................... (1.600) (1.155) (0.450) (0.640) (1.240)
------ ------ ------ ------ ------
Net asset value, end of period.......................... $19.050 $16.640 $15.500 $12.680 $13.330
======= ======= ======= ======= =======
- -----------------------------------------------------------------------------------------------------------------------------------
Total Return(2)......................................... 26.40% 15.91% 26.58% (0.15%) 8.18%(3)
- ------------
- -----------------------------------------------------------------------------------------------------------------------------------
Ratios and Supplemental Data:
- -----------------------------
Net assets, end of period (000 omitted)................. $127,675 $75,402 $63,215 $47,731 $37,235
Ratio of expenses to average net assets................. 0.67% 0.68% 0.69% 0.70% 0.80%
Ratio of expenses to average net assets
prior to expense limitation........................... 0.67% 0.68% 0.69% 0.70% 0.89%
Ratio of net investment income to
average net assets.................................... 2.85% 3.56% 3.75% 3.71% 3.33%
Ratio of net investment income to average
net assets prior to expense limitation................ 2.85% 3.56% 3.75% 3.71% 3.24%
Portfolio turnover...................................... 67% 92% 106% 140% 162%
Average commission rate paid(5)......................... $0.0600 $0.0600 N/A N/A N/A
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Delaware Series
---------------------------------------------------------
Year Ended 7/28/88(1)
through
12/31/92 12/31/91 12/31/90 12/31/89 12/31/88
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of period.................... $12.980 $10.840 $11.800 $10.160 $10.000
Income From Investment Operations:
- ----------------------------------
Net investment income................................... 0.457 1.082 0.341 0.130 0.064
Net realized and unrealized gain (loss) on investments.. 1.233 1.668 (0.391) 1.550 0.096
------- ------- ------ ------ -------
Total from investment operations........................ 1.690 2.750 (0.050) 1.680 0.160
------- ------- ------ ------ -------
Less Dividends and Distributions:
- ---------------------------------
Dividends from net investment income.................... (1.060) (0.350) (0.270) (0.040) none
Distributions from net realized gain
on investment transactions............................ (0.060) (0.260) (0.640) none none
------ ------ ------ ------ -------
Total dividends and distributions....................... (1.120) (0.610) (0.910) (0.040) none
------ ------ ------ ------ -------
Net asset value, end of period.......................... $13.550 $12.980 $10.840 $11.800 $10.160
======= ======= ======= ======= =======
- --------------------------------------------------------------------------------------------------------------------------
Total Return(2)......................................... 13.85%(3) 26.58% (0.18%) 16.60% 3.77%
- ------------
- --------------------------------------------------------------------------------------------------------------------------
Ratios and Supplemental Data:
- -----------------------------
Net assets, end of period (000 omitted)................. $15,150 $12,138 $6,137 $ 3,182 $ 151
Ratio of expenses to average net assets................. 0.86% 1.03% 1.35% 1.99% 4
Ratio of expenses to average net assets
prior to expense limitation........................... 0.94% 1.03% 1.35% 1.99% 4
Ratio of net investment income to
average net assets.................................... 3.60% 11.35% 3.84% 2.22% 4
Ratio of net investment income to average
net assets prior to expense limitation................ 3.52% 11.35% 3.84% 2.22% 4
Portfolio turnover...................................... 202% 1,010% 210% 132% 4
Average commission rate paid(5)......................... N/A N/A N/A N/A N/A
</TABLE>
(1) Date of initial public offering; ratios and total return have been
annualized. Total return for this short of a time period may not be
representative of longer term results.
(2) Total return does not reflect expenses that apply to the Separate Accounts
or to the related insurance policies and inclusion of these charges would reduce
total return figures for all periods shown.
(3) Total return reflects the expense limitation referenced in Expenses under
Management of the Fund.
(4) The ratios of expenses and net investment income to average net assets and
portfolio turnover have been omitted as management believes that such ratios are
not meaningful due to the limited net assets of this Series.
(5) Computed by dividing the total amount of commissions paid by the total
number of shares purchased and sold during the period for which there was a
commission charged.
5
<PAGE>
INVESTMENT OBJECTIVES
AND POLICIES
INTRODUCTION
The Fund, a corporation organized in Maryland on February 19, 1987, is an
open-end management investment company offering various series of shares.
The investment objective of each Series is a fundamental policy and cannot
be changed without approval by the holders of a "majority" of that Series'
outstanding shares, as defined in the 1940 Act. Although each Series will
constantly strive to attain its objective, there can be no assurance that it
will be attained. In addition to the objective and investment techniques
described below for the Series, see Other Considerations for investment
techniques available to the Series. Part B provides more information on the
Series' investment policies and restrictions.
SMALL CAP VALUE SERIES
The objective of Small Cap Value Series is capital appreciation. The
strategy will be to invest primarily in common stocks and issues convertible
into common stocks which, in the opinion of Delaware Management, have market
values which appear low relative to their underlying value or future earnings
and growth potential.
Securities will be purchased that Delaware Management believes to be
undervalued in relation to asset value or long-term earning power of the
companies. Delaware Management may also invest in securities of companies where
current or anticipated favorable changes within a company provide an opportunity
for capital appreciation. Delaware Management's emphasis will be on securities
of companies that may be temporarily out of favor or whose value is not yet
recognized by the market.
While not a fundamental policy, under normal market conditions the Fund
intends to invest 65% of its net assets in securities issued by small cap
companies, defined as those currently having a market capitalization generally
of less than $1.5 billion at the time of purchase. As a general matter, small
cap companies may have more limited product lines, markets and financial
resources than large cap companies. In addition, securities of small cap
companies, generally, may trade less frequently (and with a lesser volume), may
be more volatile and may be somewhat less liquid than securities issued by
larger capitalization companies.
<PAGE>
Delaware Management will consider the financial strength of the company, the
nature of its management and any developments affecting the security, the
company or the industry. Securities may be out of favor due to a variety of
factors, such as lack of an institutional following, or unfavorable developments
affecting the issuer of the securities, such as poor earning reports, dividend
reductions or cyclical economic or business conditions. Other securities
considered by Delaware Management would include those of companies where current
or anticipated favorable changes such as a new product or service, technological
breakthrough, management change, projected takeovers, changes in capitalization
or redefinition of future corporate operations provide an oppor tunity for
capital appreciation. Delaware Management will also consider securities where
trading patterns suggest that significant positions are being accumulated by
officers of the company, outside investors or the company itself. Delaware
Management feels it may uncover situations where those who have a vested
interest in the company feel the securities are undervalued and have
appreciation potential.
If Delaware Management believes that market conditions warrant, the
Series may employ options strategies. Also, on a temporary, defensive basis,
the Series may invest in fixed-income obligations.
INVESTMENT STRATEGY
While management believes that Small Cap Value Series' objective may best be
attained by investing in common stocks, the Series may also invest in other
securities including, but not limited to, convertible securities, warrants,
preferred stocks, bonds and foreign securities. Although it is expected to
receive relatively less emphasis, the Series may also invest in fixed-income
securities without regard to a minimum grade level in pursuit of its objective
where there are favorable changes in a company's earnings or growth potential or
where general economic conditions and the interest rate environment provide an
opportunity for declining interest rates and consequent appreciation in these
securities. The strategies employed are dependent upon the judgment of Delaware
Management.
In investing for capital appreciation, the Series may hold securities for
any period of time. The degree of portfolio activity will affect brokerage costs
of the Series.
Should the market warrant a temporary, defensive approach, the Series may
also invest in fixed-income obligations issued or guaranteed by the U.S.
government, its agencies or instrumentalities, as well as money market
instruments, and corporate bonds rated A or above by Moody's Investors Service
("Moody's") or Standard & Poor's Ratings Group ("S&P").
The Series may write covered call options on individual issues as well as
write call options on stock indices. The Series may also purchase put options on
individual issues and on stock indices. Delaware Management will employ these
techniques in an attempt to protect appreciation attained, to offset capital
losses and to take advantage of the liquidity available in the option markets.
The ability to hedge effectively using options on stock indices will depend, in
part, on the correlation between the composition of the index and the Series'
portfolio as well as the price movement of individual securities. The Series
does not currently intend to write or purchase stock index options.
6
<PAGE>
While there is no limit on the amount of the Series' assets which may be
invested in covered call options, the Series will not invest more than 2% of its
net assets in put options. The Series will only use Exchange-traded options. See
Other Considerations -- Options.
The Series may enter into futures contracts and buy and sell options on
futures contracts relating to securities, securities indices or interest
rates. See Other Considerations -- Futures Contracts and Options on Futures
Contracts.
RISK FACTORS
The Series may be suitable for the patient investor interested in long-term
capital appreciation. The investor should be willing to accept the risks
associated with investments in domestic and international securities (and
currency hedging transactions in connection therewith), as these investments may
be speculative and subject the Series to an additional risk. See Foreign
Securities and Foreign Currency Transactions under Other Considerations.
Investing in a company temporarily out of favor may involve the risk that the
anticipated favorable change may not occur and, as a result, that security may
decline in value or not appreciate as expected. Although it will receive
relatively minor emphasis in pursuit of its objective, the Series may also
purchase, at times, lower rated or unrated corporate bonds without regard to a
grade minimum, which may be considered speculative and may increase the
portfolio's credit risk. Although the Series will not ordinarily purchase bonds
rated below B by Moody's or S&P (i.e., high-yield, high risk fixed-income
securities), it may do so if Delaware Management believes that capital
appreciation is likely. The Series will not invest more than 25% of its net
assets in bonds rated below B. Investing in such lower rated debt securities may
involve certain risks not typically associated with higher rated securities.
Such bonds are considered very speculative and may possibly be in default or
have interest payments in arrears. See High-Yiel d, High Risk Securities under
Other Considerations for additional information on the risks associated with
such securities.
Net asset value may fluctuate at times in response to market conditions and,
as a result, the Series is not appropriate for a short-term investor.
This Series is designed primarily for capital appreciation. Providing
current income is not an objective of the Series. Any income produced is
expected to be minimal.
DELAWARE SERIES
Delaware Series seeks a balance of capital appreciation, income and
preservation of capital. As a "balanced" fund, the Series will generally invest
at least 25% of its assets in fixed-income securities, including U.S. government
securities and corporate bonds. The balance of the portfolio will be allocated
to equity securities principally, including convertible securities, and also to
cash and cash equivalents. If the Series invested in convertible securities, the
value of the convertible security would be allocated to its fixed-income
component and its conversion rights component for purposes of the 25%
fixed-income allocation.
<PAGE>
The Series uses a dividend-oriented valuation strategy to select individual
securities in which it will invest. In seeking capital appreciation, the Series
invests primarily in common stocks of established companies believed to have a
potential for long-term capital growth. In seeking current income and
preservation of capital, in addition to capital appreciation, the Series invests
in various types of fixed-income securities, including U.S. government and
government agency securities and corporate bonds. The Series intends to invest
in bonds that are rated in the top four grades by a nationally-recognized rating
agency (i.e., Moody's or S&P) at the time of purchase, or, if unrated, are
determined to be equivalent to the top four grades in the judgment of Delaware
Management. The fourth grade is considered medium grade and may have some
speculative characteristics. To the extent that the rating of a security held by
the Series falls below the fourth grade or Delaware Management determines that
an unrated security no longer is of comparable quality, the Series, as soon as
practicable, will dispose of such security, unless such disposal, in the
judgment of Delaware Management, would be detrimental in light of then
prevailing market conditions. Typically, the maturity of the bonds will range
between five and 30 years. The Series may not concentrate investments in any
industry, which means not investing more than 25% of its assets in any one
industry.
The Series may invest in shares or convertible bonds issued by real estate
investment trusts ("REITS"). REITS invest primarily in income producing real
estate as well as real estate related loans or interests. A REIT is not taxed on
income distributed to shareholders if it complies with several requirements
relating to its organization, ownership, assets and income, and a requirement
that it distribute to its shareholders at least 95% of its taxable income (other
than net capital gains) for each taxable year. The Series anticipates investing
only in REITS that invest the majority of their assets directly in real property
and derive their income primarily from rents, which are known as "equity REITS."
Equity REITS can also realize capital gains by selling properties that have
appreciated in value.
In pursuing its investment objective, the Series may hold securities for any
period of time. For temporary, defensive purposes, the Series may hold a
substantial portion of its assets in cash or short-term obligations, including
repurchase agreements.
The Series may be suitable for the patient investor interested in long-term
capital appreciation. The investor should be willing to accept the risks
associated with investments in equity and fixed-income securities.
The value of the Series' shares can be expected to fluctuate depending upon
market conditions and, thus, an investment in the Series may not be appropriate
for a short-term investor. Investment results of the Series will be affected by
the ability of Delaware Management to anticipate changes in economic and market
conditions and, consequently, there can be no assurance that the Series'
investment objective will be realized.
* * *
Part B contains other more specific investment restrictions and Appendix A
to this Prospectus contains descriptions of Moody's and S&P ratings.
7
<PAGE>
PURCHASE AND REDEMPTION
Shares are sold only to separate accounts of life companies at net asset
value. (See Calculation of Offering Price and Net Asset Value Per Share.)
Redemptions will be effected by the separate accounts at the net asset value
next determined after receipt of the order to meet obligations under the
variable contracts. Contract owners do not deal directly with the Fund with
respect to the acquisition or redemption of Fund shares.
DIVIDENDS AND DISTRIBUTIONS
The Fund will make payments from Small Cap Value Series' net income and net
realized securities profits, if any, once a year. Distributions from net
realized securities profits normally will be distributed following the close of
the fiscal year.
The Fund will make payments from Delaware Series' net investment income
quarterly. Distributions from the Series' net realized securities profits, if
any, normally will be made following the close of the fiscal year.
The Fund's fiscal year ends on December 31.
All dividends and distributions are automatically reinvested in
additional Series shares.
TAXES
Each Series has qualified, and intends to continue to qualify, as a
regulated investment company under Subchapter M of the Internal Revenue Code
(the "Code"). As such, a Series will not be subject to federal income tax to the
extent its earnings are distributed. The Fund intends to distribute
substantially all of the Series' net investment income and net capital gains.
Shareholders may be proportionately liable for taxes on income and gains of a
Series but shareholders not subject to tax on their income will not be required
to pay tax on amounts distributed to them, and the Fund will inform shareholders
of the amount and nature of such income or gains.
CALCULATION OF OFFERING PRICE AND NET ASSET VALUE PER SHARE
The offering price is the net asset value ("NAV") per share next determined
after an order is received. The offering price and net asset value are computed
as of the close of regular trading on the New York Stock Exchange (ordinarily, 4
p.m., Eastern time) on days when the Exchange is open.
Each Series' NAV per share is computed by adding the value of all securities
and other assets in the Series' portfolio, deducting any liabilities of the
Series (expenses and fees are accrued daily) and dividing by the number of the
Series' shares outstanding. The valuation criteria set forth below apply equally
to securities purchased in reliance upon Rule 144A of the 1933 Act. In
determining the Series' total net assets, portfolio securities listed or traded
on a national securities exchange, except for bonds, are valued at the last sale
price on the exchange upon which such securities are primarily traded.
Securities not traded on a particular day, over-the-counter securities and
government and agency securities are valued at the mean value between bid and
asked prices. Foreign securities expressed in foreign currency values will be
converted into U.S. dollar values at the mean between the currencies' bid and
offered quotations. Debt securities (other than short-term investments and, in
some cases, convertible securities) are priced at fair value by an independent
pricing service using methods approved by the Fund's Board of Directors.
Short-term investments having a maturity of less than 60 days are valued at
amortized cost, which approximates market value. All other securities are valued
at their fair value as determined in good faith and in a method approved by the
Fund's Board of Directors.
To the extent a Series holds foreign securities that are listed primarily on
foreign exchanges which trade on days when the New York Stock Exchange is closed
(such as U.S. Holidays and Saturdays), the net asset value of the Series could
be affected by trading on days when shareholders have no access to the Series.
8
<PAGE>
MANAGEMENT OF THE FUND
DIRECTORS
The business and affairs of the Fund are managed under the direction of
its Board of Directors. Part B contains additional information regarding the
directors and officers.
INVESTMENT MANAGER
Delaware Management furnishes investment management services to each Series.
The Manager and its predecessors have been managing the funds in the
Delaware Investments family since 1938. On June 30, 1998, the Manager and its
affiliates within Delaware Investments, including Delaware International
Advisers Ltd., were managing in the aggregate more than $44 billion in assets in
the various institutional or separately managed (approximately $26,604,750,000)
and investment company (approximately $17,876,100,000) accounts.
Delaware Management is a series of Delaware Management Business Trust.
Delaware Management changed its form of organization from a corporation to a
business trust on March 1, 1998. Delaware Management is an indirect, wholly
owned subsidiary of Delaware Management Holdings, Inc. ("DMH"). On April 3,
1995, a merger between DMH and a wholly owned subsidiary of Lincoln National
Corporation ("Lincoln National") was completed. DMH and Delaware Management are
now indirect, wholly owned subsidiaries, and subject to the ultimate control, of
Lincoln National. Lincoln National, with headquarters in Fort Wayne, Indiana, is
a diversified organization with operations in many aspects of the financial
services industry, including insurance and investment management. Delaware
Management's address is One Commerce Square, 2005 Market Street, Philadelphia,
PA 19103.
<PAGE>
Delaware Management manages each Series' portfolio and makes investment
decisions which are implemented by the Fund's Trading Department. For these
services, Delaware Management is paid an annual fee equal to 0.75% of the
average daily net assets of Small Cap Value Series and an annual fee equal to
0.60% of the average daily net assets of Delaware Series, less, in the case of
Delaware Series, a proportionate share of all directors' fees paid to the
unaffiliated directors of the Fund.
See Expenses for a discussion of the voluntary waiver of its management fee
undertaken by Delaware Management. For the fiscal year ended December 31, 1997,
the investment management fee, as a percentage of average daily net assets,
incurred by Small Cap Value Series was 0.75% and 0.65% was paid after the
voluntary waiver of fees by Delaware Management. For the fiscal year ended
December 31, 1997, the investment management fee, as a percentage of average
daily net assets, paid by Delaware Series was 0.60%.
The directors of the Fund annually review fees paid to Delaware Management.
Beginning in May 1997, Christopher S. Beck, Vice President/Senior
Portfolio Manager of the Fund, assumed primary responsibility for making
day-to-day investment decisions for the Series. Mr. Beck has been in the
investment business for 17 years, starting with Wilmington Trust in 1981.
Later, he became Director of Research at Cypress Capital Management in
Wilmington and Chief Investment Officer of the University of Delaware
Endowment Fund. Prior to joining Delaware Investments in May 1997, he managed
the Small Cap Fund since October 1995 at Pitcairn Trust Company. He holds a
B.S. from the University of Delaware, an MBA from Lehigh University and is a
CFA charterholder. In making investment decisions for the Series, Mr. Beck
regularly consults with Wayne A. Stork, Richard G. Unruh, Jr. and Andrea
Giles. Mr. Stork, Chairman of Delaware Management and the Fund's Board of
Directors, is a graduate of Brown University and attended New York
University's Graduate School of Business Administration. Mr. Stork joined
Delaware Investments in 1962 and has served in various executive capacities
at different times within the Delaware organization. Mr. Unruh is a graduate
of Brown University and received his MBA from the University of
Pennsylvania's Wharton School. He joined Delaware Investments in 1982 after
19 years of investment management experience with Kidder, Peabody & Co. Inc.
Mr. Unruh was named an Executive Vice President of the Fund in 1994. He is
also a member of the Board of Directors of Delaware Management and was named
an Executive Vice President of Delaware Management in 1994. Ms. Giles,
Research Analyst for the Fund, holds a BSAD from the Massachusetts Institute
of Technology and an MBA in Finance from Columbia University. Prior to
joining Delaware Investments in 1996, she was an account officer in the
Leveraged Capital Group with Citibank.
9
<PAGE>
George H. Burwell and Gary A. Reed, each a Vice President/Senior Portfolio
Manager of the Fund, have primary responsibility for making day-to-day
investment decisions for the Delaware Series. Mr. Burwell, who has been Delaware
Series' senior portfolio manager for equities since 1992, holds a BA from the
University of Virginia. Prior to joining Delaware Investments in 1992, Mr.
Burwell was a portfolio manager for Midlantic Bank in Edison, New Jersey, where
he managed an equity mutual fund and three commingled funds. Mr. Burwell is a
CFA charterholder. Mr. Reed has been Delaware Series' senior portfolio manager
for fixed-income since 1989. He holds an AB in Economics from the University of
Chicago and an MA in Economics from Columbia University. He began his career in
1978 with the Equitable Life Assurance Company in New York City, where he
specialized in credit analysis. Prior to joining Delaware Investments in 1989,
Mr. Reed was Vice President and Manager of the fixed-income department at Irving
Trust Company in New York. In making investment decisions for the Delaware
Series, Mr. Burwell and Mr. Reed regularly consult with Wayne A. Stork, Richard
G. Unruh, Jr. and Paul E. Suckow. Mr. Suckow is Delaware Management's Chief
Investment Officer for Fixed-Income. A CFA charterholder, he is a graduate of
Bradley University with an MBA from Western Illinois University. Mr. Suckow was
a fixed-income portfolio manager at Delaware Investments from 1981 to 1985. He
returned to Delaware Investments in 1993 after eight years with Oppenheimer
Management Corporation, where he served as Executive Vice President and Director
of Fixed Income.
PORTFOLIO TRADING PRACTICES
The Series normally will not invest for short-term trading purposes.
However, a Series may sell securities without regard to the length of time they
have been held. Given each Series' investment objective, Small Cap Value Series'
annual portfolio turnover rate may exceed 100% and Delaware Series' annual
portfolio turnover rate is not expected to exceed 200%. A 100% turnover rate
would occur if all of the securities in a Series were sold and replaced within
one year. The rate of portfolio turnover is not a limiting factor when Delaware
Management deems it desirable to purchase or sell securities. High portfolio
turnover (over 100%) involves correspondingly greater brokerage commissions and
other transaction costs and may affect taxes payable by the Series' shareholders
that are subject to federal income taxes. The turnover rate may also be affected
by cash requirements from redemptions and repurchases of the Series' shares. The
degree of portfolio activity may affect brokerage costs of the Series and taxes
payable by shareholders that are subject to federal income taxes.
Best efforts are used to obtain the best available price and most favorable
execution for portfolio transactions. Orders may be placed with brokers or
dealers who provide brokerage and research services to Delaware Management or
their respective advisory clients. These services may be used by Delaware
Management in servicing any of its respective accounts. Subject to best price
and execution, Delaware Management may consider a broker/dealer's sales of
shares of funds in the Delaware Investments family in placing portfolio orders,
and may place orders with broker/dealers that have agreed to defray certain
expenses of such funds, such as custodian fees.
<PAGE>
PERFORMANCE INFORMATION
From time to time, the Fund may quote each Series' total return performance
in advertising and other types of literature. Total return will be based on a
hypothetical $1,000 investment, reflecting the reinvestment of all distributions
at net asset value. Each presentation will include the average annual total
return for one-, five- and ten-year (or life of Series, if applicable) periods.
The Fund may also advertise aggregate and average total return information
concerning the Series over additional periods of time.
Because securities' prices fluctuate, investment results of a Series will
fluctuate and past performance should not be considered as a representation
of future results.
DISTRIBUTION AND SERVICE
The Distributor, Delaware Distributors, L.P., serves as the Fund's national
distributor under separate Distribution Agreements dated April 3, 1995 for each
Series. The Distributor bears all of the costs of promotion and distribution.
Delaware Service Company, Inc. (the "Transfer Agent") is the shareholder
servicing, dividend disbursing and transfer agent for each Series under the
Amended and Restated Shareholders Services Agreement dated May 1, 1998. The
Transfer Agent also provides accounting services to each Series pursuant to the
terms of a separate Fund Accounting Agreement.
The directors of the Fund annually review service fees paid to the
Distributor and Transfer Agent.
The Distributor and the Transfer Agent are indirect, wholly owned
subsidiaries of DMH.
* * *
As with other mutual funds, financial and business organizations and
individuals around the world, the Series could be adversely affected if the
computer systems used by their service providers do not properly process and
calculate date-related information from and after January 1, 2000. This is
commonly known as the "Year 2000 Problem." The Fund is taking steps to obtain
satisfactory assurances that the Series' major service providers are taking
steps reasonably designed to address the Year 2000 Problem with respect to the
computer systems that such service providers use. There can be no assurances
that these steps will be sufficient to avoid any adverse impact on the business
of the Series.
10
<PAGE>
Several European countries are participating in the European Economic and
Monetary Union, which will establish a common European currency for
participating countries. This currency will commonly be known as the "Euro." It
is anticipated that each such participating country will replace its existing
currency with the Euro on January 1, 1999. Additional European countries may
elect to participate after that date. Each Series could be adversely affected if
the computer systems used by its major service providers are not properly
prepared to handle the implementation of this single currency or the adoption of
the Euro by additional countries in the future. The Fund is taking steps to
obtain satisfactory assurances that the major service providers of the Series
are taking steps reasonably designed to address these matters with respect to
the computer systems that such service providers use. There can be no assurances
that these steps will be sufficient to avoid any adverse impact on the business
of the Series.
EXPENSES
Each Series is responsible for all of its own expenses other than those
borne by Delaware Management under the Investment Management Agreements and
those borne by the Distributor under the Distribution Agreements.
Beginning May 1, 1998, Delaware Management elected voluntarily to waive its
fee and pay the expenses of Small Cap Value Series to the extent necessary to
ensure that the Series' annual operating expenses, exclusive of taxes, interest,
brokerage commissions and extraordinary expenses, do not exceed 0.85% of average
daily net assets through October 31, 1998.
Prior to May 1, 1998, Delaware Management elected voluntarily to waive its
fee and pay the expenses of the Series to the extent necessary to ensure that
Small Cap Value Series' annual operating expenses, exclusive of taxes, interest,
brokerage commissions and extraordinary expenses, did not exceed 0.80% of
average daily net assets from the commencement of operations through April 30,
1998. For the fiscal year ended December 31, 1997, the Series' ratio of expenses
to average daily net assets was 0.80%, reflecting the voluntary waiver of fees
and payment of expenses by Delaware Management. The ratio of expenses to average
daily net assets would have been 0.90% without the voluntary waiver of fees and
payment of expenses.
Beginning May 1, 1998, Delaware Management elected voluntarily to waive its
fee and pay the expenses of Delaware Series to the extent necessary to ensure
that the Series' annual operating expenses, exclusive of taxes, interest,
brokerage commissions and extraordinary expenses, do not exceed 0.80% of average
daily net assets through October 31, 1998.
Prior to May 1, 1998, Delaware Management elected voluntarily to waive its
fee and pay the expenses of Delaware Series to the extent necessary to ensure
that the Series' annual operating expenses, exclusive of taxes, interest,
brokerage commissions and extraordinary expenses, did not exceed 0.80% of
average daily net assets for the period July 1, 1992 through April 30, 1998. For
the fiscal year ended December 31, 1997, the Series' ratio of expenses to
average daily net assets was 0.67%.
<PAGE>
DESCRIPTION OF FUND SHARES
Shares of the Fund are sold only to separate accounts of life companies.
Currently, the shares of the Fund are sold only to Variable Annuity Account C
and Flexible Premium Variable Life Account K of Lincoln National Life Insurance
Company, Variable Accounts A and B of American International Life Assurance
Company of New York, Variable Accounts I and II of AIG Life Insurance Company,
Separate Accounts VA-K, VEL II and Inheiritage of First Allmerica Life Insurance
Company and Separate Accounts VA-K, VEL, VEL II and Inheiritage of Allmerica
Life Insurance and Annuity Company and Separate Accounts ABD, ABD2, QP and QPN
of the Travelers Life and Annuity Co. In the future, shares of the Fund may be
sold to separate accounts of other affiliated or unaffiliated life companies to
fund variable contracts. The Fund's Board of Directors will monitor events in
order to identify any material irreconcilable conflicts which may possibly arise
and to determine what action, if any, should be taken in response thereto. An
irreconcilable conflict that is not resolved might result in the withdrawal of a
substantial amount of assets, causing a negative impact on net asset value.
The Fund was organized as a Maryland corporation on February 19, 1987. The
authorized capital stock of the Fund consists of one billion shares of common
stock, $.01 par value. Each Series is currently allocated fifty million shares.
Series' shares have equal voting rights and are equal in all other respects.
Shareholders get one vote for each share held; fractional shares are voted. The
Fund will hold annual meetings as necessary for shareholder matters to be voted
under the 1940 Act or otherwise. Shareholders of each Series are entitled to a
pro-rata share of all dividends and distributions arising from an investment in
the Series.
Because of current federal securities law requirements, the Fund expects
that its life company shareholders will offer their contract owners the
opportunity to instruct them as to how Series shares allocable to their variable
contracts will be voted with respect to certain matters, such as approval of
investment advisory agreements. An insurance company will vote all Series shares
held in a separate account in the same proportion as it receives instructions
from contract owners in that separate account. Under certain circumstances,
which are described more fully in the accompanying prospectus for the separate
account which invests in the Fund, the voting instructions received from
contract owners may be disregarded.
11
<PAGE>
OTHER CONSIDERATIONS
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES
Each Series may invest in U.S. government securities and corporate debt
obligations on a when-issued or delayed delivery basis. Such transactions
involve commitments to buy a new issue with settlement up to 60 days later. The
average settlement date for when-issued or delayed delivery securities purchased
by the Series is generally between 30 and 45 days. During the time between the
commitment and settlement, a Series does not accrue interest, but the market
value of the bonds may fluctuate. This can result in a Series' share value
increasing or decreasing. A Series will not ordinarily sell when-issued or
delayed delivery securities prior to settlement. If a Series invests in
securities of this type, it will maintain a segregated account to pay for them
and mark the account to market daily.
FOREIGN SECURITIES AND FOREIGN CURRENCY TRANSACTIONS
Each Series may invest a portion of its assets in securities of issuers
organized or having a majority of their assets in or deriving a majority of
their operating income outside the United States. In connection with investments
in foreign securities, a Series may, from time to time, conduct foreign currency
exchange transactions on a spot (i.e., cash) basis at the spot rate prevailing
in the foreign currency exchange market or through entering into contracts to
purchase or sell foreign currencies at a future date (i.e., a "forward foreign
currency" contract or "forward" contract). A Series will engage in these foreign
currency transactions in order to expedite settlement of portfolio transactions
and to minimize currency value fluctuations. Investing in foreign securities
and, in conjunction therewith, engaging in foreign currency transactions present
special considerations not presented by investments in securities issued by
United States companies. See Foreign Currency Transactions, below.
The risks involved in investing in foreign securities include the
possibility of expropriation, nationalization or confiscatory taxation, taxation
of income earned in foreign nations or other taxes imposed with respect to
investments in foreign nations, foreign exchange control (which may include
suspension of the ability to transfer currency from a given country), default in
foreign government securities, political or social instability or diplomatic
developments which could affect investments in securities of issuers in those
nations. In addition, in many countries, there is less publicly available
information about issuers than is available in reports about companies in the
United States, and the information that is available is often of lesser quality
than information available on U.S. companies. Foreign companies are not subject
to uniform accounting, auditing and financial reporting standards, and auditing
practices and requirements may not be comparable to those applicable to United
States companies. Further, a Series may encounter difficulty or be unable to
pursue legal remedies and obtain judgments in foreign courts. Commission rates
on securities transactions in foreign countries, which are sometimes fixed
rather than subject to negotiation as in the United States, are likely to be
higher. Moreover, the settlement period of securities transactions in foreign
markets may be longer than in domestic markets. In many foreign countries, there
is less government supervision and regulation of business and industry
practices, stock exchanges, brokers and listed companies than in the United
States. The foreign securities markets of many of the countries in which a
Series may invest may also be smaller, less liquid and subject to greater price
volatility than those in the United States.
12
<PAGE>
Emerging Markets. Compared to the United States and other developed
countries, emerging countries may have relatively unstable governments,
economies based on only a few industries, and securities markets that trade a
small number of securities. Prices on these exchanges tend to be volatile and,
in the past, securities in these countries have offered greater potential for
gain (as well as loss) than securities of companies located in developed
countries. Further, investments by foreign investors (such as the Series) are
subject to a variety of restrictions in many emerging countries. These
restrictions may take the form of prior governmental approval, limits on the
amount or type of securities held by foreigners, and limits on the types of
companies in which foreigners may invest. Additional restrictions may be imposed
at any time by these or other countries in which a Series invests. In addition,
the repatriation of both investment income and capital from several foreign
countries is restricted and controlled under certain regulations, including, in
some cases, the need for certain governmental consents. Although these
restrictions may in the future make it undesirable to invest in emerging
countries, Delaware International does not believe that any current repatriation
restrictions would affect its decision to invest in such countries. Countries
such as those in which a Series may invest have historically experienced and may
continue to experience, high rates of inflation, high interest rates, exchange
rate fluctuations or currency depreciation, large amounts of external debt,
balance of payments and trade difficulties and extreme poverty and unemployment.
Additional factors which may influence the ability or willingness to service
debt include, but are not limited to, a country's cash flow situation, the
availability of sufficient foreign exchange on the date a payment is due, the
relative size of its debt service burden to the economy as a whole, its
government's policy towards the International Monetary Fund, t he World Bank and
other international agencies and the political constraints to which a government
debtor may be subject.
With respect to investment in debt issues of foreign governments, including
Brady Bonds, the ability of a foreign government or government-related issuer to
make timely and ultimate payments on its external debt obligations will also be
strongly influenced by the issuer's balance of payments, including export
performance, its access to international credits and investments, fluctuations
in interest rates and the extent of its foreign reserves. A country whose
exports are concentrated in a few commodities or whose economy depends on
certain strategic imports could be vulnerable to fluctuations in international
prices of these commodities or imports. To the extent that a country receives
payment for its exports in currencies other than dollars, its ability to make
debt payments denominated in dollars could be adversely affected.
<PAGE>
The issuers of the emerging market country government and government-related
high yield securities in which a Series may invest have in the past experienced
substantial difficulties in servicing their external debt obligations, which
have led to defaults on certain obligations and the restructuring of certain
indebtedness. Restructuring arrangements have included, among other things,
reducing and rescheduling interest and principal payments by negotiating new or
amended credit agreements or converting outstanding principal and unpaid
interest to Brady Bonds, and obtaining new credit to finance interest payments.
Holders of certain foreign government and government-related high yield
securities may be requested to participate in the restructuring of such
obligations and to extend further loans to their issuers. There can be no
assurance that the Brady Bonds and other foreign government and
government-related high yield securities in which a Series may invest will not
be subject to similar defaults or restructuring arrangements which may adversely
affect the value of such investments. Furthermore, certain participants in the
secondary market for such debt may be directly involved in negotiating the terms
of these arrangements and may therefore have access to information not available
to other market participants.
Foreign Currency Transactions. Each Series may also purchase options and
forward contracts in foreign currency for hedging purposes in connection with
such foreign securities transactions. As in the case of other kinds of options,
the writing of an option on foreign currency will constitute only a partial
hedge, up to the amount of the premium received, and a Series could be required
to purchase or sell foreign currencies at disadvantageous exchange rates,
thereby incurring losses. The purchase of an option on foreign currency may
constitute an effective hedge against fluctuations in exchange rates, although,
in the event of rate movements adverse to a Series' position, the Series may
forfeit the entire amount of the premium plus related transaction costs.
With respect to forward foreign currency contracts, the precise matching of
forward contract amounts and the value of the securities involved is generally
not possible since the future value of such securities in foreign currencies
will change as a consequence of market movements in the value of those
securities between the date the forward contract is entered into and the date it
matures. The projection of short-term currency strategy is highly uncertain.
It is impossible to forecast the market value of portfolio securities at the
expiration of the contract. Accordingly, it may be necessary for the Series to
purchase additional foreign currency on the spot market (and bear the expense of
such purchase) if the market value of the security is less than the amount of
foreign currency the Series is obligated to deliver (and if a decision is made
to sell the security and make delivery of the foreign currency). Conversely, it
may be necessary to sell on the spot market some of the foreign currency
received upon the sale of the portfolio security if its market value exceeds the
amount of foreign currency the Series is obligated to deliver.
13
<PAGE>
Depositary Receipts. Each Series may make foreign investments through the
purchase and sale of sponsored or unsponsored American, European and Global
Depositary Receipts ("Depositary Receipts"). Depositary Receipts are receipts
typically issued by a U.S. or foreign bank or trust company which evidence
ownership of underlying securities issued by a foreign corporation. "Sponsored"
Depositary Receipts are issued jointly by the issuer of the underlying security
and a depository, whereas "unsponsored" Depositary Receipts are issued without
participation of the issuer of the deposited security. Holders of unsponsored
Depositary Receipts generally bear all the costs of such facilities and the
depository of an unsponsored facility frequently is under no obligation to
distribute shareholder communications received from the issuer of the deposited
security or to pass through voting rights to the holders of such receipts in
respect of the deposited securities. Therefore, there may not be a correlation
between information concerning the issuer of the security and the market value
of an unsponsored Depositary Receipt.
OPTIONS
To achieve its objective, each Series intends to use certain hedging
techniques which might not be conveniently available to individuals.
These techniques will be used at Delaware Management's discretion to protect
a Series' principal value.
Each Series may purchase put options, write covered call options and enter
into closing transactions in connection therewith in respect of securities in
which it may invest.
Purchasing a put option gives a Series the right to sell one of its
securities for an agreed price up to an agreed date. The advantage is that the
Series can be protected should the market value of the security decline.
However, the Series must pay a premium for this right, whether it exercises it
or not.
Writing a covered call option obligates a Series to sell one of its
securities for an agreed price up to an agreed date. The advantage is that the
Series receives premium income, which may offset the cost of purchasing put
options. However, the Series may lose the potential market appreciation of the
security if Delaware Management's judgment is wrong and interest rates fall or
stock prices rise.
A call option enables the purchaser, in return for the premium paid, to
purchase securities from the writer of the option at an agreed upon date. The
advantage is that the purchaser may hedge against an increase in the price of
securities it ultimately wishes to buy.
Closing transactions essentially let a Series offset a put option or call
option prior to its exercise or expiration. If it cannot effect a closing
transaction, it may have to hold a security it would otherwise sell with a
potential decline in net asset value, or deliver a security it might want to
hold.
Each Series will use Exchange-traded options, but reserves the right to
use over-the-counter options upon written notice to shareholders. Certain
over-the-counter options may be illiquid.
<PAGE>
The Small Cap Value Series also may write call options and purchase put
options on stock indices and enter into closing transactions in connection
therewith. The Series will not engage in transactions on stock indices for
speculative purposes. Writing or purchasing a call option on stock indices is
similar to the writing or purchasing of a call option on an individual stock.
Purchasing a protective put option on stock indices is similar to the purchase
of protective puts on an individual stock. Stock indices used will include, but
will not be limited to, the S&P 100 and the S&P Over-the-Counter 250. The
ability to hedge effectively using options on stock indices will depend on the
degree to which price movements in the underlying index correlate with price
movements in the portfolio securities of, as the case may be, the Series.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS
For hedging purposes, the Small Cap Value Series may enter into futures
contracts relating to securities, securities indices or interest rates.
A futures contract is a bilateral agreement providing for the purchase and
sale of a specified type and amount of a financial instrument or foreign
currency, or for the making and acceptance of a cash settlement at a stated time
in the future for a fixed price. By its terms, a futures contract provides for a
specified settlement date on which, in the case of the majority of interest rate
and foreign currency futures contracts, the fixed-income securities or currency
underlying the contract are delivered by the seller and paid for by the
purchaser, or on which, in the case of securities index futures contracts and
certain interest rate and foreign currency futures contracts, the difference
between the price at which the contract was entered into and the contract's
closing value is settled between the purchaser and seller in cash. Futures
contracts differ from options in that they are bilateral agreements, with both
the purchaser and the seller equally obligated to complete the transaction. In
addition, futures contracts call for settlement only on the expiration date, and
cannot be "exercised" at any other time during their term.
The purchase or sale of a futures contract also differs from the purchase or
sale of a security or the purchase of an option in that no purchase price is
paid or received. Instead, an amount of cash or cash equivalents, which varies
but may be as low as 5% or less of the value of the contract, must be deposited
with or on behalf of the broker as "initial margin" as a good faith deposit.
Subsequent payments to and from the broker, referred to as "variation margin,"
are made on a daily basis as the value of the index or instrument underlying the
futures contract fluctuates, making positions in the futures contract more or
less valuable, a process known as "marking to the market."
14
<PAGE>
A futures contract may be purchased or sold only on an exchange, known as a
"contract market," designated by the Commodity Futures Trading Commission for
the trading of such contract, and only through a registered futures commission
merchant which is a member of such contract market. A commission must be paid on
each completed purchase and sale transaction. The contract market clearing house
guarantees the performance of each party to a futures contract, by in effect
taking the opposite side of such contract. At any time prior to the expiration
of a futures contract, a trader may elect to close out its position by taking an
opposite position on the contract market on which the position was entered into,
subject to the availability of a secondary market, which will operate to
terminate the initial position. At that time, a final determination of variation
margin is made and any loss experienced by the trader is required to be paid to
the contract market clearing house while any profit due to the trader must be
delivered to it.
Interest rate futures contracts currently are traded on a variety of
fixed-income securities, including long-term U.S. Treasury Bonds, U.S. Treasury
Notes, GNMA modified pass-through mortgage-backed securities, U.S. Treasury
Bills, bank certificates of deposit and commercial paper. In addition, interest
rate futures contracts include contracts on indexes of municipal securities.
Foreign currency futures contracts currently are traded on the British pound,
Canadian dollar, Japanese yen, Swiss franc, German mark and on Eurodollar
deposits.
A securities index or municipal bond index futures contract provides for the
making and acceptance of a cash settlement in much the same manner as the
settlement of an option on a securities index. The types of indexes underlying
securities index futures contracts are essentially the same as those underlying
securities index options, as described above. The index underlying a municipal
bond index futures contract is a broad based index of municipal securities
designed to reflect movements in the municipal securities market as a whole. The
index assigns weighted values to the securities included in the index and its
composition is changed periodically.
The Series may also purchase and write options on the types of futures
contracts the Series could invest in.
<PAGE>
A call option on a futures contract provides the holder with the right to
purchase, or enter into a "long" position in, the underlying futures contract. A
put option on a futures contract provides the holder with the right to sell, or
enter into a "short" position in, the underlying futures contract. In both
cases, the option provides for a fixed exercise price up to a stated expiration
date. Upon exercise of the option by the holder, the contract market clearing
house establishes a corresponding short position for the writer of the option,
in the case of a call option, or a corresponding long position in the case of a
put option and the writer delivers to the holder the accumulated balance in the
writer's margin account which represents the amount by which the market price of
the futures contract at exercise exceeds, in the case of a call, or is less
than, in the case of a put, the exercise price of the option on the futures
contract. In the event that an option written by the Series is exercised, the
Series will be subject to all the risks associated with the trading of futures
contracts, such as payment of variation market deposits. In addition, the writer
of an option on a futures contract, unlike the holder, is subject to initial and
variation margin requirements on the option position.
A position in an option on a futures contract may be terminated by the
purchaser or seller prior to expiration by effecting a closing purchase or sale
transaction, subject to the availability of a liquid secondary market, which is
the purchase or sale of an option of the same series (i.e., the same exercise
price and expiration date) as the option previously purchased or sold. The
difference between the premiums paid and received represents the trader's profit
or loss on the transaction.
An option, whether based on a futures contract, a securities index, a
security or foreign currency, becomes worthless to the holder when it expires.
Upon exercise of an option, the exchange or contract market clearing house
assigns exercise notices on a random basis to those of its members which have
written options of the same series and with the same expiration date. A
brokerage firm receiving such notices then assigns them on a random basis to
those of its customers which have written options of the same series and
expiration date. A writer therefore has no control over whether an option will
be exercised against it, nor over the timing of such exercise.
To the extent that interest or exchange rates or securities prices move in
an unexpected direction, the Series may not achieve the anticipated benefits of
investing in futures contracts and options thereon, or may realize a loss. To
the extent that the Series purchases an option on a futures contract and fails
to exercise the option prior to the exercise date, it will suffer a loss of the
premium paid. Further, the possible lack of a secondary market could prevent the
Series from closing out its positions relating to futures.
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RISKS OF TRANSACTIONS IN OPTIONS, FUTURES AND
FORWARD CONTRACTS
The use of futures contracts, options on futures contracts, forward
contracts and certain options for hedging and other non-speculative purposes as
described above involves certain risks. For example, a lack of correlation
between price changes of an option or futures contract and the assets being
hedged could render a Series' hedging strategy unsuccessful and could result in
losses. The same results could occur if movements of foreign currencies do not
correlate as expected by the investment adviser at a time when a Series is using
a hedging instrument denominated in one foreign currency to protect the value of
a security denominated in a second foreign currency against changes caused by
fluctuations in the exchange rate for the dollar and the second currency. If the
direction of securities prices, interest rates or foreign currency prices is
incorrectly predicted, a Series will be in a worse position than if such
transactions had not been entered into. In addition, since there can be no
assurance that a liquid secondary market will exist for any contract purchased
or sold, the Series may be required to maintain a position (and in the case of
written options may be required to continue to hold the securities used as
cover) until exercise or expiration, which could result in losses. Further,
options and futures contracts on foreign currencies and forward contracts entail
particular risks related to conditions affecting the underlying currency.
Over-the-counter transactions in options and forward contracts also involve
risks arising from the lack of an organized exchange trading environment.
BORROWINGS
Each Series may borrow money as a temporary measure for extraordinary
purposes or to facilitate redemptions. A Series will not borrow money in excess
of one-third of the value of its net assets. See Part B for additional possible
restrictions on borrowing. A Series has no intention of increasing its net
income through borrowing. Any borrowing will be done from a bank and, to the
extent that such borrowing exceeds 5% of the value of the Series' net assets,
asset coverage of at least 300% is required. In the event that such asset
coverage shall at any time fall below 300%, the Series shall, within three days
thereafter (not including Sunday or holidays) or such longer period as the U.S.
Securities and Exchange Commission may prescribe by rules and regulations,
reduce the amount of its borrowings to an extent that the asset coverage of such
borrowings shall be at least 300%. A Series will not pledge more than 15% of its
net assets, or issue senior securities as defined in the 1940 Act, except for
notes to banks. Investment securities will not be purchased while the Series has
an outstanding borrowing.
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REPURCHASE AGREEMENTS
Each Series may also use repurchase agreements which are at least 102%
collateralized by U.S. government securities. Each Series may enter into
repurchase agreements with broker/dealers or banks which are deemed creditworthy
by the respective investment manager under guidelines approved by the Board of
Directors. A repurchase agreement is a short-term investment in which the
purchaser (i.e., a Series) acquires ownership of a security and the seller
agrees to repurchase the security at a future time and set price, thereby
determining the yield during the purchaser's holding period. The value of the
securities subject to the repurchase agreement is marked to market daily. In the
event of a bankruptcy or other default of the seller, the Series could
experience delays and expenses in liquidating the underlying securities.
The funds in Delaware Investments have obtained an exemption from the
joint-transaction prohibitions of Section 17(d) of the 1940 Act to allow the
funds in the Delaware Investments family jointly to invest cash balances. Each
Series may invest cash balances in joint repurchase agreements in accordance
with the terms of the Order and subject to the conditions described above.
PORTFOLIO LOAN TRANSACTIONS
Each Series may, from time to time, lend securities (but not in excess of
25% of its assets) from its portfolio to brokers, dealers and financial
institutions and receive collateral in cash or short-term U.S. government
securities. While the loan is outstanding, this collateral will be maintained at
all times in an account equal to at least 100% of the current market value of
the loaned securities plus accrued interest. Such cash collateral will be
invested in short-term securities, the income from which will increase the
return of the Series.
The major risk to which a Series would be exposed on a loan transaction is
the risk that the borrower would go bankrupt at a time when the value of the
security goes up. Therefore, a Series will only enter into loan arrangements
after a review of all pertinent facts by the respective investment manager,
subject to overall supervision by the Board of Directors, including the
creditworthiness of the borrowing broker, dealer or institution and then only if
the consideration to be received from such loans would justify the risk.
Creditworthiness will be monitored on an ongoing basis by the investment
manager.
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LIQUIDITY AND RULE 144A SECURITIES
In order to assure that each Series has sufficient liquidity, neither Series
may invest more than 10% of its net assets in illiquid assets. For the Delaware
Series, this policy shall extend to all restricted securities, including
securities eligible for resale without registration pursuant to Rule 144A ("Rule
144A Securities") (described below), and repurchase agreements maturing in more
than seven days. With respect to Small Cap Value Series and subject to the
following paragraphs, this policy shall not limit the acquisition of securities
purchased in reliance upon Rule 144A of the Securities Act of 1933 ("1933 Act").
Rule 144A permits many privately placed and legally restricted securities to be
freely traded among certain institutional buyers such as the Series. Investing
in Rule 144A Securities could have the effect of increasing the level of
illiquidity of a Series to the extent that qualified institutional buyers become
uninterested, for a time, in purchasing these securities.
While maintaining oversight, the Board of Directors has delegated to
Delaware Management the day-to-day functions of determining whether or not
individual Rule 144A Securities are liquid for purposes of the 10% limitation on
investments in illiquid assets. The Board has instructed Delaware Management to
consider the following factors in determining the liquidity of a Rule 144A
Security: (i) the frequency of trades and trading volume for the security; (ii)
whether at least three dealers are willing to purchase or sell the security and
the number of potential purchasers; (iii) whether at least two dealers are
making a market in the security; (iv) the nature of the security and the nature
of the marketplace trades (e.g., the time needed to dispose of the security, the
method of soliciting offers, and the mechanics of transfer).
If Delaware Management determines that a Rule 144A Security which was
previously determined to be liquid is no longer liquid and, as a result, the
applicable Series' holdings of illiquid securities exceed the Series' 10%
limit on investment in such securities, Delaware Management will determine
what action shall be taken to ensure that the Series continues to adhere to
such limitation.
MORTGAGE-BACKED SECURITIES
The Delaware Series may invest in mortgage-backed securities issued or
guaranteed by the U.S. government, its agencies or instrumentalities or
government sponsored corporations or those issued by certain private,
non-government corporations, such as financial institutions. Two principal types
of mortgage-backed securities are collateralized mortgage obligations (CMOs) and
real estate mortgage investment conduits (REMICs).
<PAGE>
CMOs are debt securities issued by U.S. government agencies or by financial
institutions and other mortgage lenders and collateralized by a pool of
mortgages held under an indenture. CMOs are issued in a number of classes or
series with different maturities. The classes or series are retired in sequence
as the underlying mortgages are repaid. Prepayment may shorten the stated
maturity of the obligation and can result in a loss of premium, if any has been
paid. Certain of these securities may have variable or floating interest rates
and others may be stripped (securities which provide only the principal or
interest feature of the underlying security).
REMICs, which were authorized under the Tax Reform Act of 1986, are private
entities formed for the purpose of holding a fixed pool of mortgages secured by
an interest in real property. REMICs are similar to CMOs in that they issue
multiple classes of securities.
CMOs and REMICs issued by private entities are not government securities and
are not directly guaranteed by any government agency. They are secured by the
underlying collateral of the private issuer. The Series may invest in such
private-backed securities.
The Series may invest up to 20% of its total assets in CMOs and REMICs
issued by private entities which are not collateralized by securities issued or
guaranteed by the U.S. government, its agencies or instrumentalities, so-called
non-agency mortgage-backed securities. Investments in these securities may be
made only if the securities (i) are rated at the time of purchase in the four
top rating categories by a nationally-recognized statistical rating organization
(e.g., BBB or better by S&P or Baa or better by Moody's) and (ii) represent
interests in whole-loan mortgages, multi-family mortgages, commercial mortgages
and other mortgage collateral supported by a first mortgage lien on real estate.
Non-agency mortgage-backed securities are subject to the interest rate and
prepayment risks, described above, to which other CMOs and REMICs issued by
private issuers are subject. Non-agency mortgage-backed securities may also be
subject to a greater risk of loss of interest and principal because they are not
collateralized by securities issued or guaranteed by the U.S. government. In
addition, timely information concerning the loans underlying these securities
may not be as readily available and the market for these securities may be less
liquid than other CMOs and REMICs.
ASSET-BACKED SECURITIES
The Delaware Series may invest in securities which are backed by assets such
as receivables on home equity and credit loans, receivables regarding
automobile, mobile home and recreational vehicle loans, wholesale dealer floor
plans and leases or other loans or financial receivables currently available or
which may be developed in the future. All such securities must be rated in one
of the four highest rating categories by a reputable rating agency (e.g., BBB or
better by S&P or Baa or better by Moody's).
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Such receivables are securitized in either a pass-through or a pay-through
structure. Pass-through securities provide investors with an income stream
consisting of both principal and interest payments in respect of the receivables
in the underlying pool. Pay-through asset-backed securities are debt obligations
issued usually by a special purpose entity, which are collateralized by the
various receivables and in which the payments on the underlying receivables
provide the funds to pay the debt service on the debt obligations issued.
The rate of principal payment on asset-backed securities generally depends
on the rate of principal payments received on the underlying assets. Such rate
of payments may be affected by economic and various other factors such as
changes in interest rates or the concentration of collateral in a particular
geographic area. Therefore, the yield may be difficult to predict and actual
yield to maturity may be more or less than the anticipated yield to maturity.
Due to the shorter maturity of the collateral backing such securities, there
tends to be less of a risk of substantial prepayment than with mortgage-backed
securities but the risk of such a prepayment does exist. See Mortgage-Backed
Securities, above. Such asset-backed securities do, however, involve certain
risks not associated with mortgage-backed securities, including the risk that
security interests cannot be adequately or in many cases ever established, and
other risks which may be peculiar to particular classes of collateral. For
example, with respect to credit card receivables, a number of state and federal
consumer credit laws give debtors the right to set off certain amounts owed on
the credit cards, thereby reducing the outstanding balance. In the case of
automobile receivables, there is a risk that the holders may not have either a
proper or first security interest in all of the obligations backing such
receivables due to the large number of vehicles involved in a typical issuance
and technical requirements under state laws. Therefore, recoveries on
repossessed collateral may not always be available to support payments on the
securities.
REITs
Delaware Series may invest in REITs. REITs are pooled investment vehicles
which invest primarily in income-producing real estate or real estate related
loans or interests. REITs are generally classified as equity REITs, mortgage
REITs or a combination of equity and mortgage REITs. Equity REITs invest the
majority of their assets directly in real property and derive income primarily
from the collection of rents. Equity REITs can also realize capital gains by
selling properties that have appreciated in value. Mortgage REITs invest the
majority of their assets in real estate mortgages and derive income from the
collection of interest payments. Like investment companies, REITs are not taxed
on income distributed to shareholders provided they comply with several
requirements in the Code. REITs are subject to substantial cash flow dependency,
defaults by borrowers, self-liquidation, and the risk of failing to qualify for
tax-free pass-through of income under the Code, and/or to maintain exemptions
from the 1940 Act.
<PAGE>
The Series' investments in REITs present certain further risks that are
unique and in addition to the risks associated with investing in the real estate
industry in general. Equity REITs may be affected by changes in the value of the
underlying property owned by the REITs, while mortgage REITs may be affected by
the quality of any credit extended. REITs are dependent on management skills,
are not diversified, and are subject to the risks of financing projects. REITs
whose underlying assets include long-term health care properties, such as
nursing, retirement and assisted living homes, may be impacted by federal
regulations concerning the health care industry.
REITs (especially mortgage REITs) are also subject to interest rate risks --
when interest rates decline, the value of a REIT's investment in fixed rate
obligations can be expected to rise. Conversely, when interest rates rise, the
value of a REIT's investment in fixed rate obligations can be expected to
decline. In contrast, as interest rates on adjustable rate mortgage loans are
reset periodically, yields on a REIT's investments in such loans will gradually
align themselves to reflect changes in market interest rates, causing the value
of such investments to fluctuate less dramatically in response to interest rate
fluctuations than would investments in fixed rate obligations.
REITs may have limited financial resources, may trade less frequently and
in a limited volume, and may be subject to more abrupt or erratic price
movements than other securities.
CONVERTIBLE, DEBT AND NON-TRADITIONAL EQUITY SECURITIES
Delaware Series may invest in convertible and debt securities of issuers in
any industry. A convertible security is a security which may be converted at a
stated price within a specified period of time into a certain quantity of the
common stock of the same or a different issuer. Convertible and debt securities
are senior to common stocks in a corporation's capital structure, although
convertible securities are usually subordinated to similar nonconvertible
securities. Convertible and debt securities provide a fixed-income stream and
the opportunity, through its conversion feature, to participate in the capital
appreciation resulting from a market price advance in the convertible security's
underlying common stock. Just as with debt securities, convertible securities
tend to increase in market value when interest rates decline and tend to
decrease in value when interest rates rise. However, the price of a convertible
security is also influenced by the market value of the security's underlying
common stock and tends to increase as the market value of the underlying stock
rises, whereas it tends to decrease as the market value of the underlying stock
declines.
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The Series may invest in convertible preferred stocks that offer enhanced
yield features, such as Preferred Equity Redemption Cumulative Stock ("PERCS"),
which provide an investor with the opportunity to earn higher dividend income
than is available on a company's common stock. A PERCS is a preferred stock
which generally features a mandatory conversion date, as well as a capital
appreciation limit which is usually expressed in terms of a stated price. Upon
the conversion date, most PERCS convert into com mon stock of the issuer (PERCS
are generally not convertible into cash at maturity). Under a typical
arrangement, if after a predetermined number of years the issuer's common stock
is trading at a price below that set by the capital appreciation limit, each
PERCS would convert to one share of common stock. If, however, the issuer's
common stock is trading at a price above that set by the capital appreciation
limit, the holder of the PERCS would receive less than one full share of common
stock. The amount of that fractional share of common stock received by the PERCS
holder is determined by dividing the price set by the capital appreciation limit
of the PERCS by the market price of the issuer's common stock. PERCS can be
called at any time prior to maturity, and hence do not provide call protection.
However, if called early, the issuer may pay a call premium over the market
price to the investor. This call premium declines at a preset rate daily, up to
the maturity date of the PERCS.
The Series may also invest in other enhanced convertible securities. These
include but are not limited to ACES (Automatically Convertible Equity
Securities), PEPS (Participating Equity Preferred Stock), PRIDES (Preferred
Redeemable Increased Dividend Equity Securities), SAILS (Stock Appreciation
Income Linked Securities), TECONS (Term Convertible Notes), QICS (Quarterly
Income Cumulative Securities) and DECS (Dividend Enhanced Convertible
Securities). ACES, PEPS, PRIDES, SAILS, TECONS, QICS and DECS all have the
following features: they are company-issued convertible preferred stock; unlike
PERCS, they do not have capital appreciation limits; they seek to provide the
investor with high current income, with some prospect of future capital
appreciation; they are typically issued with three- to four-year maturities;
they typically have some built-in call protection for the first two to three
years; investors have the right to convert them into shares of common stock at a
preset conversion ratio or hold them until maturity; and upon maturity, they
will automatically convert to either cash or a specified number of shares of
common stock.
HIGH-YIELD, HIGH RISK SECURITIES
Investing in so-called "high-yield" or "high risk" securities entails
certain risks, including the risk of loss of principal, which may be greater
than the risks involved in investment grade securities, and which should be
considered by investors contemplating an investment in the Small Cap Value
Series. Such securities are sometimes issued by companies whose earnings at the
time of issuance are less than the projected debt service on the high-yield
securities. The risks include the following:
<PAGE>
Youth and Volatility of the High-Yield Market--Although the market for
high-yield securities has been in existence for many years, including periods of
economic downturns, the high-yield market grew rapidly during the long economic
expansion which took place in the United States during the 1980s. During that
economic expansion, the use of high-yield debt securities to fund highly
leveraged corporate acquisitions and restructurings increased dramatically. As a
result, the high-yield market grew substantially during that economic expansion.
Although experts disagree on the impact recessionary periods have had and will
have on the high-yield market, some analysts believe a protracted economic
downturn would severely disrupt the market for high-yield securities, would
adversely affect the value of outstanding bonds and would adversely affect the
ability of high-yield issuers to repay principal and interest. Those analysts
cite volatility experienced in the high-yield market in the past as evidence for
their position. It is likely that protracted periods of economic uncertainty
would result in increased volatility in the market prices of high-yield
securities, an increase in the number of high-yield bond defaults and
corresponding volatility in the Series' net asset value.
The Series will not ordinarily purchase securities rated below B by Moody's
and S&P. However, it may do so if Delaware Management believes that capital
appreciation is likely. The Series will not invest more than 25% of its assets
in such securities.
Liquidity and Valuation--The secondary market for high-yield securities is
currently dominated by institutional investors, including mutual funds and
certain financial institutions. There is generally no established retail
secondary market for high-yield securities. As a result, the secondary market
for high-yield securities is more limited and less liquid than other secondary
securities markets. The high-yield secondary market is particularly susceptible
to liquidity problems when the institutions which dominate it temporarily cease
buying such securities for regulatory, financial or other reasons, such as the
savings and loan crisis. A less liquid secondary market may have an adverse
effect on the Series' ability to dispose of particular issues, when necessary,
to meet the Series' liquidity needs or in response to a specific economic event,
such as the deterioration in the creditworthiness of the issuer. In addition, a
less liquid secondary market makes it more difficult for the Series to obtain
precise valuations of the high-yield securities in its portfolio. During periods
involving such liquidity problems, judgment plays a greater role in valuing
high-yield securities than is normally the case. The secondary market for
high-yield securities is also generally considered to be more likely to be
disrupted by adverse publicity and investor perceptions than the more
established secondary securities markets. Privately placed high-yield securities
are particularly susceptible to the liquidity and valuation risks outlined
above.
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Legislative and Regulatory Action and Proposals--There are a variety of
legislative actions which have been taken or which are considered from time to
time by the United States Congress which could adversely affect the market for
high-yield bonds. For example, Congressional legislation limited the
deductibility of interest paid on certain high-yield bonds used to finance
corporate acquisitions. Also, Congressional legislation has, with some
exceptions, generally prohibited federally-insured savings and loan institutions
from investing in high-yield securities. Regulatory actions have also affected
the high-yield market. For example, many insurance companies have restricted or
eliminated their purchases of high-yield bonds as a result of, among other
factors, actions taken by the National Association of Insurance Commissioners.
If similar legislative and regulatory actions are taken in the future, they
could result in further tightening of the secondary market for high-yield issues
and could reduce the number of new high-yield securities being issued.
SPECIAL RISK CONSIDERATIONS
Shareholders should understand that all investments involve risk and there
can be no guarantee against loss resulting from an investment in the Series, nor
can there be any assurance that the Series' investment objective will be
attained.
* * *
Each Series' investment objective, the Fund's designation as an open-end
investment company, each Series' designation as a diversified fund, and certain
other policies of the Series may not be changed unless authorized by the vote of
a majority of the applicable Series' outstanding voting securities. A "majority
vote of the outstanding voting securities" is the vote by the holders of the
lesser of (a) 67% or more of the Series' voting securities present in person or
represented by proxy if the holders of more than 50% of the outstanding voting
securities of such Series are present or represented by proxy; or b) more than
50% of the Series' outstanding voting securities. Part B lists other more
specific investment restrictions of the Series which may not be changed without
a majority shareholder vote. A brief discussion of those factors that materially
affected each Series' performance during its most recently completed fiscal year
appears in the Series' Annual Report. The remaining investment policies are not
fundamental and may be changed by the Board of Directors of the Fund without a
shareholder vote.
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DIVERSIFICATION
The Fund was established as the underlying investment for variable contracts
issued by life companies. Section 817(h) of the Internal Revenue Code of 1986,
as amended (the "Code"), imposes certain diversification standards on the
underlying assets of variable contracts held in the Portfolios of the Fund. The
Code provides that a variable contract shall not be treated as an annuity
contract or life insurance for any period (and any subsequent period) for which
the investments are not, in accordance with regulations prescribed by the United
States Treasury Department ("Treasury Department"), adequately diversified.
Disqualification of the variable contract would result in the imposition of
federal income tax to the contract owner with respect to earnings allocable to
the contract prior to distributions under the contract (e.g., withdrawals). The
Code contains a safe harbor provision which provides that variable contracts
meet the diversification requirements if, as of the close of each quarter, the
underlyi ng assets meet the diversification standards for a regulated investment
company and no more than 55 percent of the total assets consist of cash, cash
items, U.S. government securities and securities of other regulated investment
companies.
Treasury Department Regulations (Treas. Reg. Section 1.817-5) provide that a
fund will be deemed to be considered adequately diversified if (i) no more than
55 percent of the value of the total assets of the fund is represented by any
one investment; (ii) no more than 70 percent of such value is represented by any
two investments; (iii) no more than 80 percent of such value is represented by
any three investments; and (iv) no more than 90 percent of such value is
represented by any four investments.
The Technical and Miscellaneous Revenue Act of 1988 provides that for
purposes of determining whether or not the diversification standards imposed on
the underlying assets of variable contracts by Section 817(h) of the Code have
been met, "each United States government agency or instrumentality shall be
treated as a separate issuer."
Each Series will be managed in such a manner as to comply with these
diversification requirements.
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APPENDIX A--RATINGS
General Rating Information
BONDS
Excerpts from Moody's description of its bond ratings: Aaa--judged to be the
best quality. They carry the smallest degree of investment risk; Aa--judged to
be of high quality by all standards; A--possess favorable attributes and are
considered "upper medium" grade obligations; Baa--considered as medium grade
obligations. Interest payments and principal security appear adequate for the
present but certain protective elements may be lacking or may be
characteristically unreliable over any great length of time; Ba--judged to have
speculative elements; their future cannot be considered as well assured. Often
the protection of interest and principal payments may be very moderate and
thereby not well safeguarded during both good and bad times over the future.
Uncertainty of position characterizes bonds in this class; B--generally lack
characteristics of the desirable investment. Assurance of interest and principal
payments or of maintenance of other terms of the contract over any long period
of time may be small; Caa--are of poor standing. Such issues may be in default
or there may be present elements of danger with respect to principal or
interest; Ca--represent obligations which are speculative in a high degree. Such
issues are often in default or have other marked shortcomings; C--the lowest
rated class of bonds and issues so rated can be regarded as having extremely
poor prospects of ever attaining any real investment standing.
Excerpts from S&P's description of its bond ratings: AAA--highest grade
obligations. They possess the ultimate degree of protection as to principal and
interest; AA--also qualify as high grade obligations, and in the majority of
instances differ from AAA issues only in a small degree; A--strong ability to
pay interest and repay principal although more susceptible to changes in
circumstances; BBB--regarded as having an adequate capacity to pay interest and
repay principal; BB, B, CCC, CC--regarded, on balance, as predominantly
speculative with respect to capacity to pay interest and repay principal in
accordance with the terms of the obligation. BB indicates the lowest degree of
speculation and CC the highest degree of speculation. While such debt will
likely have some quality and protective characteristics, these are outweighed by
large uncertainties or major risk exposures to adverse conditions; C--reserved
for income bonds on which no interest is being paid; D--in default, and payment
of interest and/or repayment of principal is in arrears.
COMMERCIAL PAPER
Excerpts from Moody's description of its two highest commercial paper
ratings: P-1--the highest grade possessing greatest relative strength;
P-2--second highest grade possessing less relative strength than the highest
grade.
Excerpts from S&P's description of its two highest commercial paper ratings:
A-1--judged to be the highest investment grade category possessing the highest
relative strength; A-2--investment grade category possessing less relative
strength than the highest rating.
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