VAN KAMPEN MERRITT SERIES TRUST
One Parkview Plaza
Oakbrook Terrace, Illinois 60181
VAN KAMPEN MERRITT SERIES TRUST ("Trust") is intended to meet differing
investment objectives with its separate Portfolios. The Trust is a series fund
with seven Portfolios. However, only shares of the Quality Income Portfolio,
Money Market Portfolio and Stock Index Portfolio are being offered herein. The
Trustees may provide for additional Portfolios from time to time. Each
Portfolio issues its own class of shares which has rights separate from the
other classes of shares.
This Prospectus concisely sets forth the information about the Trust that a
prospective investor should know before investing. Investors should read and
retain this Prospectus for future reference.
A Statement of Additional Information, dated May 1, 1995, as amended June 1,
1995, containing information about the Trust has been filed with the
Securities and Exchange Commission and is hereby incorporated by reference
into this Prospectus. A copy of the Statement of Additional Information may be
obtained without charge by calling (800) 831-LIFE, or writing Cova Life Sales
Company, the distributor of the Trust's shares, at One Tower Lane, Suite 3000,
Oakbrook Terrace, Illinois 60181-4644.
PURCHASERS SHOULD BE AWARE THAT AN INVESTMENT IN THE MONEY MARKET PORTFOLIO IS
NEITHER INSURED NOR GUARANTEED BY THE U. S. GOVERNMENT. THERE CAN BE NO
ASSURANCE THAT THE MONEY MARKET PORTFOLIO WILL BE ABLE TO MAINTAIN A STABLE
NET ASSET VALUE OF $1.00 PER SHARE.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
THIS PROSPECTUS IS DATED: MAY 1, 1995, AS AMENDED JUNE 1, 1995.
<PAGE>
TABLE OF CONTENTS
FINANCIAL HIGHLIGHTS
ADDITIONAL PERFORMANCE INFORMATION
THE TRUST
INVESTMENT OBJECTIVES
Money Market Portfolio
Quality Income Portfolio
Stock Index Portfolio
INVESTMENT PRACTICES
Investment Limitations
RISK FACTORS
Tax Considerations
Special Considerations Relating to Foreign Securities
PORTFOLIO TURNOVER RATES
Money Market Portfolio and Quality Income Portfolio
Stock Index Portfolio
MANAGEMENT OF THE TRUST
The Trustees
The Investment Advisor
Portfolio Management
Expenses of the Trust
DESCRIPTION OF THE TRUST
Shareholder Rights
Inquiries
Distribution and Redemption of Shares
Dividends
Tax Status
Net Asset Values
FUND PERFORMANCE
APPENDIX - DESCRIPTION OF CORPORATE BOND RATINGS
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<TABLE>
<CAPTION>
FINANCIAL HIGHLIGHTS
(FOR ONE SHARE OUTSTANDING THROUGHOUT THE PERIOD)
The following schedule presents financial highlights for one share of the Portfolio throughout the periods indicated. The
financial highlights have been audited by KPMG Peat Marwick LLP, independent auditors, for each of the periods through
December 31, 1994 presented below, and their report thereon appears in the Portfolio's related Statement of Additional
Information. This information should be read in conjunction with the financial statements and related notes thereto
included in the Statement of Additional Information, a copy of which may be obtained without charge as indicated elsewhere
in this Prospectus.
QUALITY INCOME PORTFOLIO
December 11, 1989
(Commencement of
Year Ended December 31 Investment
-------- -------- ------------- Operations) to
1994 1993 1992 1991 1990 December 31, 1989
-------- -------- ------------- -------- ------- -------------------
<S> <C> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period $10.886 $10.699 $ 10.618 $ 9.969 $9.930 $ 10.000
-------- -------- ------------- -------- ------- -------------------
Net Investment Income .603 .641 .696 .753 .713 .043
Net Realized and Unrealized Gain/Loss on
Investments (1.071) .518 .081 .649 .039 (.070)
-------- -------- ------------- -------- ------- -------------------
Total from Investment Operations (.468) 1.159 .777 1.402 .752 (.027)
-------- -------- ------------- -------- ------- -------------------
Less:
Distributions from Net Investment Income .603 .641 .696 .753 .713 .043
Distributions from Net Realized Gain on
Investments .000 .331 .000 .000 .000 .000
-------- -------- ------------- -------- ------- -------------------
Total Distributions .603 .972 .696 .753 .713 .043
-------- -------- ------------- -------- ------- -------------------
Net Asset Value, End of Period $ 9.815 $10.886 $ 10.699 $10.618 $9.969 $ 9.930
======== ======== ============= ======== ======= ===================
Total Investment Return (Non-Annualized) (4.33%) 11.04% 7.61% 14.71% 7.99% (.27%)
Net Assets at End of Period (in millions) $ 33.9 $ 51.1 $ 24.1 $ 6.8 $ 6.1 $ 2.5
Ratio of Expenses to Average Net Assets*
(Annualized) .59% .60% .60% .60% .74% .70%
Ratio of Net Investment Income to Average
Net Assets* (Annualized) 5.69% 5.82% 6.87% 7.45% 7.64% 7.83%
Portfolio Turnover 177.63% 318.40% 231.91% 12.86% 59.25% .00%
*If certain expenses had not been assumed
by Cova Life (formerly known as Xerox
Financial Services Life Insurance Company),
total investment return would have been lower
and the ratios would have been as follows:
Ratio of Expenses to Average Net Assets
(Annualized) .68% .70% .88% 1.10% 1.53% 9.15%
Ratio of Net Investment Income to Average
Net Assets (Annualized) 5.60% 5.73% 6.59% 6.96% 6.85% N/A
</TABLE>
See Financial Statements and Notes Thereto
<PAGE>
<TABLE>
<CAPTION>
FINANCIAL HIGHLIGHTS
(FOR ONE SHARE OUTSTANDING THROUGHOUT THE PERIOD)
The following schedule presents financial highlights for one share of the Portfolio throughout the periods
indicated. The financial highlights have been audited by KPMG Peat Marwick LLP, independent auditors, for
each of the periods through December 31, 1994 presented below, and their report thereon appears in the
Portfolio's related Statement of Additional Information. This information should be read in conjunction
with the financial statements and related notes thereto included in the Statement of Additional
Information, a copy of which may be obtained without charge as indicated elsewhere in this Prospectus.
MONEY MARKET PORTFOLIO
July 1, 1991
(Commencement of
Year Ended December 31 Investment
------ ------- ------------- Operations) to
1994 1993 1992 December 31, 1991
------ ------- ------------- -------------------
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Period $1.00 $ 1.00 $ 1.00 $ 1.00
------ ------- ------------- -------------------
Net Investment Income .041 .032 .038 .027
------ ------- ------------- -------------------
Less Distributions from Net Investment Income .041 .032 .038 .027
------ ------- ------------- -------------------
Net Asset Value, End of Period $1.00 $ 1.00 $ 1.00 $ 1.00
====== ======= ============= ===================
Total Investment Return* (Non-Annualized) 4.23% 3.24% 3.88% 2.75%
Net Assets at End of Period (in millions) $75.9 $ 6.6 $ 4.0 $ 5.4
Ratio of Expenses to Average Net Assets* (Annualized) .10% .10% .10% .09%
Ratio of Net Investment Income to Average Net
Assets* (Annualized) 4.37% 3.23% 3.63% 5.11%
*If certain expenses had not been assumed
by Cova Life (formerly known as Xerox
Financial Services Life Insurance Company),
total investment return would have been lower
and the ratios would have been as follows:
Ratio of Expenses to Average Net Assets (Annualized) .68% .86% 1.30% 1.11%
Ratio of Net Investment Income to Average
Net Assets (Annualized) 3.79% 2.47% 2.43% 4.10%
</TABLE>
See Financial Statements and Notes Thereto
<PAGE>
<TABLE>
<CAPTION>
FINANCIAL HIGHLIGHTS
(FOR ONE SHARE OUTSTANDING THROUGHOUT THE PERIOD)
The following schedule presents selected per share data and related ratios for one share of the Portfolio
throughout the periods indicated. The financial highlights have been audited by KPMG Peat Marwick LLP,
independent auditors, for each of the periods through December 31, 1994 presented below, and their report
thereon appears in the Portfolio's related Statement of Additional Information. This information should be read
in conjunction with the financial statements and related notes thereto included in the Statement of Additional
Information, a copy of which may be obtained without charge as indicated elsewhere in this Prospectus.
STOCK INDEX PORTFOLIO
November 1, 1991
(Commencement of
Investment
Year Ended December 31 Operations) to
-------- -------- -------------
1994 1993 1992 December 31, 1991
-------- -------- ------------- -------------------
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Period $11.115 $10.552 $ 10.572 $ 10.000
-------- -------- ------------- -------------------
Net Investment Income .311 .205 .172 .038
Net Realized and Unrealized Gain/Loss on Investments (.337) .726 .477 .534
-------- -------- ------------- -------------------
Total from Investment Operations (.026) .931 .649 .572
-------- -------- ------------- -------------------
Less:
Distributions from Net Investment Income .311 .205 .210 .000
Distributions from Net Realized Gain on Investments .185 .163 .459 .000
Return of Capital Distributions .006 .000 .000 .000
-------- -------- ------------- -------------------
Total Distributions .502 .368 .669 .000
-------- -------- ------------- -------------------
Net Asset Value, End of Period $10.587 $11.115 $ 10.552 $ 10.572
======== ======== ============= ===================
Total Investment Return (Non-Annualized) (.11%) 8.84% 6.22% 5.70%
Net Assets at End of Period (in millions) $ 36.8 $ 91.3 $ 35.0 $ 6.8
Ratio of Expenses to Average Net Assets* (Annualized) .58% .60% .59% .40%
Ratio of Net Investment Income to Average Net
Assets* (Annualized) 2.23% 2.29% 2.54% 3.02%
Portfolio Turnover 47.05% 44.09% 85.73% .00%
*If certain expenses had not been assumed
by Cova Life (formerly known as Xerox
Financial Services Life Insurance Company),
total investment return would have been lower
and the ratios would have been as follows:
Ratio of Expenses to Average Net Assets (Annualized) .80% .74% 1.21% 1.84%
Ratio of Net Investment Income to Average
Net Assets (Annualized) 2.01% 2.15% 1.92% 1.58%
</TABLE>
See Financial Statements and Notes Thereto
<PAGE>
ADDITIONAL PERFORMANCE INFORMATION
Further information about the Trust's performance is contained in the Annual
Report to shareholders which may be obtained, without charge, by calling (800)
831-LIFE, or writing Cova Life Sales Company, the distributor of the Trust's
shares, at One Tower Lane, Suite 3000, Oakbrook Terrace, Illinois 60181-4644.
THE TRUST
VAN KAMPEN MERRITT SERIES TRUST (the "Trust") is a diversified open-end
management investment company established as a Massachusetts business trust
under a Declaration of Trust dated July 9, 1987. The Trust is currently
comprised of seven separate Portfolios, three of which are being offered
herein: Money Market Portfolio, Quality Income Portfolio and Stock Index
Portfolio. The Trustees may provide for additional Portfolios from time to
time. Each Portfolio issues a separate class of shares. The Declaration of
Trust permits the Trustees to issue an unlimited number of full or fractional
shares of each class of stock.
INVESTMENT OBJECTIVES
Each Portfolio of the Trust has a different investment objective which it
pursues through separate investment policies as described below. Each
Portfolio is managed separately by Van Kampen American Capital Investment
Advisory Corp. (F/K/A Van Kampen Merritt Investment Advisory Corp.) (the
"Investment Advisor"). The risks and opportunities of each Portfolio should be
examined separately. The differences in objectives and policies among the
Portfolios can be expected to affect the return of each Portfolio and the
degree of market and financial risk of each Portfolio.
There is no assurance that the investment objectives of the various Portfolios
will be met.
MONEY MARKET PORTFOLIO
The investment objective of the Money Market Portfolio is to provide high
current income consistent with the preservation of capital and liquidity
through investment in a broad range of money market instruments that will
mature within 12 months of the date of purchase.
INVESTMENT PROGRAM
__________________
The Money Market Portfolio seeks to achieve its objective by investing only in
the following securities and instruments: (a) obligations of or guaranteed by
the U.S. government, its agencies or instrumentalities ("U.S. Government
Securities"); (b) obligations of banks subject to U.S. government regulation
as well as such other bank obligations as are insured by a U.S. government
agency ("Bank Obligations"); (c) commercial paper (including variable amount
master demand notes); and (d) debt obligations (other than commercial paper)
of corporate issuers.
<PAGE>
U.S. Government Securities include Treasury Bills, Notes and Bonds issued by
the U.S. government and backed by the full faith and credit of the U.S.
government, as well as securities issued or guaranteed as to principal and
interest by agencies and instrumentalities of the U.S. government. Bank
Obligations include certificates of deposit and bankers' acceptances of
domestic banks (or Euro-dollar obligations of foreign branches of those
domestic banks) subject to U.S. government regulation and time deposits of
federal and state banks whose accounts are insured by a government agency as
well as the accounts themselves.
See "Risk Factors - Tax Considerations" for a discussion of special
diversification standards which the Portfolio will meet.
The Portfolio may lend portfolio securities. The Portfolio may also enter into
repurchase agreements but only if the underlying securities are either
Government securities or First Tier Securities (see "Investment Quality" and
"Portfolio Maturity", below). The Portfolio may purchase and sell securities
on a "when issued" and "delayed delivery" basis. The Portfolio may borrow up
to 10% of its net assets in order to pay for redemptions when liquidation of
portfolio securities is considered disadvantageous or inconvenient and may
pledge up to 10% of its net assets to secure borrowings. The Portfolio may
invest up to 10% of its net assets in restricted securities. A more complete
description of these investments and transactions is contained under
"Investment Practices".
The Portfolio may also invest in Floating Rate Securities. Floating Rate
Securities provide for automatic adjustment of the interest rate whenever some
specified interest rate index changes. The interest rate on Floating Rate
Securities is ordinarily determined by reference to or is a percentage of a
bank's prime rate, the 90-day U.S. Treasury bill rate, the rate of return on
commercial paper or bank certificates of deposit, an index of short-term
interest rates, or some other objective measure. Floating Rate Securities
often include a demand feature which entitles the holder to sell the
securities to the issuer at par. In many cases, the demand feature can be
exercised at any time on seven days' notice; in other cases, the demand
feature is exercisable at any time on 30 days' notice or on similar notice at
intervals of not more than one year. With respect to Floating Rate Securities,
the financial institution issuing the instrument is considered the issuer.
However, where the securities are backed by an irrevocable letter of credit or
by insurance, without which the securities would not qualify for purchase
under the Portfolio's quality restrictions, the issuer of the letter of credit
will be considered the issuer of the securities.
Although the securities in which the Portfolio invests are of high quality and
the transactions which it enters into entail low risk, there is still the
possibility of loss of principal. Corporate issuers may default on their
obligations. Repurchase agreements may be deemed to be collateralized loans
and the Portfolio could experience delay and expenses in liquidating
collateral in the event of the failure of the repurchasing party to honor its
agreement to repurchase. Agencies or instrumentalities of the U.S. government
could also default on their securities which may not be guaranteed by or be
backed by the full faith and credit of the U.S. government.
<PAGE>
INVESTMENT QUALITY
__________________
(a) Eligible Securities
The Money Market Portfolio will invest only in United States
dollar-denominated instruments which, at the time of acquisition, are
determined to be eligible securities ("Eligible Securities") by the Investment
Advisor and which are determined by the Investment Advisor to present minimal
credit risks.
An Eligible Security is any security that has a remaining maturity of less
than one year and (i) which is rated in one of the two highest rating
categories for short-term debt obligations by any two nationally recognized
statistical rating organizations ("NRSROs") that have issued a rating with
respect to a security or class of debt obligations of an issuer, or if only
one NRSRO has issued a rating, that NRSRO ("Requisite NRSROs"); or (ii) has a
security that has been issued by an issuer that has outstanding short-term
debt obligations (or security within that class) that are comparable in
priority and security with the security ("CPS Security") which is rated, or
the issuer of which is rated, by the Requisite NRSROs in one of the two
highest rating categories for short-term debt obligations. An unrated security
may also be an Eligible Security if it is determined by the Investment Advisor
to be of comparable quality ("Comparable Quality Security") to either a First
Tier Security or Second Tier Security, as those terms are defined below.
A First Tier Security is an Eligible Security that (i) is itself rated, has a
CPS Security rated or the issuer of which security is rated by the Requisite
NRSROs in the highest rating category for short-term debt obligations or (ii)
is a Comparable Quality Security which is determined by the Investment Advisor
to be of comparable quality to a First Tier Security.
A Second Tier Security is (i) an Eligible Security that is itself rated, has a
CPS Security rated or the issuer of which security is rated by the Requisite
NRSROs in the second highest rating category for short-term debt obligations,
(ii) an instrument that has been rated in the highest rating category for
short-term debt obligations by one NRSRO and has been rated in the second
highest rating category for short-term debt obligations by one or more other
NRSROs or (iii) a comparable Quality Security which is determined by
the Investment Advisor to be of comparable quality to a Second Tier Security.
(b) Guidelines for Purchasing Eligible Securities
The Investment Advisor, on behalf of the Money Market Portfolio, may (i)
acquire any First Tier Security that, at the time of acquisition, has received
the highest rating from any two NRSROs; (ii) acquire any Second Tier Security
that, at the time of acquisition, has received the second highest rating from
any two NRSROs, and (iii) acquire any First Tier Security or any Second Tier
Security that at time of purchase is rated by a single NRSRO, or any
Comparable Quality Security, subject to approval by the Board of Trustees of
the Trust.
<PAGE>
PORTFOLIO MATURITY
__________________
The Money Market Portfolio may not purchase any instrument, other than a
Government security, with a remaining maturity of greater than one year. A
Government security is any security issued or guaranteed as to principal or
interest by the United States, or by a person controlled or supervised by and
acting as an instrumentality of the Government of the United States, or any
certificate of deposit for any of the above.
The Money Market Portfolio maintains a dollar-weighted average portfolio
maturity of ninety (90) days or less. The Portfolio determines the maturity of
portfolio investments in accordance with Rule 2a-7, a valuation and pricing
rule under the Investment Company Act of 1940, as amended.
QUALITY INCOME PORTFOLIO
The investment objective of the Quality Income Portfolio is to seek a high
level of current income, consistent with safety of principal, by investing in
obligations issued or guaranteed by the U.S. government or its agencies or
instrumentalities or in various investment grade debt obligations including
mortgage pass-through certificates and collateralized mortgage obligations.
The Investment Advisor will use the Lehman Brothers Government/Corporate Bond
Index as a benchmark against which it will gauge the performance of the
Portfolio and determine risk measurement. The Lehman Brothers
Government/Corporate Bond Index is comprised of all publicly issued,
non-convertible, domestic debt of the U.S. Government or any agency thereof,
quasi-Federal corporation, or corporate debt guaranteed by the U.S. Government
and all publicly issued, fixed-rate, non-convertible, domestic debt of the
four major corporate classifications: industrial, utility, financial and
Yankee bond. Only notes and bonds with a minimum outstanding principal amount
of $50,000,000 and a minimum maturity of one year are included. Bonds included
must have a rating of at least Baa by Moody's Investors Service, Inc.
("Moody's"), BBB by Standard & Poor's Corporation ("S&P") or in the case of
bank bonds not rated by either Moody's or S&P, BBB by Fitch Investors Service,
Inc.
Depending on market conditions and subject to the special diversification
provisions imposed on the Portfolio (see "Risk Factors"), the Portfolio may
invest a substantial portion of its assets in Government National Mortgage
Association ("GNMA") Certificates of the modified pass-through type. These
GNMA Certificates are debt securities issued by a mortgage holder (such as a
mortgage banker) and represent an interest in a pool of mortgages insured by
the Federal Housing Administration or the Farmers Home Administration or
guaranteed by the Veterans Administration. GNMA guarantees the timely payment
of monthly installments of principal and interest on the GNMA Certificates.
These guarantees are backed by the full faith and credit of the U.S.
government.
<PAGE>
To the extent the Portfolio acquires GNMA Certificates at par or at discount,
the GNMA Certificates offer a high degree of safety of the principal
investment because of the GNMA guarantee. If the Portfolio buys GNMA
Certificates at a premium, however, mortgage foreclosures and repayments of
principal by mortgagors (which may be made at any time without penalty) may
result in some loss of the Portfolio's principal investment to the extent of
the premium paid. To avoid loss of this premium and of any gain in value of
its GNMA Certificates resulting from a decrease in interest rates generally,
the Portfolio may sell its GNMA Certificates which are selling at a
substantial premium. This practice may increase the Portfolio's portfolio
turnover rate. A more complete description of GNMA Certificates is contained
in the Statement of Additional Information.
The Portfolio, subject to the limitations on investments as described in "Risk
Factors", may invest in other obligations issued or guaranteed by the U.S.
government or by its agencies or instrumentalities. These instruments may be
either direct obligations of the Treasury (such as U.S. Treasury Notes, Bills
or Bonds) or securities issued or guaranteed by government agencies or
instrumentalities. Of the obligations issued or guaranteed by agencies or
instrumentalities of the U.S. government, some are backed by the full faith
and credit of the U.S. government (such as Maritime Administration Title XI
Ship Financing Bonds) and others are backed only by the rights of the issuer
to borrow from the U.S. Treasury (such as Federal Home Loan Bank Bonds and
Federal National Mortgage Association Bonds).
The Portfolio may also invest in one or more of the following:
(1) Marketable straight-debt securities of domestic issuers, and of
foreign issuers (payable in U.S. dollars) rated at the time of purchase within
the four highest grades assigned by Moody's (Aaa, Aa, A or Baa) or by S&P
(AAA, AA, A or BBB);
(2) Commercial paper rated at time of purchase Prime-3 by Moody's or A-3
by S&P;
(3) Bank obligations (including repurchase agreements and those
denominated in Eurodollars) of banks having total assets in excess of $1
billion; and
(4) Mortgage pass-through certificates and collateralized mortgage
obligations.
Securities rated Baa or BBB may have speculative characteristics and changes
in economic conditions or other circumstances are more likely to lead to a
weakened capacity to make principal and interest payments than is the case
with higher grade bonds. For a further description of the above investments
and the ratings used, see "Appendix - Description of Corporate Bond Ratings"
herein and "Description of Securities Ratings - Commercial Paper Ratings" in
the Statement of Additional Information.
The Portfolio may invest up to 35% of its assets in securities of foreign
issuers. These investments will be marketable straight-debt securities of
foreign issuers payable in U.S. dollars and rated at the time of purchase
<PAGE>
within the four highest grades assigned by Moody's or by S&P. Investments in
foreign securities present certain risks not ordinarily found in investments
in securities of U.S. issuers. See "Risk Factors - Special Considerations
Relating to Foreign Securities".
The Portfolio may lend portfolio securities. The Portfolio may borrow under
certain circumstances. The Portfolio may also enter into repurchase
agreements, reverse repurchase agreements and may sell securities short. The
Portfolio may purchase and sell securities on a "when issued" and "delayed
delivery" basis. The Portfolio may invest in restricted securities. A more
complete description of these investments and transactions is contained under
"Investment Practices".
If the Investment Advisor deems it appropriate to seek to partially hedge the
Portfolio's assets against market value changes, the Portfolio may enter into
various hedging transactions, such as futures contracts, financial index
futures contracts, and the related put or call options contracts on futures
contracts. Hedging is a means of offsetting, or neutralizing, the price
movement of an investment by making another investment, the price of which
should tend to move in the opposite direction from that of the original
investment. See "Investment Practices - Strategic Transactions" and the
Statement of Additional Information for a more complete description of these
transactions.
The Portfolio will be affected by general changes in interest rates resulting
in increases or decreases in the value of the Portfolio securities. Market
prices of debt securities tend to rise when interest rates fall and market
prices tend to fall when interest rates rise. Repurchase agreements may be
deemed to be collateralized loans and the Portfolio could experience delay and
expenses in liquidating such collateral in the event of the failure of the
repurchasing party to honor its agreement to repurchase. Agencies or
instrumentalities of the U.S. government could also default on their
securities which may not be guaranteed by or be backed by the full faith and
credit of the U.S. government.
See "Risk Factors - Tax Considerations" for a discussion of special
diversification standards which the Portfolio will meet.
STOCK INDEX PORTFOLIO
INVESTMENT OBJECTIVE
___________________
The investment objective of the Stock Index Portfolio is to achieve investment
results that approximate the aggregate price and yield performance of the
Standard & Poor's 500 Composite Stock Price Index (the "S&P 500 Index" or the
"Index").
The S&P 500 Index represents more than 70% of the total market value of all
publicly-traded common stocks, and is widely viewed among investors as a good
representative of the aggregate performance of publicly-traded common stocks.
<PAGE>
"Standard & Poor's", "S&P", "S&P 500", "Standard & Poor's 500", and "500" are
trademarks of McGraw-Hill Inc. and have been licensed for use by Cova
Financial Services Life Insurance Company (formerly Xerox Financial Services
Life Insurance Company) and its affiliates ("Cova Life"). The Stock Index
Portfolio is not sponsored, endorsed, sold or promoted by Standard & Poor's
Corporation ("S&P") and S&P makes no representation or warranty, express or
implied, to the owners of the Stock Index Portfolio or any member of the
public regarding the advisability of investing in securities generally or in
the Stock Index Portfolio particularly or the ability of the S&P 500 Index to
track general stock market performance. S&P's only relationship to Cova Life
is the licensing of certain trademarks and trade names of S&P and of the S&P
500 Index which is determined, composed and calculated by S&P without regard
to Cova Life or the Stock Index Portfolio. S&P has no obligation to take the
needs of Cova Life or the owners of the Stock Index Portfolio into
consideration in determining, composing or calculating the S&P 500 Index. S&P
is not responsible for and has not participated in the determination of the
prices and amount of the Stock Index Portfolio or the timing of the issuance
or sale of the Stock Index Portfolio or in the determination or calculation of
the equation by which the Stock Index Portfolio is to be converted into cash.
S&P has no obligation or liability in connection with the administration,
marketing or trading of the Stock Index Portfolio.
S&P DOES NOT GUARANTEE THE ACCURACY AND/OR THE COMPLETENESS OF THE S&P 500
INDEX OR ANY DATA INCLUDED THEREIN AND S&P SHALL HAVE NO LIABILITY FOR ANY
ERRORS, OMISSIONS, OR INTERRUPTIONS THEREIN. S&P MAKES NO WARRANTY, EXPRESS OR
IMPLIED, AS TO RESULTS TO BE OBTAINED BY COVA LIFE, OWNERS OF THE STOCK INDEX
PORTFOLIO, OR ANY OTHER PERSON OR ENTITY FROM THE USE OF THE S&P 500 INDEX OR
ANY DATA INCLUDED THEREIN. S&P MAKES NO EXPRESS OR IMPLIED WARRANTIES, AND
EXPRESSLY DISCLAIMS ALL WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A
PARTICULAR PURPOSE OR USE WITH RESPECT TO THE S&P 500 INDEX OR ANY DATA
INCLUDED THEREIN. WITHOUT LIMITING ANY OF THE FOREGOING, IN NO EVENT SHALL S&P
HAVE ANY LIABILITY FOR ANY SPECIAL, PUNITIVE, INDIRECT, OR CONSEQUENTIAL
DAMAGES (INCLUDING LOST PROFITS), EVEN IF NOTIFIED OF THE POSSIBILITY OF SUCH
DAMAGES.
INVESTMENT POLICIES
___________________
The Stock Index Portfolio is not managed according to traditional methods of
"active investment management, which involve the buying and selling of
securities based upon economic, financial and market analysis and investment
judgment. Instead, the Portfolio, utilizing a "passive" or "indexing"
investment approach, attempts to duplicate the investment performance of the
respective index through statistical procedures.
The Investment Advisor believes that the "indexing approach described above is
an effective method of substantially duplicating percentage changes in the S&P
500 Index. It is a reasonable expectation that the correlation between the
performance of the Portfolio and that of the Index will be approximately 98%;
a figure of 100% would indicate perfect correlation. Perfect correlation would
be achieved when the net asset value per share of the Portfolio increases and
decreases in exact proportion to changes in the Index. The Board of Trustees
of the Trust will review the correlation between the Portfolio and the Index
<PAGE>
on a quarterly basis. See the Statement of Additional Information for a
description of the monitoring procedures established by the Board.
In pursuing its investment objective, the Portfolio will invest in no fewer
than 100 stocks with the majority of the Portfolio consisting of those stocks
having the largest weightings in the Index. The Investment Advisor will select
stocks for the Portfolio after taking into account their individual weights in
the Index and the weights in the Index of the industry groups to which they
belong.
Although the Portfolio will attempt to remain fully invested in common stocks,
it may also invest in certain short-term fixed income securities such as cash
reserves.
As described further below under "Implementation of Policies", the Portfolio
may also enter into stock index futures contracts and options on stock indexes
and stock index futures contracts for various reasons including to hedge
against changes in security prices. Hedging is a means of offsetting, or
neutralizing, the price movement of an investment by making another
investment, the price of which should tend to move in the opposite direction
from that of the original investment. See the Statement of Additional
Information for a more complete description of hedging and for a discussion of
the risks involved therein.
IMPLEMENTATION OF POLICIES
__________________________
The S&P 500 Index is composed of 500 common stocks which are chosen by S&P to
be included in the unmanaged Index. Market value, liquidity and industry
representation are considered in the selection process. The inclusion of a
stock in the S&P 500 Index in no way implies that S&P believes the stock to be
an attractive investment. The 500 securities, 95% of which trade on the New
York Stock Exchange, represent approximately 75% of the market value of all
U.S. common stocks. Each stock in the S&P 500 Index is weighted by its market
value: its market price per share times the number of shares outstanding.
Because of the market-value weighting, the 50 largest companies in the S&P 500
Index currently account for approximately 50% of the Index. Typically,
companies included in the S&P 500 Index are the largest and most dominant
firms in their respective industries. As of December 31, 1994, the five
largest companies in the Index were: General Electric (2.54%), Exxon
Corporation (2.28%), American Telephone & Telegraph Corporation (2.08%), Coca
Cola Enterprises (1.90%) and Royal Dutch Petroleum (1.73%). The largest
industry categories were: Oil, Telephone and Electric Companies.
Although the Portfolio will normally seek to remain substantially fully
invested in common stocks, the Portfolio may invest temporarily in certain
short-term fixed income securities. Such securities may be used to invest
uncommitted cash balances or to maintain liquidity to meet shareholder
redemptions. These securities include: obligations of the United States
government and its agencies or instrumentalities; commercial paper, bank
certificates of deposit and bankers' acceptances; and repurchase agreements
and reverse repurchase agreements collateralized by these securities.
<PAGE>
Repurchase agreements may be deemed to be collateralized loans and the
Portfolio could experience delay and expenses in liquidating such collateral
in the event of the failure of the repurchasing party to honor its agreement
to repurchase.
The Portfolio will employ a combination of an indexing strategy known as
"sampling" and stock index futures contracts and options. Sampling is a method
that is used to attempt to replicate the return of the Index without having to
purchase a weighted portfolio containing all 500 stocks in the Index. This
process selects stocks for the Portfolio so that various industry weightings,
market capitalizations and fundamental characteristics (e.g. price to book,
price to earnings, debt to asset ratios and dividend yields) match those of
the Index. The use of sampling involves certain risks with respect to the
ability of the Portfolio to achieve the desired correlation with the Index.
(See "Risk Factors - Stock Index Portfolio - Sampling").
As indicated above, the Portfolio may utilize stock index futures contracts
and options on stock indexes and stock index futures contracts.
Specifically, the Portfolio may enter into futures contracts provided that
not more than 5% of its assets are required as a futures contract deposit.
Stock index futures contracts and options may be used for several reasons: to
maintain cash reserves while remaining fully invested, to facilitate trading,
to reduce transaction costs, to hedge against changes in securities prices, or
to seek higher investment returns when a futures contract is priced more
attractively than the underlying equity security or the Index.
The Portfolio may lend its investment securities to qualified institutional
investors for the purpose of realizing additional income. Loans of securities
by the Portfolio will be collateralized by cash or securities issued or
guaranteed by the U.S. government or its agencies. The collateral will equal
at least 100% of the current market value of the loaned securities. The
Portfolio may borrow money from a bank but only for temporary or emergency
purposes. The Portfolio may borrow money up to one-third of the value of its
total assets taken at current value. The Portfolio would borrow money only to
meet redemption requests prior to the settlement of securities already sold or
in the process of being sold by the Portfolio. To the extent that the
Portfolio borrows money prior to selling securities, the Portfolio may be
leveraged; at such times, the Portfolio may appreciate or depreciate in value
more rapidly than the Index. The Portfolio may purchase and sell securities on
a "when issued" and "delayed delivery" basis. The Portfolio may invest in
restricted securities and may sell securities short. See "Investment
Practices" for a description of these investments and transactions.
See "Risk Factors - Tax Considerations" for a discussion of special
diversification standards which the Portfolio will meet.
<PAGE>
RISK FACTORS - STOCK INDEX PORTFOLIO
___________________________________
FUTURES CONTRACTS AND OPTIONS
_____________________________
The primary risks associated with the use of futures contracts and options
are: (i) imperfect correlation between the change in market value of the
stocks held by the Portfolio and the prices of futures contracts and options;
and (ii) possible lack of a liquid secondary market for a futures contract and
the resulting inability to close a futures position when desired. The risk of
imperfect correlation will be minimized by investing only in those contracts
whose behavior is expected to resemble that of the Portfolio's underlying
securities. The risk that the Portfolio will be unable to close out a futures
position will be minimized by entering into such transactions on a national
exchange with an active and liquid secondary market. See the Statement of
Additional Information for a more complete discussion of the risks involved
with respect to investment in stock index futures contracts and options on
stock indexes and stock index futures contracts.
MARKET RISK
___________
As the Portfolio invests primarily in common stocks, the Portfolio is subject
to market risk - i.e. the possibility that common stock prices will decline
over short or even extended periods. The U.S. stock market tends to be
cyclical, with periods when stock prices generally rise and periods when
prices generally decline.
To illustrate the volatility of stock prices, the following table sets forth
the extremes for stock market returns as well as the average return for the
period from 1926 to 1990, as measured by the S&P 500 Index:
<TABLE>
<CAPTION>
U.S. STOCK MARKET RETURNS (1926-1990)
OVER VARIOUS TIME HORIZONS
One Five Ten Twenty
Year Years Years Years
------ ------ ------ -------
<S> <C> <C> <C> <C>
Best +53.9% +23.9% +20.1% +16.9%
Worst -43.3 -12.5 -0.9 +3.1
Average +12.0 + 9.9 +10.2 +10.3
</TABLE>
<PAGE>
As shown, from 1926 to 1990, common stocks, as measured by the S&P 500 Index,
have provided an average annual total return (capital appreciation plus
dividend income) of +12.0%. While this average return can be used as a guide
for setting reasonable expectations for future stock market returns, it may
not be useful for forecasting future returns in any particular period, as
stock returns are quite volatile from year to year.
SAMPLING
________
The use of the sampling technique may, particularly under certain market
conditions, result in a lower correlation between the Portfolio and the Index
than if the Portfolio owned all 500 stocks in the Index. The sampling
technique, when employed successfully, is effective primarily due to the
existence of long-term correlations between groups of stocks and whole
industry sectors within the Index. Sampling, by definition, creates a bias
toward the purchase by the Portfolio of the stocks of larger capitalization
companies. As a result, the Portfolio can be negatively impacted by the use of
sampling in a market where the stocks of smaller capitalization companies are
outperforming those of larger capitalization companies. When this happens, it
may result in the Portfolio underperforming the Index and not achieving its
anticipated degree of correlation with the Index. The Investment Advisor will
actively monitor the effectiveness of its sampling technique and will
undertake corrective actions should the use of the sampling technique result
in underperformance or undercorrelation with respect to the Index. Such
corrective actions may include, but not necessarily be limited to, increasing
the number of companies represented in the Portfolio to incorporate more
secondary issues. As described under "Investment Policies" above, the Board of
Trustees of the Trust reviews the correlation between the Portfolio and the
Index on a quarterly basis. The Board has adopted monitoring procedures which
require, among other things, that the Investment Advisor notify the Board in
the event that the correlation between the performance of the Portfolio and
that of the Index falls below 95%.
INVESTMENT PRACTICES
In connection with the investment policies of the Portfolios described above,
the Portfolios may engage in certain investment practices subject to the
limitations set forth below. These investments entail risks.
STRATEGIC TRANSACTIONS. The Quality Income Portfolio may purchase and sell
exchange-listed and over-the-counter put and call options on securities,
financial futures, fixed-income indices and other financial instruments and
purchase and sell financial futures contracts. The Stock Index Portfolio may
enter into stock index futures contracts and options on stock indexes and
stock index futures contracts. Collectively, all of the above are referred to
as "Strategic Transactions." Strategic Transactions are hedging transactions
which may be used to attempt to protect against possible changes in the market
value of securities held in or to be purchased for a Portfolio, to protect a
Portfolio's unrealized gains in the value of its portfolio securities, to
facilitate the sale of such securities for investment purposes, to manage the
effective interest rate exposure of a Portfolio, to protect against changes in
<PAGE>
currency exchange rates, or to establish a position in the derivatives markets
as a temporary substitute for purchasing or selling particular securities. Any
or all of these investment techniques may be used at any time and there is no
particular strategy that dictates the use of one technique rather than
another, as use of any Strategic Transaction is a function of numerous
variables including market conditions. The ability of a Portfolio to utilize
these Strategic Transactions successfully will depend on the Investment
Advisor's ability to predict pertinent market movements, which cannot be
assured. The Portfolios will comply with applicable regulatory requirements
when implementing these strategies, techniques and instruments.
Strategic Transactions have risks associated with them including possible
default by the other party to the transaction, illiquidity and, to the extent
the Investment Advisor's view as to certain market movements is incorrect, the
risk that the use of such Strategic Transactions could result in losses
greater than if they had not been used. Use of put and call options may result
in losses to a Portfolio, force the sale of portfolio securities at
inopportune times or for prices other than at current market values, limit the
amount of appreciation a Portfolio can realize on its investments or cause a
Portfolio to hold a security it might otherwise sell. The use of options and
futures transactions entails certain other risks. In particular, the variable
degree of correlation between price movements of futures contracts and price
movements in the related portfolio position of a Portfolio creates the
possibility that losses on the hedging instrument may be greater than gains in
the value of a Portfolio's position. In addition, futures and options markets
may not be liquid in all circumstances and certain over-the-counter options
may have no markets. As a result, in certain markets, a Portfolio might not be
able to close out a transaction without incurring substantial losses, if at
all. Although the contemplated use of these futures contracts and options
thereon should tend to minimize the risk of loss due to a decline in the value
of the hedged position, at the same time they tend to limit any potential gain
which might result from an increase in value of such position. Finally, the
daily variation margin requirements for futures contracts would create a
greater ongoing potential financial risk than would purchases of options,
where the exposure is limited to the cost of the initial premium. Losses
resulting from the use of Strategic Transactions would reduce net asset value,
and possibly income, and such losses can be greater than if the Strategic
Transactions had not been utilized. The Strategic Transactions that the
Portfolios may use and some of their risks are described more fully in the
Statement of Additional Information.
Income earned or deemed to be earned, if any, by a Portfolio from its
Strategic Transactions will generally be taxable income of a Portfolio.
REPURCHASE AGREEMENTS. All of the Portfolios may enter into repurchase
agreements with selected commercial banks and broker-dealers, under which the
Portfolio acquires securities and agrees to resell the securities at an agreed
upon time and at an agreed upon price. The Portfolio accrues as interest the
difference between the amount it pays for the securities and the amount it
receives upon resale. At the time the Portfolio enters into a repurchase
agreement, the value of the underlying security including accrued interest
will be equal to or exceed the value of the repurchase agreement and, for
<PAGE>
repurchase agreements that mature in more than one day, the seller will agree
that the value of the underlying security including accrued interest will
continue to be at least equal to the value of the repurchase agreement. The
Investment Advisor will monitor the value of the underlying security in this
regard. The Portfolio will enter into repurchase agreements only with
commercial banks whose deposits are insured by the Federal Deposit Insurance
Corporation and whose assets exceed $500 million or broker-dealers who are
registered with the SEC. In determining whether the Portfolio should enter
into a repurchase agreement with a bank or broker-dealer, the Investment
Advisor will take into account the credit-worthiness of the party and will
monitor its credit-worthiness on an ongoing basis in accordance with standards
established by the Board of Trustees. In the event of a default by the party,
the delays and expenses potentially involved in establishing the Portfolio's
rights to, and in liquidating, the security may result in a loss to the
Portfolio. The Portfolio's ability to invest in repurchase agreements that
mature in more than seven days is subject to an investment restriction that
limits the Portfolio's investment in restricted securities, including
repurchase agreements, to 10% of the Portfolio's net assets. The Money Market
Portfolio may not invest in repurchase agreements which mature in more than
seven days.
There are additional limitations and restrictions relating to the ability of
the Money Market Portfolio to invest in repurchase agreements which have been
adopted by the Board of Trustees of the Trust and which relate primarily to
investment quality and diversification.
WHEN ISSUED AND DELAYED DELIVERY TRANSACTIONS. All Portfolios may purchase and
sell securities on a "when issued" and "delayed delivery" basis, that is,
obligate themselves to purchase or sell securities with delivery and payment
to occur at a later date in order to secure what is considered to be an
advantageous price and yield to the Portfolio at the time of entering into the
obligation. When a Portfolio engages in "when issued" and "delayed delivery"
transactions, the Portfolio relies on the buyer or seller, as the case may be,
to consummate the sale. Failure to do so may result in the Portfolio missing
the opportunity of obtaining a price or yield considered to be advantageous.
No income accrues to or is earned by the Portfolio on portfolio securities in
connection with such transactions prior to the date the Portfolio actually
takes delivery of such securities. These transactions are subject to market
fluctuation; the value of such securities at delivery may be more or less than
their purchase price, and yields generally available on such securities when
delivery occurs may be higher than yields on such securities obtained pursuant
to such transactions. Because the Portfolio relies on the buyer or seller, as
the case may be, to consummate the transaction, failure by the other party to
complete the transaction may result in the Portfolio missing the opportunity
of obtaining a price or yield considered to be advantageous. When the
Portfolio is the buyer in such a transaction, however, it will maintain, in a
segregated account with its custodian, cash or high-grade portfolio securities
having an aggregate value equal to the amount of such purchase commitments
until payment is made. The Portfolio will make commitments to purchase
securities on such basis only with the intention of actually acquiring these
securities, but the Portfolio may sell such securities prior to the settlement
date if such sale is considered to be advisable. To the extent the Portfolio
engages in "when issued" and "delayed delivery" transactions, it will do so
<PAGE>
for the purpose of acquiring securities for the Portfolio consistent with the
Portfolio's investment objectives and policies and not for the purposes of
investment leverage. No specific limitation exists as to the percentage of any
Portfolio's assets which may be used to acquire securities on a "when issued"
or "delayed delivery" basis.
RESTRICTED SECURITIES. The Portfolios may each invest up to 10% of their
respective net assets in securities the disposition of which is subject to
substantial legal or contractual restrictions on resale and securities that
are not readily marketable. The sale of restricted securities often requires
more time and results in higher brokerage charges or dealer discounts and
other selling expenses than does the sale of securities eligible for trading
on national securities exchanges or in the over-the-counter markets.
Restricted securities may sell at a price lower than similar securities that
are not subject to restrictions on resale. Restricted securities in all
Portfolios will be valued at fair value as determined in good faith by or at
the direction of the Trustees for the purposes of determining the net asset
value of each Portfolio. Restricted securities salable among qualified
institutional buyers without restriction pursuant to Rule 144A under the
Securities Act of 1933 that are determined to be liquid by the Investment
Advisor under guidelines adopted by the Board of Trustees of the Trust (under
which guidelines the Investment Advisor will consider factors such as trading
activities and the availability of price quotations), will not be treated as
restricted securities by the Portfolios pursuant to such rules.
LOANS OF PORTFOLIO SECURITIES. Consistent with applicable regulatory
requirements, all of the Portfolios may lend their securities to selected
commercial banks or broker-dealers up to a maximum of 25% of the assets of
each Portfolio. Such loans must be callable at any time and be continuously
secured by collateral deposited by the borrower in a segregated account with
the Trust's custodian consisting of cash or of securities issued or guaranteed
by the U.S. Government or its agencies, which collateral is equal at all times
to at least 100% of the value of the securities loaned, including accrued
interest. A Portfolio will receive amounts equal to earned income for having
made the loan. Any cash collateral pursuant to these loans will be invested in
short-term instruments. A Portfolio is the beneficial owner of the loaned
securities in that any gain or loss in the market price during the loan inures
to the Portfolio and its shareholders. Thus, when the loan is terminated, the
value of the securities may be more or less than their value at the beginning
of the loan. In determining whether to lend its portfolio securities to a bank
or broker-dealer, a Portfolio will take into account the credit-worthiness of
such borrower and will monitor such credit-worthiness on an ongoing basis in
as much as a default by the other party may cause delays or other collection
difficulties. A Portfolio may pay finders' fees in connection with loans of
its portfolio securities.
REVERSE REPURCHASE AGREEMENTS AND BORROWINGS. All of the Portfolios may enter
into reverse repurchase agreements with selected commercial banks or
broker-dealers with respect to securities which could otherwise be sold by the
Portfolios. Reverse repurchase agreements involve sales by a Portfolio of
Portfolio assets concurrently with an agreement by the Portfolio to repurchase
the same assets at a later date at a fixed price which is greater than the
sales price. The difference between the amount the Portfolio receives for the
<PAGE>
securities and the amount it pays on repurchase is deemed to be a payment of
interest by the Portfolio. The Portfolio will maintain, in a segregated
account with its custodian, cash, Treasury bills, or other U.S. government
securities having an aggregate value equal to the amount of commitment to
repurchase, including accrued interest, until payment is made. The Portfolio
will enter into reverse repurchase agreements only with commercial banks whose
deposits are insured by the Federal Deposit Insurance Corporation and whose
assets exceed $500 million or broker-dealers who are registered with the SEC.
In determining whether the Portfolio should enter into a reverse repurchase
agreement with a bank or broker-dealer, the Investment Advisor will take into
account the credit-worthiness of the party and will monitor the
credit-worthiness on an ongoing basis. During the reverse repurchase agreement
period, the Portfolio continues to receive principal and interest payments on
these securities. Reverse repurchase agreements involve the risk that the
market value of the securities retained by the Portfolio may decline below the
price of the securities the Portfolio has sold but is obligated to repurchase
under the agreement. In the event the buyer of securities under a reverse
repurchase agreement files for bankruptcy or becomes insolvent, the
Portfolio's use of the proceeds of the agreement may be restricted pending a
determination by the other party, or its trustee or receiver, whether to
enforce the Portfolio's obligation to repurchase the securities. Reverse
repurchase agreements create leverage and will be treated as borrowings for
the purposes of each Portfolio's investment restriction on borrowings.
The Quality Income Portfolio and Stock Index Portfolio are permitted to borrow
money up to one-third of the value of their net assets taken at current value.
The Money Market Portfolio may borrow up to 10% of its net assets. Borrowing
by these Portfolios may be only from banks as a temporary measure for
extraordinary or emergency purposes and not for investment leverage. The
Portfolios may each enter into reverse repurchase agreements in an amount not
exceeding 5% of the net assets of each such Portfolio at the time of entering
into any agreement.
As a matter of operating policy, the Money Market Portfolio, the Quality
Income Portfolio and the Stock Index Portfolio will not borrow more than 10%
of their net asset value when borrowing is for any general purpose and 25% of
their net asset value when borrowing as a temporary measure to facilitate
redemptions.
Borrowing by a Portfolio creates an opportunity for increased net income but,
at the same time, creates special risk considerations such as changes in the
net asset value of the shares and in the yield on the Portfolio. Although the
principal of such borrowings will be fixed, the Portfolio's assets may change
in value during the time the borrowing is outstanding. Borrowing will create
interest expenses for the Portfolio which can exceed the income from the
assets retained. To the extent the income derived from securities purchased
with borrowed funds exceeds the interest the Portfolio will have to pay, the
Portfolio's net income will be greater than if borrowing were not used.
Conversely, if the income from the assets retained with borrowed funds is not
sufficient to cover the cost of borrowing, the net income of the Portfolio
will be less than if borrowing were not used.
<PAGE>
SHORT SALES. The Quality Income Portfolio and Stock Index Portfolio may
utilize short sales on securities to implement their investment objectives. A
short sale is effected when it is believed that the price of a particular
investment will decline, and involves the sale of an investment which the
Portfolio does not own in the hope of purchasing the same investment at a
later date at a lower price. To make delivery to the buyer, the Portfolio must
borrow the investment, and the Portfolio is obligated to return the investment
to the lender, which is accomplished by a later purchase of the investment by
the Portfolio.
The Portfolio will incur a loss as a result of the short sale if the price of
the investment increases between the date of the short sale and the date on
which the Portfolio purchases the investment to replace the borrowed
investment. The Portfolio will realize a gain if the investment declines in
price between those dates. The amount of any gain will be decreased and the
amount of any loss increased by any premium or interest the Portfolio may be
required to pay in connection with a short sale. It should be noted that
possible losses from short sales differ from those that could arise from a
cash investment in that the former may be limitless while the latter can only
equal the total amount of the Portfolio's investment in the investment. For
example, if the Portfolio purchases a $10 investment, the most that can be
lost is $10. However, if the Portfolio sells a $10 investment short, it may
have to purchase the investment for return to the lender when the market value
is $50, thereby incurring a loss of $40. The amount of any gain or loss on a
short sale transaction is also dependent on brokerage and other transaction
costs.
INVESTMENT LIMITATIONS
In addition to the investment policies set forth above, certain additional
restrictive policies relating to the investment of assets of the Portfolios
have been adopted by the Trust. The Investment Limitations of the Trust are
deemed fundamental and may not be changed without the approval of the holders
of a majority of the outstanding voting shares of each Portfolio affected
(which for this purpose and under the Investment Company Act of 1940 means the
lesser of (i) 67% of the shares represented at a meeting at which more than
50% of the outstanding shares are present or represented by proxy and (ii)
more than 50% of the outstanding shares). A change in policy affecting only
one Portfolio may be effected with the approval of a majority of the
outstanding shares of the Portfolio. Details as to the policies are set forth
in the Statement of Additional Information.
RISK FACTORS
TAX CONSIDERATIONS
The Trust was established as the underlying investment for variable contracts
issued by Cova Life.
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 Trust. The Code provides that a
variable contract shall not be treated as an annuity contract for any period
<PAGE>
(and any subsequent period) for which the investments are not, in accordance
with regulations prescribed by the Treasury Department, adequately
diversified. Disqualification of the variable contract as an annuity contract
would result in imposition of federal income tax on contract owners with
respect to earnings allocable to the variable contract prior to the receipt of
payments under the variable contract. Section 817(h)(2) of the Code is a safe
harbor provision which provides that contracts such as the variable contracts
meet the diversification requirements if, as of the close of each quarter, the
underlying assets meet the diversification standards for a regulated
investment company and no more than fifty-five percent (55%) of the total
assets consists of cash, cash items, U.S. government securities and securities
of other regulated investment companies.
On March 2, 1989, the Treasury Department issued Regulations (Treas. Reg.
1.817-5), which established diversification requirements for the investment
portfolios underlying variable contracts. The Regulations amplify the
diversification requirements for variable contracts set forth in Section
817(h) of the Code and provide an alternative to the safe harbor provision
described above. Under the Regulations, an investment portfolio will be deemed
adequately diversified if (i) no more than 55 percent of the value of the
total assets of the portfolio 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. For purposes of these Regulations, all securities of the
same issuer are treated as a single investment.
The Code 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 Portfolio of the Trust will be managed in such a manner as to comply with
these diversification requirements. It is possible that in order to comply
with the diversification requirements, less desirable investment decisions may
be made which would affect the investment performance of the Portfolios.
SPECIAL CONSIDERATIONS RELATING TO
FOREIGN SECURITIES
All of the Portfolios may invest in foreign securities. The Stock Index
Portfolio, however, may only invest in foreign securities to the extent that
it invests in American Depository Receipts ("ADRs") for foreign securities.
ADRs are dollar-denominated receipts issued generally by domestic banks and
representing the deposit with the bank of a security of a foreign issuer. ADRs
are publicly traded on exchanges or over-the-counter in the United States. The
Quality Income Portfolio may invest up to 35% in foreign securities. However,
the Trust has no current intention that these investments will exceed 20% of a
Portfolio's assets. Investments in the securities of foreign entities and
securities denominated in foreign currencies involve risks not typically
involved in domestic investment, including fluctuations in foreign exchange
rates, future foreign political and economic developments, and the possible
imposition of exchange controls or other foreign or United States governmental
<PAGE>
laws or restrictions applicable to such investments. Where a Portfolio invests
in securities denominated or quoted in currencies other than the United States
dollar, changes in foreign currency exchange rates may affect the value of
investments in the Portfolio and the accrued income and unrealized
appreciation or depreciation of investments. Changes in foreign currency
exchange rates relative to the U.S. dollar will affect the U.S. dollar value
of a Portfolio's assets denominated in that currency and the Portfolio's yield
on such assets. With respect to certain foreign countries, there is the
possibility of expropriation of assets, confiscatory taxation, political or
social instability or diplomatic developments which could affect investment in
those countries. There may be less publicly available information about a
foreign security than about a United States security, and foreign entities may
not be subject to accounting, auditing and financial reporting standards and
requirements comparable to those of United States entities. In addition,
certain foreign investments made by a Portfolio may be subject to foreign
withholding taxes, which would reduce the Portfolio's total return on such
investments and the amounts available for distributions by the Portfolio to
its shareholders. Foreign financial markets, while growing in volume, have,
for the most part, substantially less volume than United States markets, and
securities of many foreign companies are less liquid and their prices more
volatile than securities of comparable domestic companies. The foreign markets
also have different clearance and settlement procedures and in certain markets
there have been times when settlements have been unable to keep pace with the
volume of securities transactions making it difficult to conduct such
transactions. Delays in settlement could result in temporary periods when
assets of a Portfolio are not invested and no return is earned thereon. The
inability of a Portfolio to make intended security purchases due to settlement
problems could cause the Portfolio to miss attractive investment
opportunities. Inability to dispose of portfolio securities due to settlement
problems could result either in losses to a Portfolio due to subsequent
declines in value of the portfolio security or, if a Portfolio has entered
into a contract to sell the security, could result in possible liability to
the purchaser. Costs associated with transactions in foreign securities,
including custodial costs and foreign brokerage commissions, are generally
higher than with transactions in United States securities. In addition, a
Portfolio will incur costs in connection with conversions between various
currencies. There is generally less government supervision and regulation of
exchanges, financial institutions and issuers in foreign countries than there
is in the United States.
As a matter of operating policy, the Money Market Portfolio, the Quality
Income Portfolio and the Stock Index Portfolio will comply with the following:
1. a Portfolio will be invested in a minimum of five different foreign
countries at all times. However, this minimum is reduced to four when foreign
country investments comprise less than 80% of the Portfolio's net asset value;
to three when less than 60% of such value; to two when less than 40% of such
value and to one when less than 20% of such value.
2. except as set forth in items 3 and 4 below, a Portfolio will have no
more than 20% of its net asset value invested in securities of issuers located
in any one country.
<PAGE>
3. a Portfolio may have an additional 15% of its value invested in
securities of issuers located in any one of the following countries:
Australia, Canada, France, Japan, the United Kingdom or Germany.
4. a Portfolio's investments in United States issuers are not subject to
the foregoing operating policies.
PORTFOLIO TURNOVER RATES
MONEY MARKET PORTFOLIO AND QUALITY INCOME PORTFOLIO
Although the Money Market and Quality Income Portfolios are not subject to
specific restrictions on portfolio turnover, they generally do not seek
profits by short-term trading. However, they may dispose of a portfolio
security prior to its maturity where disposition seems advisable because of a
revised credit evaluation of the issuer or other considerations. Because
brokerage commissions are not customarily charged on the investments invested
in by each of the two Portfolios, a high turnover rate should not affect the
net asset value.
STOCK INDEX PORTFOLIO
Although the Portfolio generally seeks to invest for the long term, the
Portfolio retains the right to sell securities irrespective of how long they
have been held. However, because of the "passive" investment management
approach of the Portfolio, the portfolio turnover rate is expected to be under
50%, a generally lower turnover rate than for most other investment companies.
A portfolio turnover rate of 50% would occur if one-half of the Portfolio's
securities were sold within one year. Ordinarily, securities will be sold from
the Portfolio only to reflect certain administrative changes in the Index
(including mergers or changes in the composition of the Index) or to
accommodate cash flows into and out of the Portfolio while maintaining the
similarity of the Portfolio to the Index. For the years ended December 31,
1994 and 1993, the portfolio turnover rates for the Stock Index Portfolio were
47.05% and 44.09%, respectively.
MANAGEMENT OF THE TRUST
THE TRUSTEES
The Trust is organized as a Massachusetts business trust. The overall
responsibility for the supervision of the affairs of the Trust vests in the
Trustees. The Trustees have entered into an Investment Advisory Agreement with
the Investment Advisor to handle the day-to-day affairs of the Trust (see
below). The Trustees meet periodically to review the affairs of the Trust and
to establish certain guidelines which the Investment Advisor is expected to
follow in implementing the investment policies and objectives of the Trust.
<PAGE>
THE INVESTMENT ADVISOR
Van Kampen American Capital Investment Advisory Corp. (the "Investment
Advisor") is the Trust's investment adviser. The Investment Advisor is a
wholly-owned subsidiary of Van Kampen American Capital, Inc. which in turn is
a wholly-owned subsidiary of VK/AC Holding, Inc. VK/AC Holding, Inc. is
indirectly controlled by Clayton & Dubilier Associates IV Limited Partnership,
the general partners of which are Joseph L. Rice, III, B. Charles Ames,
William A. Barbe, Alberto Cribiore, Donald J. Gogel, Leon J. Hendrix, Jr.,
Hubbard C. Howe and Andrall E. Pearson, each of whom is a principal of
Clayton, Dubilier & Rice, Inc., a New York based private investment
partnership. The Investment Advisor's principal office is located at One
Parkview Plaza, Oakbrook Terrace, Illinois 60181.
Van Kampen American Capital, Inc. is a diversified asset management company
with more than two million retail investor accounts, extensive capabilities
for managing institutional portfolios, and nearly $50 billion under management
or supervision. Van Kampen American Capital, Inc.'s over 40 open-end and 38
closed-end funds and more than 2,700 unit investment trusts are professionally
distributed by leading financial advisers nationwide. In connection with
advising the Trust, the Investment Advisor will utilize at its own expense
credit analysis and research services provided by its affiliate, McCarthy,
Crisanti & Maffei.
Pursuant to its investment advisory agreement with the Investment Advisor
("Investment Advisory Agreement") dated March 9, 1993, and approved by
shareholders of the Trust at a meeting held on January 14, 1993, the Trust
will pay the Investment Advisor the following fees (accrued daily and paid
monthly) equal to a percentage of the average daily net assets of the
Portfolios:
<TABLE>
<CAPTION>
Average Daily
Portfolio Net Assets % Per Annum
<S> <C> <C>
Money Market First $500 million .500 of 1%
Portfolio Over $500 million .400 of 1%
Quality Income First $500 million .500 of 1%
Portfolio Over $500 million .450 of 1%
Stock Index - .500 of 1%
Portfolio
</TABLE>
<PAGE>
Under the Investment Advisory Agreement, the Investment Advisor regularly
provides each Portfolio of the Trust with investment advice and
recommendations and continuously furnishes the Portfolios of the Trust with an
investment program for each Portfolio's assets. Under the Investment Advisory
Agreement, the Trust has agreed to assume and pay the charges and expenses of
the Trust's operation, including the compensation of the Trustees of the Trust
(other than those who are interested persons, as defined in the Investment
Company Act of 1940, as amended, of the Investment Advisor or Cova Life Sales
Company), the charges and expenses of independent accountants, legal counsel,
any transfer or dividend disbursing agent and the custodian (including fees
for safekeeping of securities), costs of calculating net asset value, costs of
acquiring and disposing of portfolio securities, interest (if any) on
obligations incurred by the Trust, costs of share certificates, membership
dues in the Investment Company Institute or any similar organization, reports
and notices to shareholders, costs of registering shares of the Trust under
the federal securities laws, miscellaneous expenses and all taxes and fees to
federal, state or other governmental agencies.
PORTFOLIO MANAGEMENT
The day to day management of all Portfolios of the Trust offered herein is the
responsibility of a committee composed of persons who are officers or
employees of the Investment Advisor and includes officers of the Trust.
For the year ended December 31, 1994, the Investment Advisor was paid advisory
fees as follows: $200,948 with respect to the Quality Income Portfolio and
$266,474 with respect to the Stock Index Portfolio. The Investment Advisor
waived its advisory fee of $293,512 with respect to the Money Market
Portfolio.
EXPENSES OF THE TRUST
Although each Portfolio must bear the expenses directly attributable to it,
the Portfolios are expected to experience cost savings over the aggregate
amount that would be payable if each Portfolio were a separate fund, because
they have the same Trustees, accountants, attorneys and other general and
administrative expenses. Any expenses which are not directly attributable to a
specific Portfolio are allocated on the basis of the net assets of the
respective Portfolios.
For the year ended December 31, 1994, the expenses, taking into account the
waivers and expense assumptions, borne by the Quality Income Portfolio
amounted to $242,458 or .59% of its average net assets on an annualized basis;
the expenses borne by the Money Market Portfolio amounted to $58,739 or .10%
of its average net assets on an annualized basis; and the net expenses borne
by the Stock Index Portfolio amounted to $319,899 or .58% of its average net
assets on an annualized basis.
Cova Life may at its discretion, but is not obligated to, assume all or any
portion of Trust expenses. For the year ended December 31, 1994, Xerox
Financial Services Life Insurance Company (now known as Cova Financial
Services Life Insurance Company) assumed expenses of $39,622 with respect to
the Quality Income Portfolio; $38,836 with respect to the Money Market
<PAGE>
Portfolio; and $118,434 with respect to the Stock Index Portfolio.
DESCRIPTION OF THE TRUST
SHAREHOLDER RIGHTS
The Trust is an unincorporated business trust established under the laws of
the Commonwealth of Massachusetts by a Declaration of Trust dated July 9,
1987. The Declaration of Trust permits the Trustees to issue an unlimited
number of full and fractional shares.
Each Portfolio issues its own class of shares. Each share represents an equal
proportionate interest in the assets of the Portfolio with each other share in
the Portfolio. On any matter submitted to a vote of shareholders, all shares
of the Trust then issued and outstanding and entitled to vote will be voted in
the aggregate and not by class except for matters concerning only one class.
The holders of each share of stock of the Trust will be entitled to one vote
for each full share and a fractional vote for each fractional share of stock.
Shares of one class may not bear the same economic relationship to the Trust
as another class.
In accordance with its view of present applicable law, the separate account(s)
of Cova Life as shareholder(s) of the Trust, have the right to vote Trust
shares at any meeting of shareholders and will provide pass-through voting
privileges to all contract owners. Cova Life will vote shares of the Trust
held in the separate account(s) for which no timely voting instructions from
contract owners are received, as well as shares it owns, in the same
proportion as those shares for which voting instructions are received.
Additional information concerning voting rights is described in the Variable
Account Prospectus attached hereto under the caption, "The Variable Account -
Voting Rights".
The Trust is not required to hold annual meetings of shareholders and does not
plan to do so. The Trustees may call special meetings of shareholders for
action by shareholder vote as may be required by the Investment Company Act of
1940, as amended, or the Declaration of Trust. The Trust will hold a
shareholder meeting to fill existing vacancies on the Board in the event that
less than a majority of Trustees were elected by the shareholders. The
Trustees shall also call a meeting of shareholders for the purpose of voting
upon the question of removal of any Trustee when requested in writing to do so
by the record holders of not less than 10 percent of the outstanding shares.
The Trust has an obligation to assist shareholder communications.
The Declaration of Trust provides that shareholders are not liable for any
liabilities of the Trust, requires inclusion of a clause to that effect in
every agreement entered into by the Trust and indemnifies shareholders against
any liability. Although shareholders of an unincorporated business trust
established under Massachusetts law may, under certain limited circumstances,
be held personally liable for the obligations of the Trust as though they were
general partners in a partnership, the provisions of the Declaration of Trust
described in the foregoing sentence make the likelihood of personal liability
remote.
<PAGE>
The Trustees may amend the Declaration of Trust in any manner without
shareholder approval, except that the Trustees may not adopt any amendment
adversely affecting the rights of shareholders without approval by a majority
of the shares present at a meeting of shareholders (or higher vote as may be
required by the Investment Company Act of 1940, as amended, or other
applicable law) and except that the Trustees cannot amend the Declaration of
Trust to impose any liability on shareholders, make any assessment on shares,
or impose liabilities on the Trustees without approval from each affected
shareholder or Trustee, as the case may be.
INQUIRIES
Any inquiries should be directed to Cova Financial Services Life Insurance
Company, One Tower Lane, Suite 3000, Oakbrook Terrace, Illinois 60181-4644.
The telephone number is (800) 831-LIFE.
DISTRIBUTION AND REDEMPTION OF SHARES
The distribution of Trust shares is through Cova Life Sales Company, an
affiliate of Cova Life. Prior to May 1, 1993, the Trust's shares were
distributed through Van Kampen Merritt Inc. Shares of the Trust are currently
issued and redeemed only in connection with investment in and payments under
certain variable annuity contracts ("variable contracts") issued by Cova Life.
The shares of the Trust are purchased and redeemed at net asset value (see
below). Redemptions will be effected by the separate accounts to meet
obligations under the variable contracts. Contract Owners do not deal directly
with the Trust with respect to acquisition or redemption of shares.
DIVIDENDS
All dividends are distributed to the separate accounts and will be
automatically reinvested in Trust shares. Dividends and distributions made by
the Portfolios are taxable, if at all, to Cova Life; they are not taxable to
variable annuity contract owners.
TAX STATUS
It is the intention of the Trust to qualify as a "regulated investment
company" under Sub-chapter M of the Internal Revenue Code. If the Trust so
qualifies and distributes each year to its shareholders at least 90% of its
net investment income in each year, it will not be required to pay federal
income taxes on any income distributed to shareholders. Each Portfolio of the
Trust distributes all of its net income and gains to its shareholders (the
separate accounts). Each Portfolio is treated as a separate entity for Federal
income tax purposes and, therefore, the investments and results of the
Portfolio are determined separately for purposes of determining whether the
Trust qualifies as a "regulated investment company" and for purposes of
determining net ordinary income (or loss) and net realized capital gains (or
losses).
<PAGE>
Some of the Trust's investment practices are subject to special provisions of
the Code that, among other things, may defer the use of certain losses of the
Trust and affect the holding period of the securities held by the Trust and
the character of the gains or losses realized by the Trust. These provisions
may also require the Trust to mark-to-market some of the positions in its
portfolio (i.e., treat them as if they were closed out), which may cause the
Trust to recognize income without receiving cash with which to make
distributions in amounts necessary to satisfy the 90% distribution requirement
and the distribution requirements for avoiding income and excise taxes. The
Trust will monitor its transactions and may make certain tax elections in
order to mitigate the effect of these rules and prevent disqualification of
the Trust as a regulated investment company.
Investments of the Trust in securities issued at a discount or providing for
deferred interest or payment of interest in kind are subject to special tax
rules that will affect the amount, timing and character of distributions to
shareholders. For example, with respect to securities issued at a discount,
the Trust will be required to accrue as income each year a portion of the
discount and to distribute such income each year in order to maintain its
qualification as a regulated investment company and to avoid income and excise
taxes. In order to generate sufficient cash to make distributions necessary to
satisfy the 90% distribution requirement and to avoid income and excise taxes,
the Trust may have to dispose of securities that it would otherwise have
continued to hold.
The Trust's ability to dispose of portfolio securities may be limited by the
requirement for qualification as a regulated investment company that less than
30% of the Trust's annual gross income be derived from the disposition of
securities held for less than three months.
NET ASSET VALUES
Portfolio shares are sold and redeemed at a price equal to the share's net
asset value. The net asset value of a Portfolio is determined by calculating
the total value of the Portfolio's assets, deducting its total liabilities,
and dividing the result by the number of shares outstanding. The net asset
value for each Portfolio is computed once daily as of the close of the New
York Stock Exchange, Monday through Friday, except on customary business
holidays, or except on any day on which no purchase or redemption orders are
received, or there is not a sufficient degree of trading in the Portfolio's
investments so that the Portfolio's net asset value per share might be
materially affected. The Trust reserves the right to calculate the net asset
value and to adjust the public offering price based thereon more frequently
than once a day if deemed desirable.
Securities that are listed on a securities exchange are valued at their
closing sales price on the day of the valuation. Price valuations for listed
securities are based on market quotations where the security is primarily
traded or, if not available, are valued at the mean of the bid and asked
prices on any valuation date. Unlisted securities in a Portfolio are primarily
valued based on their latest quoted bid price or, if not available, are valued
by a method determined by the Trustees to accurately reflect fair value. Money
<PAGE>
market instruments maturing in 60 days or less are valued on the basis of
amortized cost, which means that securities are valued at their acquisition
cost to reflect a constant amortization rate to maturity of any premium or
discount, rather than at current market value.
The Money Market Portfolio values its securities on the basis of amortized
cost, which means that securities are valued at their acquisition cost to
reflect a constant amortized rate to maturity of any premium or discount,
rather than at current market value. Calculations are made to compare the
amortized cost valuation of the securities with current market values. Money
market valuations are obtained by using market quotations provided by market
makers, estimates of market values, or values obtained from published yield
data of money market instruments. If a deviation of 1/2 of 1% or more were to
occur between the net asset value calculated by reference to market values and
the Portfolio's $1.00 per share net asset value, or if there were any other
deviation which the Trustees believe would result in a material dilution to
shareholders, the Trustees would promptly consider what action, if any, should
be initiated. Other assets are valued at fair value as determined in good
faith by the Trustees. The method of calculating yields is described in the
Statement of Additional Information.
FUND PERFORMANCE
From time to time advertisements and other sales materials for the Trust may
include information concerning the historical performance of the Trust. Such
advertisements will also describe the performance of the relevant insurance
company separate accounts. Any such information will include the average total
return of the Trust calculated on a compounded basis for specified periods of
time. Total return information will be calculated pursuant to rules
established by the Securities and Exchange Commission. In lieu of or in
addition to total return calculations, such information may include
performance rankings and similar information from independent organizations
such as Lipper Analytical Services, Inc., Morningstar, Business Week, Forbes
or other industry publications.
The Trust calculates average compounded total return by determining the
redemption value at the end of specified periods (assuming reinvestment of all
dividends and distributions) of a $1,000 investment in the Trust at the
beginning of the period, deducting the initial $1,000 investment, annualizing
the increase or decrease over the specified period and expressing the result
as a percentage.
Total return figures utilized by the Trust are based on historical performance
and are not intended to indicate future performance. Total return and net
asset value per share can be expected to fluctuate over time, and accordingly,
upon redemption, shares may be worth more or less than their original cost.
<PAGE>
APPENDIX - DESCRIPTION OF
CORPORATE BOND RATINGS
STANDARD & POOR'S CORPORATION. A brief description of the applicable Standard
& Poor's Corporation ("S&P") rating symbols and their meanings (as published
by S&P) follows:
An S&P corporate or municipal debt rating is a current assessment of the
creditworthiness of an obligor with respect to a specific obligation. This
assessment may take into consideration obligors such as guarantors, insurers,
or lessees.
The debt rating is not a recommendation to purchase, sell, or hold a security,
inasmuch as it does not comment as to market price or suitability for a
particular investor.
The ratings are based on current information furnished by the issuer or
obtained by S&P from other sources it considers reliable. S&P does not perform
an audit in connection with any rating and may, on occasion, rely on unaudited
financial information. The ratings may be changed, suspended, or withdrawn as
a result of changes in, or unavailability of, such information, or for other
circumstances.
The ratings are based, in varying degrees, on the following considerations:
1. Likelihood of default - capacity and willingness of the obligor as to
the timely payment of interest and repayment of principal in accordance with
the terms of the obligation;
2. Nature of and provisions of the obligation;
3. Protection afforded by, and relative position of, the obligation in the
event of bankruptcy, reorganization, or other arrangement under the laws of
bankruptcy and other laws affecting creditors' rights.
LONG-TERM CORPORATE BONDS.
AAA Debt rated 'AAA' has the highest rating assigned by S&P. Capacity to
pay interest and repay principal is extremely strong.
AA Debt rated 'AA' has a very strong capacity to pay interest and repay
principal and differs from the highest rated issues only in small degree.
A Debt rated 'A' has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories.
BBB Debt rated 'BBB' is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
<PAGE>
BB Debt rated 'BB', 'B', 'CCC', or 'CC' is regarded,
B on balance, as predominantly speculative with
CCC respect to capacity to pay interest and repay
CC 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 This rating is reserved for income bonds on which no interest is being
paid.
D Debt rated 'D' is in default, and payment of interest and/or repayment of
principal is in arrears.
PLUS (+) or MINUS (-): The ratings from 'A' to 'B' may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
PROVISIONAL RATINGS: The letter "p" indicates that the rating is provisional.
A provisional rating assumes the successful completion of the project being
financed by the debt being rated and indicates that payment of debt service
requirements is largely or entirely dependent upon the successful and timely
completion of the project. This rating, however, while addressing credit
quality subsequent to completion of the project, makes no comment on the
likelihood of, or the risk of default upon failure of, such completion. The
investor should exercise judgment with respect to such likelihood and risk.
L The letter 'L' indicates that the rating pertains
to the principal amount of those bonds where the underlying deposit collateral
is fully insured by the Federal Deposit Insurance Corp.
l Continuance of the rating is contingent upon S&P's receipt of closing
documentation confirming investments and cash flow.
* Continuance of the rating is contingent upon S&P's receipt of an
executed copy of the escrow agreement.
NR Indicates no rating has been requested, that there is insufficient
information on which to base a rating, or that S&P does not rate a particular
type of obligation as a matter of policy.
MOODY'S INVESTORS SERVICE, INC. A brief description of the applicable Moody's
Investors Service, Inc. rating symbols and their meanings (as published by
Moody's Investors Service, Inc.) follows:
LONG-TERM CORPORATE BONDS.
Aaa - Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt edge". Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements
<PAGE>
are likely to change, such changes as can be visualized are most unlikely to
impair the fundamentally strong position of such issues.
Aa - Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known
as high grade bonds. They are rated lower than the best bonds because margins
of protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long term risks appear somewhat larger than in Aaa
securities.
A - Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper medium grade obligations. Factors giving
security to principal and interest are considered adequate but elements may be
present which suggest a susceptibility to impairment sometime in the future.
Baa - Bonds which are rated Baa are considered as medium grade obligations,
i.e. they are neither highly protected nor poorly secured. 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. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba - Bonds which are rated Ba are 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 - Bonds which are rated 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 - Bonds which are rated 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 - Bonds which are rated Ca represent obligations which are
speculative in a high degree. Such issues are often in default or
have other marked shortcomings.
C - Bonds which are rated C are 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.
Note: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's believes
possess the strongest investment attributes are designated by the symbols Aa
1, A 1, Baa 1, Ba 1 and B 1.
<PAGE>
