<PAGE>
PLACE
STAMP HERE
[LOGO OF THE VANGUARD GROUP APPEARS HERE]
P.O. BOX 2600
VALLEY FORGE, PA 19482-2600
<PAGE>
I understand that a "Statement of Additional Information" about the Vanguard
Variable Annuity Plan contract has been filed with the Securities and Exchange
Commission. Please send me a free copy of the "Statement." I have printed my
name and address below.
Name ___________________________________________________________________________
Address ________________________________________________________________________
________________________________________________________________________________
City _____________________ State _____________________ ZIP _____________________
PSAI-st
1191
<PAGE>
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(ART) A Member of The Vanguard Group
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PROSPECTUS--JANUARY 10, 1995
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INVESTMENT Vanguard Variable Insurance Fund (the "Fund") is an open-
OBJECTIVES AND end diversified investment company. The Fund is intended
POLICIES exclusively as an investment vehicle for variable annuity
or variable life insurance contracts offered by the sepa-
rate accounts of various insurance companies. The Fund of-
fers seven distinct Portfolios.
The MONEY MARKET PORTFOLIO seeks to provide current income
and a stable net asset value of $1.00 per share by invest-
ing in high-quality money market instruments. ALTHOUGH THE
MONEY MARKET PORTFOLIO INVESTS IN HIGH QUALITY INSTRUMENTS,
AN INVESTMENT IN THE PORTFOLIO IS NEITHER INSURED NOR GUAR-
ANTEED BY THE U.S. GOVERNMENT AND THERE CAN BE NO ASSURANCE
THAT THE PORTFOLIO WILL BE ABLE TO MAINTAIN A STABLE NET
ASSET VALUE OF $1.00 PER SHARE. The HIGH-GRADE BOND PORTFO-
LIO seeks to duplicate the total return of publicly-traded,
investment grade fixed-income securities as represented by
a broad investment grade bond index. The BALANCED PORTFOLIO
seeks to provide capital growth and a reasonable level of
current income by investing in a diversified portfolio of
common stocks and bonds. The objective of the EQUITY INCOME
PORTFOLIO is to provide a high level of current income by
investing principally in dividend-paying equity securities.
The EQUITY INDEX PORTFOLIO seeks to parallel the investment
results of the Standard & Poor's 500 Composite Stock Price
Index by investing in common stocks included in the Index.
The GROWTH PORTFOLIO seeks to provide long-term capital ap-
preciation by investing in equity securities of companies
based in the United States. The INTERNATIONAL PORTFOLIO
seeks to provide long-term capital appreciation by invest-
ing in equity securities of companies based outside the
United States. There is no assurance that a Portfolio will
achieve its objective.
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OPENING AN Shares of the Portfolios are sold exclusively to separate
ACCOUNT accounts of insurance companies that offer variable annuity
or variable life insurance contracts. To open an account
and purchase shares of a Portfolio, please see the prospec-
tus for the insurance company separate account governing
the variable annuity or variable life insurance contract.
- --------------------------------------------------------------------------------
ABOUT THIS This Prospectus sets forth concisely the information you
PROSPECTUS should know about the Fund. It should be retained for fu-
ture reference. You should read this Prospectus in conjunc-
tion with the prospectus describing the related insurance
company separate account. A "Statement of Additional Infor-
mation" containing additional information about the Fund
has been filed with the Securities and Exchange Commission.
Such Statement is dated January 10, 1995, and has been in-
corporated by reference into this Prospectus. A copy may be
obtained without charge by writing to the Fund or by call-
ing the insurance company sponsoring the variable life in-
surance or variable annuity contract.
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
<S> <C>
Highlights............................................................ 2
Financial Highlights.................................................. 5
Yield and Total Return ............................................... 8
Investment Objectives................................................. 8
Investment Policies................................................... 9
</TABLE>
<TABLE>
<CAPTION>
Page
<S> <C>
Investment Risks...................................................... 13
Who Should Invest..................................................... 17
Implementation of Policies............................................ 18
Investment Limitations................................................ 22
Management of the Fund................................................ 23
Investment Advisers................................................... 24
</TABLE>
<TABLE>
<CAPTION>
Page
<S> <C>
Dividends, Capital Gains and Taxes.................................... 29
The Share Price of Each Portfolio..................................... 29
General Information................................................... 31
Shareholder Guide..................................................... 31
</TABLE>
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
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<PAGE>
HIGHLIGHTS
INVESTMENT Vanguard Variable Insurance Fund (the "Fund") is an open-
OBJECTIVES AND end diversified investment company. The Fund is intended
POLICIES exclusively as an investment vehicle for variable annuity
or variable life insurance contracts offered by the sepa-
rate accounts of various insurance companies.
The Fund offers seven Portfolios -- a money market portfo-
lio, a bond portfolio, a balanced portfolio,. an equity in-
dex portfolio, an equity income portfolio, a growth portfo-
lio and an international portfolio -- each with distinct
investment objectives and policies.
MONEY MARKET PORTFOLIO -- seeks to provide a current income
and a stable net asset value of $1.00 per share. The Port-
folio invests primarily in high-quality money market in-
struments issued by financial institutions, nonfinancial
corporations, and the U.S. Government, state and municipal
governments and their agencies or instrumentalities, as
well as repurchase agreements collateralized by such secu-
rities.
HIGH-GRADE BOND PORTFOLIO -- seeks to parallel the invest-
ment results (income plus capital change) of publicly-
traded investment grade fixed-income securities in the ag-
gregate by attempting to duplicate the investment perfor-
mance of a broad investment grade bond index. The Portfolio
invests primarily in a diversified portfolio of U.S. Gov-
ernment, corporate and foreign dollar- denominated bonds
and mortgage-backed securities.
BALANCED PORTFOLIO -- seeks to provide capital growth and a
reasonable level of current income by investing in a diver-
sified portfolio of common stocks and bonds.
EQUITY INCOME PORTFOLIO -- seeks to provide a high level of
current income by investing principally in dividend-paying
equity securities.
EQUITY INDEX PORTFOLIO -- seeks to parallel the investment
results of the Standard & Poor's 500 Composite Stock Price
Index (the "S&P 500"). The Portfolio invests primarily in
common stocks included in the S&P 500.
GROWTH PORTFOLIO -- seeks to provide long-term capital ap-
preciation by investing primarily in equity securities of
seasoned U.S. companies with above-average prospects for
growth.
INTERNATIONAL PORTFOLIO -- seeks to provide long-term capi-
tal appreciation by investing primarily in equity securi-
ties of seasoned companies located outside the United
States.
The investment objectives and policies of the Fund's Port-
folios are similar to those of other Vanguard funds. The
Money Market Portfolio of the Fund is similar to the Prime
Portfolio of Vanguard Money Market Reserves; the High-Grade
Bond Portfolio is similar to Vanguard Bond Index Fund's--
Total Bond Market Portfolio; the Balanced Portfolio is sim-
ilar to Vanguard Wellington Fund; the Equity Index Portfo-
lio is similar to the 500 Portfolio of Vanguard Index
Trust; the Equity Income Portfolio is similar to the Van-
guard Equity Income Fund; the Growth Portfolio is similar
to the Vanguard U.S. Growth Portfolio; and the Interna-
tional Portfolio is similar to the Vanguard Interna-
2
<PAGE>
tional Growth Portfolio. Because of differences in the in-
vestments held and additional administrative and insurance
costs associated with insurance company separate accounts,
the Portfolios' investment performance will differ from the
performance of the corresponding Vanguard funds.
There is no assurance that a Portfolio will achieve its
stated objective. PAGE 8
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INVESTMENT RISKS The MONEY MARKET PORTFOLIO is exposed primarily to credit
risk, the possibility that an issuer of securities will
fail to make timely payments of interest or principal to
the Portfolio. The Money Market Portfolio seeks to minimize
such risk by investing in top-rated money market instru-
ments.
The HIGH-GRADE BOND PORTFOLIO is subject primarily to in-
terest rate and credit risk. The Portfolio, like the Lehman
Brothers Aggregate Bond Index (the "Lehman Bond Index") it
seeks to match, is expected to maintain an average weighted
maturity generally in excess of nine years. As a result,
interest rate risk -- i.e., the potential for a decline in
the market value of the Portfolio's fixed income securities
due to rising interest rates -- may range from moderate to
high. Credit risk, however, should be nominal, since the
Portfolio invests primarily in highly rated bonds and mort-
gage-backed securities.
The BALANCED PORTFOLIO, with its mix of both stocks and
bonds, is subject to stock market risk and interest rate
risk. However, the Portfolio is expected to exhibit less
volatility than a portfolio consisting entirely of com-
mon stocks.
The EQUITY INCOME, EQUITY INDEX AND GROWTH PORTFOLIOS are
exposed to stock market risk, the possibility that 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 stock
prices generally decline.
The INTERNATIONAL PORTFOLIO is exposed to foreign stock
market risk which can be as volatile, if not more volatile,
than investments in U.S. markets. In a period when the U.S.
dollar generally rises against foreign currencies, the re-
turns on foreign stocks for a U.S. investor may be dimin-
ished. By contrast, in a period when the U.S. dollar gener-
ally declines, the returns on foreign stocks may be
enhanced. PAGE 13
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THE VANGUARD The Fund is a member of The Vanguard Group of Investment
GROUP Companies, a group of more than 30 investment companies
with more than 80 distinct portfolios and total assets in
excess of $130 billion. The Vanguard Group, Inc. ("Van-
guard"), a subsidiary jointly-owned by the Vanguard Funds,
provides all corporate management, administrative, distri-
bution, and shareholder accounting services on an at-cost
basis to the Funds in the Group. PAGE 23
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FUND EXPENSES The Fund incurs annual operating expenses which include
Management, Advisory and Distribution expenses. For more
information please see the section entitled "Management of
the Fund" in this Prospectus and the "Fee Table" section of
the Plan's Prospectus. PAGE 23
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3
<PAGE>
INVESTMENT The Money Market and High-Grade Bond Portfolios receive in-
ADVISERS vestment advisory services on an at-cost basis from Van-
guard's Fixed Income Group. Vanguard's Core Management
Group serves as investment adviser to the Equity Index
Portfolio. Wellington Management Company, Newell Associates
and Lincoln Capital Management Company, serve as indepen-
dent investment advisers to the Balanced, Equity Income and
Growth Portfolios, respectively. The International Portfo-
lio employs Schroder Capital Management International, Inc.
as its investment adviser. PAGE 24
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DIVIDENDS AND Both the Money Market and High-Grade Bond Portfolios de-
CAPITAL GAINS clare dividends daily based on ordinary income and distrib-
ute dividends monthly. The Balanced, Equity Income and Eq-
uity Index Portfolios distribute dividends based on ordi-
nary income quarterly, while the Growth and International
Portfolios distribute dividends annually. Any capital gains
distributions in the High-Grade Bond, Balanced, Equity In-
come, Equity Index, Growth and International Portfolios are
made annually. PAGE 29
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TAXES The tax consequences of your investment in the Fund depend
upon the specific provisions of your variable life insur-
ance or annuity contract. For more information, please re-
fer to the prospectus of the insurance company separate ac-
count that offers your contract.
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PURCHASING AND You cannot purchase shares of the Fund directly, but only
SELLING SHARES through a variable life insurance or variable annuity con-
tract offered through an insurance company separate ac-
count. Please refer to the prospectus of the insurance com-
pany separate account for information on how to purchase
and redeem shares. PAGE 31
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4
<PAGE>
FINANCIAL The following financial highlights, for a share outstanding
HIGHLIGHTS throughout each period presented, have been audited by
Price Waterhouse LLP, independent accountants, whose report
thereon was unqualified. This information should be read in
conjunction with the Fund's financial statements and notes
thereto, which are incorporated by reference in the
Statement of Additional Information and in this Prospectus,
and which appear, along with the report of Price Waterhouse
LLP, in the Fund's 1994 Annual Report to Shareholders. For
a more complete discussion of the Fund's performance,
please see the Fund's 1994 Annual Report to Shareholders,
which may be obtained without charge by writing to the Fund
or by calling our Vanguard Variable Annuity Department at
1-800-522-5555.
<TABLE>
<CAPTION>
---------------------------------
MONEY MARKET PORTFOLIO
---------------------------------
MAY 2+ TO
YEAR ENDED SEPT. 30, SEPT. 30,
1994 1993 1992 1991
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD....... $ 1.00 $ 1.00 $ 1.00 $ 1.00
------ ------ ------ ------
INVESTMENT OPERATIONS
Net Investment Income..................... .035 .030 .040 .023
Net Realized and Unrealized Gain (Loss) on
Investments.............................. -- -- -- --
------ ------ ------ ------
TOTAL FROM INVESTMENT OPERATIONS.......... .035 .030 .040 .023
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DISTRIBUTIONS
Dividends from Net Investment Income...... (.035) (.030) (.040) (.023)
Distributions from Realized Capital Gains. -- -- -- --
------ ------ ------ ------
TOTAL DISTRIBUTIONS....................... (.035) (.030) (.040) (.023)
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NET ASSET VALUE, END OF PERIOD............. $ 1.00 $ 1.00 $ 1.00 $ 1.00
- -------------------------------------------------------------------------------
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TOTAL RETURN............................... 3.63% 3.05% 4.11% 2.35%**
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RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions)....... $ 171 $ 114 $ 71 $ 27
Ratio of Expenses to Average Net Assets.... .23% .29% .33% .34%*
Ratio of Net Investment Income to Average
Net Assets................................ 3.66% 3.00% 3.90% 5.50%*
Portfolio Turnover Rate.................... N/A N/A N/A N/A
</TABLE>
* Annualized.
** Not Annualized.
+ Commencement of operations.
5
<PAGE>
<TABLE>
<CAPTION>
-------------------------------------
HIGH-GRADE BOND PORTFOLIO
-------------------------------------
APRIL 29+ TO
YEAR ENDED SEPT. 30, SEPT. 30,
1994 1993 1992 1991
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD..... $10.94 $10.64 $10.24 $10.00
------ ------ ------ ------
INVESTMENT OPERATIONS
Net Investment Income................... .619 .636 .705 .299
Net Realized and Unrealized Gain (Loss)
on Investments......................... (.966) .349 .427 .240
------ ------ ------ ------
TOTAL FROM INVESTMENT OPERATIONS........ (.347) .985 1.132 .539
- --------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income.... (.619) (.636) (.705) (.299)
Distributions from Realized Capital
Gains.................................. (.154) (.049) (.027) --
------ ------ ------ ------
TOTAL DISTRIBUTIONS..................... (.773) (.685) (.732) (.299)
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NET ASSET VALUE, END OF PERIOD........... $ 9.82 $10.94 $10.64 $10.24
- --------------------------------------------------------------------------------
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TOTAL RETURN............................. (3.31)% 9.64% 11.47% 5.48%**
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RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions)..... $ 80 $ 85 $ 52 $ 16
Ratio of Expenses to Average Net Assets.. .24% .29% .32% .40%*
Ratio of Net Investment Income to Average
Net Assets.............................. 5.98% 5.92% 6.66% 6.89%*
Portfolio Turnover Rate.................. 46% 73% 31% 9%
</TABLE>
* Annualized.
** Not Annualized.
+ Commencement of operations.
<TABLE>
<CAPTION>
----------------------------------
BALANCED PORTFOLIO
----------------------------------
MAY 23+ TO
YEAR ENDED SEPT. 30, SEPT. 30,
1994 1993 1992 1991
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD....... $11.58 $10.83 $10.25 $10.00
------ ------ ------ ------
INVESTMENT OPERATIONS
Net Investment Income..................... .46 .50 .51 .19
Net Realized and Unrealized Gain (Loss) on
Investments.............................. (.16) .97 .52 .06
------ ------ ------ ------
TOTAL FROM INVESTMENT OPERATIONS.......... .30 1.47 1.03 .25
- --------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income...... (.39) (.69) (.45) --
Distributions from Realized Capital Gains. (.16) (.03) -- --
------ ------ ------ ------
TOTAL DISTRIBUTIONS....................... (.55) (.72) (.45) --
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NET ASSET VALUE, END OF PERIOD............. $11.33 $11.58 $10.83 $10.25
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
TOTAL RETURN............................... 2.67% 14.10% 10.29% 2.50%**
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RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions)....... $ 230 $ 191 $ 76 $ 13
Ratio of Expenses to Average Net Assets.... .34% .39% .42% .51%*
Ratio of Net Investment Income to Average
Net Assets................................ 4.11% 4.45% 4.77% 5.24%*
Portfolio Turnover Rate.................... 42% 41% 15% 3%
</TABLE>
* Annualized.
** Not Annualized.
+ Commencement of operations.
6
<PAGE>
<TABLE>
<CAPTION>
------------------------------------
EQUITY INDEX PORTFOLIO
------------------------------------
APRIL 29+ TO
YEAR ENDED SEPT. 30, SEPT. 30,
1994 1993 1992 1991
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD...... $12.37 $11.32 $10.45 $10.00
------ ------ ------ ------
INVESTMENT OPERATIONS
Net Investment Income.................... .31 .34 .26 .08
Net Realized and Unrealized Gain (Loss)
on Investments.......................... .12 1.07 .85 .37
------ ------ ------ ------
TOTAL FROM INVESTMENT OPERATIONS......... .43 1.41 1.11 .45
- --------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income..... (.23) (.34) (.24) --
Distributions from Realized Capital
Gains................................... (.10) (.02) -- --
------ ------ ------ ------
TOTAL DISTRIBUTIONS...................... (.33) (.36) (.24) --
- --------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD............ $12.47 $12.37 $11.32 $10.45
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
TOTAL RETURN.............................. 3.53% 12.68% 10.74% 4.50%**
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions)...... $ 186 $ 165 $ 85 $ 24
Ratio of Expenses to Average Net Assets... .24% .29% .32% .45%*
Ratio of Net Investment Income to Average
Net Assets............................... 2.60% 2.63% 2.84% 3.22%*
Portfolio Turnover Rate................... 7% 16% 1% 5%
</TABLE>
* Annualized.
** Not Annualized.
+ Commencement of operations.
<TABLE>
<CAPTION>
------------- --------------------- ---------------------
INTERNATIONAL EQUITY INCOME
PORTFOLIO PORTFOLIO GROWTH PORTFOLIO
------------- --------------------- ---------------------
JUNE 3+ TO YEAR ENDED JUNE 7+ TO YEAR ENDED JUNE 7+ TO
SEPT. 30, SEPT. 30, SEPT. 30, SEPT. 30, SEPT. 30,
1994 1994 1993 1994 1993
- -------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE,
BEGINNING OF PERIOD.... $10.00 $10.57 $10.00 $10.26 $10.00
------ ------ ------ ------ ------
INVESTMENT OPERATIONS
Net Investment Income.. .05 .45 .14 .14 .04
Net Realized and
Unrealized Gain (Loss)
on Investments........ .26 (.63) .54 .46 .22
------ ------ ------ ------ ------
TOTAL FROM INVESTMENT
OPERATIONS............ .31 (.18) .68 .60 .26
- -------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net
Investment Income..... -- (.33) (.11) (.07) --
Distributions from
Realized Capital
Gains................. -- (.01) -- -- --
------ ------ ------ ------ ------
TOTAL DISTRIBUTIONS.... -- (.34) (.11) (.07) --
- -------------------------------------------------------------------------------------
NET ASSET VALUE, END OF
PERIOD................. $10.31 $10.05 $10.57 $10.79 $10.26
- -------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------
TOTAL RETURN............ 3.10%** (1.64)% 6.81%** 5.87% 2.60%**
- -------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of
Period (Millions)...... $ 63 $ 68 $ 50 $ 82 $ 36
Ratio of Expenses to
Average Net Assets..... .30%* .34% .39%* .38% .43%*
Ratio of Net Investment
Income to Average Net
Assets................. 1.91%* 4.57% 4.30%* 1.55% 1.63%*
Portfolio Turnover Rate. 0% 18% 2% 34% 10%
</TABLE>
* Annualized.
** Not Annualized.
+ Commencement of operations.
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7
<PAGE>
YIELD AND TOTAL From time to time, a Portfolio of the Fund may advertise
RETURN its yield and total return. Both yield and total return
figures are based on historical earnings and are not in-
tended to indicate future performance. The "total return"
of a Portfolio refers to the average annual compounded
rates of return over one-, five-, and ten-year periods or
for the life of the Portfolio (as stated in the advertise-
ment) that would equate an initial amount invested at the
beginning of a stated period to the ending redeemable value
of the investment, assuming the reinvestment of all divi-
dend and capital gains distributions.
In accordance with industry guidelines set forth by the
U.S. Securities and Exchange Commission, the "30-day yield"
of a Portfolio is calculated by dividing net investment in-
come per share earned during a 30-day period by the net as-
set value per share on the last day of the period. Net in-
vestment income includes interest and dividend income
earned on the Portfolio's securities; it is net of all ex-
penses and all recurring and nonrecurring charges that have
been applied to all shareholder accounts. The yield calcu-
lation assumes that net investment income earned over 30
days is compounded monthly for six months and then
annualized. Methods used to calculate advertised yields are
standardized for all stock and bond mutual funds. However,
these methods differ from the accounting methods used by a
Portfolio to maintain its books and records, and so the ad-
vertised 30-day yield may not fully reflect the income paid
to your own account.
The Money Market Portfolio's "seven-day" or "current" yield
reflects the income earned by a hypothetical account in the
Portfolio during a seven-day period, expressed as an annual
percentage rate. The Portfolio's "effective yield" assumes
that the income over the seven-day period is reinvested
weekly, resulting in a slightly higher stated yield through
compounding.
YIELDS AND TOTAL RETURNS QUOTED FOR THE PORTFOLIOS INCLUDE
THE EFFECT OF DEDUCTING THE PORTFOLIOS' EXPENSES, BUT MAY
NOT INCLUDE CHARGES AND EXPENSES ATTRIBUTABLE TO ANY PAR-
TICULAR INSURANCE PRODUCT. SINCE YOU CAN ONLY PURCHASE
SHARES OF THE PORTFOLIOS THROUGH A VARIABLE ANNUITY OR
VARIABLE LIFE CONTRACT, YOU SHOULD CAREFULLY REVIEW THE
PROSPECTUS OF THE INSURANCE PRODUCT YOU HAVE CHOSEN FOR IN-
FORMATION ON RELEVANT CHARGES AND EXPENSES. EXCLUDING THESE
CHARGES FROM QUOTATIONS OF THE PORTFOLIOS' PERFORMANCE HAS
THE EFFECT OF INCREASING THE PERFORMANCE QUOTED. YOU SHOULD
BEAR IN MIND THE EFFECT OF THESE CHARGES WHEN COMPARING THE
PORTFOLIOS' PERFORMANCE TO THOSE OF OTHER MUTUAL FUNDS.
PLEASE REVIEW CAREFULLY THE YIELD AND TOTAL RETURN FIGURES
FOR THE PARTICULAR INSURANCE PRODUCT WHICH ACCOMPANY THE
YIELDS AND TOTAL RETURNS QUOTED FOR THE PORTFOLIOS.
- --------------------------------------------------------------------------------
INVESTMENT The Fund is intended exclusively as an investment vehicle
OBJECTIVES for variable annuity or variable life insurance contracts
offered by various insurance companies.
THE FUND OFFERS The Fund offers seven distinct Portfolios--a money market
SEVEN DISTINCT portfolio, a bond portfolio, a balanced portfolio, an eq-
PORTFOLIOS uity index portfolio, an equity income portfolio, a growth
portfolio and an international portfolio:
8
<PAGE>
The MONEY MARKET PORTFOLIO seeks to provide a current in-
come consistent with the preservation of capital and li-
quidity. The Portfolio also seeks to maintain a stable net
asset value of $1.00 per share.
The HIGH-GRADE BOND PORTFOLIO seeks to duplicate the total
return of publicly-traded investment grade fixed-income se-
curities in the aggregate by attempting to duplicate the
investment performance of a broad investment grade bond
index.
The BALANCED PORTFOLIO seeks to provide capital growth and
a reasonable level of current income.
THE EQUITY INCOME PORTFOLIO seeks to provide a high level
of current income.
The EQUITY INDEX PORTFOLIO seeks to parallel the investment
results of the Standard & Poor's 500 Composite Stock Price
Index (the "S&P 500").
THE GROWTH AND INTERNATIONAL PORTFOLIOS seek to provide
long-term capital appreciation.
There is no assurance that a Portfolio will achieve its
stated objective.
- --------------------------------------------------------------------------------
INVESTMENT The seven Portfolios of the Fund follow distinct investment
POLICIES policies. The Portfolios are managed without regard to tax
ramifications.
THE MONEY MARKET The MONEY MARKET PORTFOLIO invests in the following high-
PORTFOLIO quality money market obligations issued by financial insti-
INVESTS IN HIGH- tutions, nonfinancial corporations, and the U.S. Govern-
QUALITY MONEY ment, state and municipal governments and their agencies or
MARKET instrumentalities:
SECURITIES
(1) Negotiable certificates of deposit and bankers' accept-
ances of U.S. banks having total assets in excess of $1
billion.
(2) Commercial paper (including variable amount master de-
mand notes) rated Prime-1 by Moody's Investors Service,
Inc. ("Moody's") or A-1 by Standard and Poor's Corpora-
tion ("Standard and Poor's") or, if unrated, issued by
a corporation having an outstanding debt issue rated
Aa3 or better by Moody's or AA- or better by Standard
and Poor's.
(3) Short-term corporate obligations rated Aa3 or better by
Moody's or AA- or better by Standard and Poor's.
(4) Short-term Eurodollar and Yankee bank obligations. Eu-
rodollar bank obligations are dollar-denominated cer-
tificates of deposit or time deposits issued outside
the U.S. capital markets by foreign branches of U.S.
banks or by foreign banks; Yankee bank obligations are
dollar-denominated obligations issued in the U.S. capi-
tal markets by foreign banks.
(5) U.S. Treasury obligations including bills, notes,
bonds, and other debt obligations issued by the U.S.
Treasury. These securities are backed by the full faith
and credit of the U.S. Government.
(6) Securities issued or guaranteed by agencies and instru-
mentalities of the U.S. Government. These include secu-
rities issued by the Federal Home Loan Banks, Federal
Land Bank, Farmers Home Administration, Farm
9
<PAGE>
Credit Banks, Federal Intermediate Credit Bank, Federal
National Mortgage Association, Federal Financing Bank,
the Tennessee Valley Authority, and others. Such "agency"
securities may not be backed by the full faith and credit
of the U.S. Government.
(7) Repurchase agreements that are collateralized by the
securities listed in (1), (5), and (6) above.
In addition, up to 10% of the Money Market Portfolio's as-
sets may be invested in "restricted" money market securi-
ties that are not freely marketable or that are subject to
restrictions on disposition under the Securities Act of
1933.
The Money Market Portfolio will only invest in securities
that mature in 13 months or less and will maintain an aver-
age weighted maturity of 90 days or less.
THE HIGH-GRADE The HIGH-GRADE BOND PORTFOLIO will invest in a statisti-
BOND PORTFOLIO cally selected sample of fixed-income and mortgage-backed
INVESTS IN securities included in the Lehman Brothers Aggregate Bond
GOVERNMENT AND Index (the "Lehman Bond Index"). The Portfolio will invest
CORPORATE BONDS 80% or more of its assets in securities included in the
Lehman Bond Index, including not less than 65% of its as-
sets in U.S. Government or corporate bonds.
The Portfolio encompasses four major classes of investment
grade fixed income securities in the United States: U.S.
Treasury and agency securities, corporate debt obligations,
foreign dollar-denominated debt obligations, and mortgage-
backed securities. As of August 31, 1994, these four clas-
ses represented the following proportions of the Portfo-
lio's total market value:
<TABLE>
<S> <C>
U.S. Treasury and agency
securities 36%
Corporate debt obligations 30%
Foreign U.S. dollar obligations 3%
Mortgage-backed securities 31%
</TABLE>
Since 1980, the effective average weighted maturity of the
Portfolio has ranged from a high of 11.2 years to a low of
8.8 years; it was 9.0 years on August 31, 1994.
The Portfolio may, from time to time, substitute one type
of investment grade bond for another. For instance, the
Portfolio may hold more short-term corporate bonds (fewer
short U.S. Treasury bonds) than represented in the Index so
as to increase income. This corporate substitution strategy
will entail the assumption of additional credit risk; how-
ever, substantial diversification within the corporate sec-
tor should moderate issue-specific credit risk. In addi-
tion, current investment policy restricts corporate substi-
tutions to issues with less than 4 years remaining to matu-
rity and in aggregate no more than 15% of net assets. Over-
all, credit risk is expected to be very low for the Portfo-
lio.
THE BALANCED The BALANCED PORTFOLIO invests in a diversified portfolio
PORTFOLIO of both common stocks and bonds. Under normal circumstanc-
INVESTS IN BOTH es, it is expected that common stocks will represent 60% to
STOCKS AND BONDS 70% of the Portfolio's total assets. The Portfolio's common
stocks are held for the purpose of providing reasonable
dividend income and long-term growth of capital and income.
10
<PAGE>
The remaining 30% to 40% of the Portfolio's assets will be
invested in high-quality fixed-income securities. These se-
curities include investment grade corporate bonds (those
rated a minimum of Baa by Moody's or BBB by Standard &
Poor's) as well as securities issued by the U.S. Govern-
ment, its agencies and instrumentalities, including Govern-
ment National Mortgage Association ("GNMA") mortgage pass-
through certificates. The Portfolio may also hold short-
term fixed income securities of the type authorized for the
Money Market Portfolio as cash reserves.
The amount invested in stocks, bonds and cash reserves may
be varied from time to time, depending upon the assessment
of business, economic and market conditions by the Portfo-
lio's adviser, Wellington Management Company. The Portfolio
reserves the right to hold equity, fixed-income and cash
securities in whatever proportions deemed desirable at any
given time for defensive purposes.
The Balanced Portfolio may also invest up to 10% of its as-
sets in foreign securities, and may invest in stock and
bond index futures and options to a limited extent. The
Portfolio is also authorized to invest in preferred stocks,
although it does not presently intend to do so.
THE EQUITY INDEX The EQUITY INDEX PORTFOLIO expects to invest in all 500
PORTFOLIO stocks in the Standard & Poor's 500 Composite Stock Price
INVESTS IN S&P Index ("S&P 500 Index") in approximately the same propor-
500 STOCKS tions as they are represented in the Index. The 500 stocks
in the S&P 500 Index are selected by Standard & Poor's Cor-
poration to be included in the Index. The 500 securities,
most of which trade on the New York Stock Exchange, repre-
sent approximately 75% of the market value of all U.S. com-
mon stocks.
THE EQUITY Under normal circumstances, the EQUITY INCOME PORTFOLIO
INCOME PORTFOLIO will invest at least 80% of its assets in income-producing
INVESTS IN equity securities, including dividend-paying common stocks
STOCKS and securities which are convertible into common stocks.
The Portfolio intends to invest in securities which gener-
ate relatively high levels of dividend income and have the
potential for capital appreciation. These generally include
common stocks of established, high-quality U.S. corpora-
tions. In addition, the Portfolio will seek to diversify
its investments over a carefully selected list of securi-
ties in order to moderate the risks inherent in equity in-
vestments.
The EQUITY INCOME PORTFOLIO will invest in a company's se-
curities following a fundamental analysis of the issuing
company. An important part of this analysis will be the ex-
amination of the company's ability to maintain its divi-
dend. Over time, dividend income has proven to be an impor-
tant component of total return. For example, during the
ten-year period ended September 1994, reinvested dividend
income accounted for approximately 26% of the total return
of the S&P 500 Index. Also, dividend income tends to be a
more stable source of total return than capital apprecia-
tion. While the price of a company's common stock can be
significantly affected by market fluctuations and other
short-term factors, its dividend level usually has greater
stability. For this reason, securities which pay a high
level of dividend income are generally less volatile in
price than securities which pay a low level of dividend in-
come.
11
<PAGE>
Although the Portfolio intends to invest primarily in eq-
uity securities, it may invest up to 20% of its assets in
certain cash investments and investment grade fixed-income
securities (those rated BBB or better by Standard & Poor's
Corporation or Baa or better by Moody's Investors Service).
See "Implementation of Policies" for a description of these
and other investment practices of the Fund.
THE GROWTH The GROWTH PORTFOLIO invests primarily in equity securities
PORTFOLIO of seasoned U.S. companies with above-average prospects for
INVESTS IN growth. In selecting securities for the Portfolio, Lincoln
STOCKS Capital Management, adviser to the Portfolio, emphasizes
common stocks of high quality, established growth compa-
nies. Such companies tend to have exceptional growth rec-
ords, strong market positions, reasonable financial
strength, and relatively low sensitivity to changing eco-
nomic conditions. The adviser seeks to identify common
stocks that sell at attractive valuations and companies
that have the best prospects for continued above-average
growth.
Besides investing in equity securities, the Portfolio may
utilize stock index futures contracts and options to a lim-
ited extent. In addition, although the Portfolio will nor-
mally remain fully invested in equity securities, the Port-
folio may temporarily invest in certain short-term fixed
income securities. See "Implementation of Policies" for a
description of these and other investment practices of the
Portfolio.
THE The INTERNATIONAL PORTFOLIO invests primarily in apprecia-
INTERNATIONAL tion-oriented equity securities of seasoned companies lo-
PORTFOLIO cated outside the United States. The Portfolio seeks to di-
INVESTS IN versify its assets among many foreign stock markets: in-
FOREIGN STOCKS cluding Japan, the United Kingdom, Germany, France, Swit-
zerland, the Netherlands, Sweden, Australia, Hong Kong and
Singapore. Schroder Capital Management International, ad-
viser to the Portfolio, believes that both the selection of
individual stocks and the allocation of the Portfolio's as-
sets across foreign stock markets are important in managing
an international equity portfolio. Within each country, the
adviser seeks to invest in securities of companies with
consistent above-average earnings prospects whose value is
not yet recognized by the stock market.
Besides investing in equity securities, the International
Portfolio may also enter into forward foreign currency ex-
change contracts in order to protect against fluctuations
in exchange rates. See "Implementation of Policies" for a
description of such contracts.
TWO PORTFOLIOS The HIGH-GRADE BOND and EQUITY INDEX PORTFOLIOS are not
USE A "PASSIVE" managed according to traditional methods of "active" in-
INVESTMENT vestment management, which involve the buying and selling
APPROACH of securities based upon economic, financial and market
analyses and investment judgment. Instead, these Portfo-
lios, utilizing a "passive" or "indexing" investment ap-
proach, attempt to provide investment results that parallel
their respective indexes through statistical procedures.
These statistical techniques are expected to enable the
Portfolios to track their benchmark indexes, while minimiz-
ing brokerage, custodial and accounting costs.
For the High-Grade Bond and Equity Index Portfolios, the
ability to parallel the investment results of an index de-
pends upon the Portfolio's total assets.
12
<PAGE>
In the initial phases of the Fund, when a Portfolio's as-
sets are still at a low level, a Portfolio's investment
performance may diverge significantly from that of its
benchmark index. Once the Portfolio has reached a substan-
tial asset size, however, the correlation between the per-
formance of a Portfolio and its benchmark index is expected
to be 0.95 or higher. (A correlation of 1.00 would indicate
perfect correlation, which would be achieved when the net
asset value of a Portfolio, including the value of its div-
idend and capital gains distributions, increases or de-
creases in exact proportion to changes in an index.) A cor-
relation of 0.95 or higher is expected to be achieved when
the Portfolios exceeds $100 million in assets.
The High-Grade Bond and Equity Index Portfolios may invest
in the same money market instruments authorized for the
Money Market Portfolio, although cash or cash equivalents
are normally expected to represent less than 1% of each
Portfolio's assets. These two Portfolios may also invest up
to 20% of their assets in futures contracts and options in
order to invest uncommitted cash balances, to maintain li-
quidity to meet shareholder redemptions, or to minimize
trading costs.
However, in keeping with their "passive" investment strate-
gy, the two Portfolios will not invest in cash reserves,
futures contracts, or options transactions as part of a
temporary defensive strategy -- e.g., increasing a Portfo-
lio's cash position--in order to protect against stock or
bond market declines. The Portfolios intend to remain fully
invested, to the extent practicable, in a pool of securi-
ties with investment characteristics similar to those of
their respective indexes.
See "Implementation of Policies" for a further description
of these and other investment practices of the Fund.
The investment policies of the Fund are not fundamental and
so may be changed by the Board of Trustees without share-
holder approval. However, shareholders would be notified
prior to a material change.
- --------------------------------------------------------------------------------
INVESTMENT RISKS The seven Portfolios differ substantially in terms of in-
vestment risks.
CREDIT RISK FOR The MONEY MARKET PORTFOLIO is subject primarily to credit
THE MONEY MARKET risk, the possibility that an issuer of securities will be
PORTFOLIO SHOULD unable to make timely payments of interest and principal to
BE VERY LOW the Portfolio. Because the Portfolio invests in obligations
of private financial and non-financial corporations, credit
risk is higher than for a money market fund investing in
securities of the U.S. Government. However, relative to the
fixed-income market generally, the quality of the bank and
corporate obligations held by the Money Market Portfolio is
high, and so credit risk should be very low. Although the
Portfolio invests in high quality instruments, money market
portfolios, unlike federally-insured bank deposits, are not
insured or guaranteed.
THE HIGH-GRADE As a mutual fund investing in U.S. Government and corporate
BOND PORTFOLIO IS bonds and mortgage-backed securities, the HIGH-GRADE BOND
SUBJECT TO PORTFOLIO is exposed to interest rate, prepayment, and
INTEREST RATE, credit risks.
PREPAYMENT, AND
CREDIT RISKS
13
<PAGE>
INTEREST RATE RISK is the potential for a decline in the
value of fixed-income securities due to rising interest
rates. In general, bond prices vary inversely with interest
rates. If interest rates rise, bond prices generally de-
cline; if interest rates fall, bond prices generally rise.
In addition, for a given change in interest rates, longer-
maturity bonds fluctuate more in price (gaining or losing
more in value) than shorter-maturity bonds.
The Lehman Bond Index and the High-Grade Bond Portfolio are
expected to maintain an intermediate-term average weighted
maturity, and may therefore be subject to a moderate to
high level of interest rate risk. The following chart il-
lustrates the potentially high level of interest rate risk
of the Lehman Bond Index and the Portfolio by summarizing
the effect of rising and falling interest rates on a single
7-year bond yielding 7%:
<TABLE>
<CAPTION>
CHANGE IN
PRINCIPAL VALUE
OF 7-YEAR BOND
PERCENTAGE POINT ----------------
CHANGE IN RISING FALLING
INTEREST RATES RATES RATES
---------------- ------- --------
<S> <C> <C>
1% Change - 4.9% + 5.2%
2% Change - 9.5 +10.7
3% Change -13.8 +16.7
</TABLE>
This chart is intended to provide you with general guide-
lines for determining the degree of interest rate risk to
which the Portfolio may be exposed.
Because of its holdings of mortgage-backed securities, the
High-Grade Bond Portfolio will also be subject to MORTGAGE
PREPAYMENT RISK to a limited extent. Prepayment risk is the
possibility that, during periods of declining interest
rates, the principal invested in high-yielding mortgage-
backed securities will be repaid earlier than scheduled. As
a result, the Portfolio will be forced to reinvest the un-
anticipated payments at generally lower rates.
Prepayment risk has three important effects. First, when
mortgage prepayments are reinvested at lower rates, the in-
come from the Portfolio's mortgage-backed securities will
decline. Second, when interest rates fall and prepayments
increase, mortgage-backed securities will not enjoy as
large a gain in market value as ordinary bonds do. Third,
when interest rates rise and mortgage prepayments decrease,
mortgage-backed securities may decline in market value more
than ordinary bonds. To compensate for these risks, mort-
gage-backed securities generally offer higher yields than
bonds of comparable quality and maturity.
CREDIT RISK for the High-Grade Bond Portfolio is expected
to be low, in part reflecting the high quality of the secu-
rities included in the Lehman Bond Index. A large propor-
tion of securities in the Index are AAA-rated U.S. Govern-
ment bonds or Government-guaranteed mortgage-backed securi-
ties. It is anticipated that the average credit quality of
the Portfolio will be equivalent to a rating of at least
AAA from Standard & Poor's or Aaa from Moody's.
However, to a limited extent, the High-Grade Bond Portfolio
will be exposed to event risk -- i.e., the possibility that
corporate or foreign dollar-denominated fixed-income secu-
rities held by the Portfolio may decline substantially in
credit quality and market value due to a corporate merger,
leveraged
14
<PAGE>
buyout, takeover or other event. While event risk may be
high for certain securities held by the Portfolio, event
risk for the Portfolio in the aggregate should be low be-
cause of the Portfolio's diversified holdings and the small
percentage of the Portfolio's assets likely to be invested
in such obligations.
THE BALANCED As a mutual fund investing in both stocks and bonds, the
PORTFOLIO IS BALANCED PORTFOLIO is subject to both stock market and in-
EXPOSED TO THE terest rate (bond) risk. Fluctuating stock prices are ex-
RISKS OF STOCKS pected to have a significant effect on the Portfolio's
AND BONDS AND share price, as the Portfolio invests 60% to 70% of its as-
MANAGER RISK sets in common stocks. Bond price fluctuations will have a
correspondingly smaller influence. In the past, the stock
and bond markets have, from time to time, fluctuated inde-
pendently of one another. As a result, with its mix of
stocks and bonds, the Balanced Portfolio is likely to en-
tail less investment risk--and a potentially lower return--
than a portfolio investing exclusively in common stocks.
To a limited extent, the Balanced Portfolio is also subject
to credit risk--i.e., the likelihood that a bond issuer
will fail to make timely payments of interest and principal
to the Balanced Portfolio. Such credit risk is expected to
be low, however, due to the credit quality and diversifica-
tion of the Balanced Portfolio's bond investments.
The investment adviser of the Balanced Portfolio manages
the Portfolio according to the traditional methods of "ac-
tive" investment management, which involves the buying and
selling of securities based upon economic, financial and
market analysis and investment judgement. Manager risk re-
fers to the possibility that the Portfolio's investment ad-
viser may fail to execute the Portfolio's investment strat-
egy effectively. As a result, the Portfolio may fail to
achieve its stated objective.
THE EQUITY The EQUITY INCOME, EQUITY INDEX AND GROWTH PORTFOLIOs are
INCOME, EQUITY subject to stock market risk--i.e., the possibility that
INDEX AND GROWTH common stock prices will decline over short or even ex-
PORTFOLIOS ARE tended periods. The U.S. stock market tends to be cyclical,
SUBJECT TO STOCK with periods when stock prices generally rise and periods
MARKET RISK when stock 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
1993, as measured by the S&P 500 Index:
AVERAGE ANNUAL U.S. STOCK MARKET RETURNS (1926-1993) OVER
VARIOUS TIME HORIZONS
<TABLE>
<CAPTION>
1 YEAR 5 YEARS 10 YEARS 20 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 +12.3 +10.3 +10.6 +10.6
</TABLE>
As shown, from 1926 to 1993, common stocks, as measured by
the S&P 500 Index, have provided an average annual total
return (capital appreciation plus dividend income), for 10
years, of +10.6%. Average annual returns may not be useful
for forecasting future returns in any particular period, as
stock market returns are quite volatile from year to year.
15
<PAGE>
THE EQUITY The investment advisers manage the Portfolios according to
INCOME AND the traditional methods of "active" investment management,
GROWTH which involves the buying and selling of securities based
PORTFOLIOS ARE upon economic, financial and market analysis and investment
SUBJECT TO judgment. MANAGER RISK refers to the possibility that the
MANAGER RISK Fund's investment advisers may fail to execute the Portfo-
lio's investment strategy effectively. As a result, each
Portfolio may fail to achieve its stated objective.
THE As a mutual fund investing in equity securities, the Port-
INTERNATIONAL folio is subject to market risk--i.e., the possibility that
PORTFOLIO IS stock prices in general will decline over short or even ex-
SUBJECT TO STOCK tended periods. Stock markets tend to be cyclical, with pe-
MARKET RISK riods when stock prices generally rise and periods when
stock prices generally decline.
THE Investments in foreign stock markets can be as volatile, if
INTERNATIONAL not more volatile, than investments in U.S. markets. To il-
PORTFOLIO STOCKS lustrate the volatility of foreign stock market returns for
MAY BE MORE the U.S. dollar-based investor, the following table sets
VOLATILE THAN forth the extremes for foreign stock market returns as well
U.S. STOCKS as the average return for the period from 1969 to 1993, as
measured by the Morgan Stanley Capital International Eu-
rope, Australia, Far East (EAFE) Index:
AVERAGE ANNUAL INTERNATIONAL STOCK MARKET RETURNS (1969-
1993) OVER VARIOUS TIME HORIZONS
<TABLE>
<CAPTION>
1 YEAR 5 YEARS 10 YEARS 20 YEARS
------ ------- -------- --------
<S> <C> <C> <C> <C>
Best +70.2% +36.8% +22.9% +16.3%
Worst -23.0% +1.4% +7.0% +12.1%
Average +15.3% +14.7% +15.9% +14.8%
</TABLE>
As shown, over the period from 1969 to 1993, international
(non-U.S.) stocks have provided an average annual total re-
turn, for 10 years, of +15.9%. By comparison, the annual
total return, on average, for U.S. stocks during this same
period was +10.6% (as measured by the Standard & Poor's 500
Composite Stock Price Index). Note, however, that the pe-
riod from 1969 to 1993 was a favorable one for foreign
stock market investing. As a result, the figures on total
return and stock market volatility are provided here only
as a guide to potential market risk, and may not be useful
for forecasting future returns in any particular period.
The table on international stock market returns should not
be viewed as a representation of future returns from inter-
national stock markets or the International Portfolio. The
illustrated returns represent the historical performance of
unmanaged portfolios of securities (before subtracting
portfolio transaction costs and other expenses of an in-
vestment portfolio), which may be a poor guide to future
returns. In addition, the International Portfolio is likely
to differ in terms of portfolio composition from the EAFE
Index, and so the performance of the International Portfo-
lio should not be expected to mirror the return provided by
the index.
INTERNATIONAL For U.S. investors, the returns of foreign investments,
STOCKS ALSO such as those held by the International Portfolio, are in-
EXPOSE INVESTORS fluenced by not only the returns on foreign common stocks
TO CURRENCY AND themselves, but also by currency risk--i.e., changes in the
OTHER RISKS value of the currencies in which the stocks are denominat-
ed. In a period when
16
<PAGE>
the U.S. dollar generally rises against foreign currencies,
the returns on foreign stocks for a U.S. investor may be
diminished. By contrast, in a period when the U.S. dollar
generally declines, the returns on foreign stocks may be
enhanced.
Other risks and considerations of international investing
include the following: differences in accounting, auditing
and financial reporting standards; generally higher commis-
sion rates on foreign portfolio transactions; the smaller
trading volumes and generally lower liquidity of foreign
stock markets, which may result in greater price volatili-
ty; foreign withholding taxes payable on the Portfolio's
foreign securities, which may reduce dividend income pay-
able to shareholders; the possibility of expropriation or
confiscatory taxation; adverse changes in investment or ex-
change control regulations; difficulty in obtaining a judg-
ment from a foreign court; political instability which
would affect U.S. investment in foreign countries; and po-
tential restrictions on the flow of international capital.
THE The investment adviser manages the Portfolio according to
INTERNATIONAL the traditional methods of "active" investment management,
PORTFOLIO IS which involves the buying and selling of securities based
SUBJECT TO upon economic, financial and market analysis and investment
MANAGER RISK judgment. MANAGER RISK refers to the possibility that the
Fund's investment advisers may fail to execute the Portfo-
lio's investment strategy effectively. As a result, the
Portfolio may fail to achieve its stated objective.
- --------------------------------------------------------------------------------
WHO SHOULD The Portfolios of the Fund are intended exclusively as in-
INVEST vestment vehicles for variable annuity and variable life
insurance contracts offered by the separate accounts of
INVESTORS various insurance companies. Such contracts may provide
SEEKING A certain tax benefits, as outlined in the accompanying pro-
DIVERSIFIED spectus for the insurance company's variable life insurance
INVESTMENT or variable annuity policy.
PROGRAM FOR
VARIABLE The Money Market Portfolio is appropriate for investors who
INSURANCE OR desire maximum principal stability with current income. The
ANNUITY High-Grade Bond Portfolio is designed for investors who are
CONTRACTS seeking a higher level of income than generally provided by
the Money Market Portfolio, and who are willing to accept
short-term price fluctuations in the value of their invest-
ment. The Balanced Portfolio is designed for investors who
are seeking the potential capital appreciation provided by
common stocks, but who also wish to counterbalance the in-
herent risks of common stocks with an investment in fixed-
income securities. The Equity Income Portfolio is designed
for investors who are seeking a high level of current in-
come and the potential for long-term capital appreciation
with lower investment risk and volatility than is normally
available from common stock portfolios. The Equity Index,
Growth and International Portfolios are intended for in-
vestors who are seeking the potentially higher returns of
common stocks and who can tolerate sudden, often substan-
tial, fluctuations in the value of their investment. The
International Portfolio investor should be cognizant of the
unique risks of international investing, including their
exposure to currency fluctuations. In general, there can be
no assurance that a Portfolio will achieve its stated ob-
jective.
The Fund's Portfolios are intended to be long-term invest-
ment vehicles and are not designed to provide investors
with a means of speculating on short-term market movements.
Investors who engage in excessive account activity
17
<PAGE>
generate additional costs which are borne by all of the
Fund's shareholders. In order to minimize such costs, the
Fund has adopted the following policies. The Fund reserves
the right to reject any purchase request (including ex-
change purchases from other Vanguard portfolios) that is
reasonably deemed to be disruptive to efficient portfolio
management, either because of the timing of the investment
or previous excessive trading by the investor. Addition-
ally, the Fund has adopted exchange privilege limitations
in order to prevent excessive use of the exchange privilege
afforded shareholders. Exchange activity generally will not
be deemed excessive if limited to TWO SUBSTANTIVE EXCHANGE
REDEMPTIONS (AT LEAST 30 DAYS APART) from a Portfolio dur-
ing any calendar year. These limitations do not apply to
exchanges from the Fund's Money Market Portfolio. Finally,
the Fund reserves the right to suspend the offering of its
shares. For a further explanation see the "EXCHANGE AMONG
THE PORTFOLIOS" section in the insurance prospectus.
An investment in a single Portfolio of the Fund should not
be considered a complete investment program. Most investors
should maintain diversified holdings with different risk
characteristics--including common stocks, bonds, and money
market instruments.
- --------------------------------------------------------------------------------
IMPLEMENTATION Each Portfolio follows a number of additional investment
OF POLICIES practices in pursuit of its investment objective.
EACH PORTFOLIO The seven Portfolios of the Fund may invest in repurchase
MAY INVEST IN agreements according to the restrictions and limitations
REPURCHASE set forth previously in "Investment Policies." A repurchase
AGREEMENTS agreement is a means of investing monies for a short peri-
od. In a repurchase agreement, a seller--a U.S. commercial
bank or recognized U.S. securities dealer--sells securities
to a Portfolio and agrees to repurchase the securities at
the Portfolio's cost plus interest within a specified pe-
riod (normally one day). In these transactions, the securi-
ties purchased by the Portfolio will have a total value
equal to, or in excess of, the value of the repurchase
agreement and will be held by the Fund's custodian bank un-
til repurchased.
The use of repurchase agreements involves certain risks.
For example, if the seller of the agreement defaults on its
obligation to repurchase the underlying securities at a
time when the value of these securities has declined, the
Portfolio may incur a loss upon disposition of them. If the
seller of the agreement becomes insolvent and subject to
liquidation or reorganization under the bankruptcy code or
other laws, a bankruptcy court may determine that the un-
derlying securities are collateral not within the control
of the Portfolio and therefore subject to sale by the
trustee in bankruptcy. Finally, it is possible that the
Portfolio may not be able to substantiate its interest in
the underlying securities. While the Fund's management ac-
knowledges these risks, it is expected that they can be
controlled through stringent security selection and careful
monitoring.
THE MONEY MARKET Eurodollar bank obligations are dollar-denominated certifi-
PORTFOLIO MAY cates of deposit or time deposits issued outside the U.S.
INVEST IN capital markets by the foreign branches of U.S. banks and
EURODOLLAR OR by foreign banks; Yankee bank obligations are dollar-
YANKEE denominated obligations issued in the U.S. capital markets
OBLIGATIONS by foreign banks.
18
<PAGE>
Eurodollar and Yankee obligations are subject to the same
risks that pertain to domestic issues, notably credit risk,
market risk, and liquidity risk. Additionally, Eurodollar
(and, to a limited extent, Yankee) obligations are subject
to certain sovereign risks. One such risk is the possibil-
ity that a foreign government might prevent dollar-denomi-
nated funds from flowing across its borders. Other risks
include: adverse political and economic developments in a
foreign country; the extent and quality of government regu-
lation of financial markets and institutions; the imposi-
tion of foreign withholding taxes; and expropriation or na-
tionalization of foreign issuers. However, Eurodollar and
Yankee obligations will undergo the same credit analysis as
domestic issues in which the Money Market Portfolio in-
vests, and foreign issuers will be required to meet the
same tests of financial strength as the domestic issuers
approved for the Money Market Portfolio.
THE HIGH-GRADE The High-Grade Bond Portfolio will invest 80% or more of
BOND PORTFOLIO its assets in securities included in the Lehman Bond Index.
INVESTS IN BONDS The Lehman Bond Index measures the total investment return
AND MORTGAGE (capital change plus income) provided by a universe of
SECURITIES fixed-income securities, weighted by the market value out-
standing of each security. As of August 31, 1994, over
4,800 issues (including bonds, notes, debentures and mort-
gage issues) were included in the Lehman Bond Index, repre-
senting more than $4.0 trillion in market value. The secu-
rities included in the Lehman Bond Index generally meet the
following criteria, as defined by Lehman Brothers: an ef-
fective maturity of not less than one year; an outstanding
market value of at least $100 million; and investment-grade
quality (i.e., rated a minimum of Baa- by Moody's).
THE HIGH-GRADE The High-Grade Bond Portfolio will not invest in all of the
BOND PORTFOLIO individual issues that comprise the Lehman Bond Index be-
USES A "SAMPLING" cause of the large number of securities (approximately
TECHNIQUE 6,000) involved. Instead, the Portfolio will hold a repre-
sentative sample of the securities in the Index. Securities
will be chosen for the Portfolio so that the Portfolio's
fundamental characteristics are similar to those of the
Lehman Bond Index.
Over time, as the Portfolio's assets increase, the Portfo-
lio will seek to hold securities which reflect the weight-
ing of the four major classes in the Index -- U.S. Treasury
and agency securities, corporate and foreign dollar-denomi-
nated debt, and mortgage-backed securities. For example, if
U.S. Treasury and agency securities represent 60% of the
Index, then approximately 60% of the Portfolio's assets
will also be invested in such securities. As the Portfolio
grows, these classes will be further delineated along the
lines of sector, term to maturity, coupon, and credit rat-
ing. For example, within the corporate debt class, all
long-term, low coupon AA-rated utility bonds might be rep-
resented in the Portfolio by one or two individual utility
securities.
THE HIGH-GRADE As part of its effort to duplicate the investment perfor-
BOND PORTFOLIO mance of the Lehman Bond Index, the High-Grade Bond Portfo-
MAY INVEST IN lio will invest in mortgage-backed securities. Mortgage-
MORTGAGE-BACKED backed securities represent an interest in an underlying
SECURITIES pool of mortgages. Unlike ordinary fixed-income securities,
which generally pay a fixed rate of interest and return
principal upon maturity, mortgage-backed securities repay
both interest income and principal as part of their
19
<PAGE>
periodic payments. Because the mortgages underlying mort-
gage-backed certificates can be prepaid at any time by
homeowners or corporate borrowers, mortgage-backed securi-
ties give rise to certain unique "prepayment" risks. See
"Investment Risks."
The High-Grade Bond Portfolio may purchase mortgage-backed
securities issued by the Government National Mortgage Asso-
ciation (GNMA), the Federal Home Loan Mortgage Corporation
(FHLMC), the Federal National Mortgage Association (FNMA),
and the Federal Housing Authority (FHA). GNMA securities
are guaranteed by the U.S. Government as to the timely pay-
ment of principal and interest; securities from other gov-
ernment-sponsored entities are generally not secured by an
explicit pledge of the U.S. Government. The Portfolio may
also invest in conventional mortgage securities, which are
packaged by private corporations and are not guaranteed by
the U.S. Government, to the extent that these securities
are represented in the index.
Mortgage securities that are guaranteed by the U.S. Govern-
ment are guaranteed only as to the timely payment of prin-
cipal and interest. The market value of such securities is
not guaranteed and may fluctuate. See "Investment Risks."
THE EQUITY INDEX The Equity Index Portfolio attempts to duplicate the in-
PORTFOLIO vestment results of the S&P 500 Index by holding all 500
INVESTS IN ALL stocks in approximately the same proportions as they are
500 S&P STOCKS represented in the S&P 500 Index. This indexing technique
is known as "complete replication."
Each stock in the S&P 500 Index is weighted by its market
value. Because of the market-value weighting, the 50 larg-
est companies in the S&P 500 Index currently account for
approximately 50% of the Index. Typically, companies in-
cluded in the S&P 500 Index are the largest and most domi-
nant firms in their respective industries. As of November,
1994, the five largest companies in the Index were General
Electric (2.4%), AT&T (2.3%), Exxon (2.3%), Coca Cola Co.
(2.0%) and Royal Dutch (1.8%). The largest industry catego-
ries were drug companies (9.1%) telephone companies (8.6%),
international oil companies (7.5%), food and agriculture
(6.7%) and general retailers (6.1%).
The Equity Index Portfolio is not sponsored, endorsed,
sold, or promoted by Standard & Poor's. Standard & Poor's
makes no representation or warranty, implied or express, to
the purchasers of the Portfolio or any member of the public
regarding the advisability of investing in index funds or
the ability of the S&P 500 Index to track general stock
market performance. Standard & Poor's does not guarantee
the accuracy and/or the completeness of the S&P 500 Index
or any data included therein.
Standard & Poor's makes no warranty, express or implied, as
to the results to be obtained by the Portfolio, owners of
the Portfolio, any person or any entity from the use of the
S&P 500 Index or any data included therein. Standard &
Poor's makes no express or implied warranties and hereby
expressly disclaims all such warranties of merchantability
or fitness for a particular purpose for use with respect to
the S&P 500 Index or any data included therein. Standard &
Poor's only relationship to the Portfolio is the licensing
of the Standard & Poor's marks and the S&P 500 Index, which
is determined, composed and calculated by Standard & Poor's
without regard to the Equity Index Portfolio.
20
<PAGE>
THE In addition to foreign equity securities, the International
INTERNATIONAL Portfolio may enter into forward foreign currency exchange
PORTFOLIO MAY contracts. Such contracts are used to protect the Portfo-
ENTER INTO lio's securities against uncertainty in the level of future
FORWARD CURRENCY foreign exchange rates. The Portfolio may not enter into
CONTRACTS such contracts for speculative purposes.
A forward foreign currency exchange contract is an obliga-
tion to purchase or sell a specific currency at a future
date, which may be any fixed number of days from the date
of the contract agreed upon by the parties, at a price set
at the time of the contract. These contracts may be bought
or sold to protect the Portfolio to a limited extent
against adverse changes in exchange rates between foreign
currencies and the U.S. dollar. Such contracts, which pro-
tect the value of a Portfolio's investment securities
against a decline in the value of a currency, do not elimi-
nate fluctuations in the underlying prices of the securi-
ties. They simply establish an exchange rate at a future
date. Also, although such contracts tend to minimize the
risk of loss due to a decline in the value of the hedged
currency, at the same time they tend to limit any potential
gain that might be realized should the value of such cur-
rency increase.
SIX PORTFOLIOS The High-Grade Bond, Balanced, Equity Income, Equity Index,
MAY USE FUTURES Growth and International Portfolios may utilize futures
CONTRACTS AND contracts and options to a limited extent. Specifically,
OPTIONS each Portfolio may enter into futures contracts provided
that not more than 5% of its assets are required as a
futures contract margin deposit; in addition, a Portfolio
may enter into futures contracts and options transactions
only to the extent that obligations under such contracts or
transactions represent not more than 20% of the Portfolio's
assets.
Futures contracts and options may be used for several rea-
sons: to maintain cash reserves while simulating full in-
vestment, to facilitate trading, or to reduce transaction
costs. While futures contracts and options can be used as
leveraged investments, a Portfolio may not use futures con-
tracts or options transactions to leverage its net assets.
FUTURES The primary risks associated with the use of futures con-
CONTRACTS AND tracts and options are: (i) imperfect correlation between
OPTIONS POSE the change in market value of the stocks held by a Portfo-
CERTAIN RISKS lio 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 prior to its maturity date. The risk of
imperfect correlation will be minimized by investing only
in those contracts whose behavior is expected to resemble
that of a Portfolio's underlying securities. The risk that
a 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 mar-
ket.
The risk of loss in trading futures contracts in some
strategies can be substantial, due both to the low margin
deposits required and the extremely high degree of leverage
involved in futures pricing. As a result, a relatively
small price movement in a futures contract may result in
immediate and substantial loss (or gain) to the investor.
When investing in futures contracts, a Portfolio will seg-
regate cash or cash equivalents in the amount of the under-
lying obligation.
21
<PAGE>
SIX PORTFOLIOS The High-Grade Bond, Balanced, Equity Income, Equity Index,
MAY LEND THEIR Growth and International Portfolios may lend their invest-
SECURITIES ment securities to qualified institutional investors for
the purpose of realizing additional income. Loans of secu-
rities by a Portfolio will be collateralized by cash, let-
ters of credit, 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 se-
curities. In keeping with statutory restrictions, securi-
ties lending will not exceed 33 1/3% of a Portfolio's as-
sets.
PORTFOLIO Each Portfolio of the Fund retains the right to sell secu-
TURNOVER IS rities irrespective of how long they have been held. Be-
EXPECTED TO BE cause of their "passive" investment management approach,
LOW however, portfolio turnover for the High-Grade Bond and Eq-
uity Index Portfolios is expected to be under 50%, a gener-
ally lower turnover rate than for most investment compa-
nies. A portfolio turnover rate of 50% would occur if one
half of a Portfolio's securities matured or were sold
within one year. Ordinarily, securities will be sold from
the two "passive" Portfolios only to reflect structural
changes in their respective indexes (including mergers or
changes in the composition of an index) or to accommodate
cash flows out of a Portfolio while maintaining the simi-
larity of the Portfolio to its benchmark index.
Portfolio turnover for the Balanced, Equity Income, Growth
and International Portfolios is not expected to exceed
100%. For the Money Market Portfolio, portfolio turnover
should be high due to the short-term maturities of the se-
curities held by the Portfolio.
EACH PORTFOLIO Each Portfolio of the Fund may borrow money from a bank up
MAY BORROW MONEY to a limit of 15% of the market value of its assets, but
only for temporary or emergency purposes. A 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 a Portfolio
borrows money prior to selling securities, the Portfolio
may be leveraged; at such times, the Portfolio may appreci-
ate or depreciate in value more rapidly than its benchmark
index. A Portfolio will repay any money borrowed in excess
of 5% of the market value of its total assets prior to pur-
chasing additional portfolio securities.
- --------------------------------------------------------------------------------
INVESTMENT The Fund has adopted certain limitations on its investment
LIMITATIONS practices. Specifically, each Portfolio of the Fund will
not:
THE FUND HAS (a) with respect to 75% of a Portfolio's assets, purchase
ADOPTED CERTAIN more than 10% of the outstanding voting securities of
FUNDAMENTAL any issuer;
LIMITATIONS
(b) with respect to 75% of a Portfolio's assets, purchase
securities of any issuer (except obligations of the
U.S. Government and its instrumentalities) if, as a re-
sult, more than 5% of the Portfolio's total assets
would be invested in the securities of such issuer;
(c) borrow money, except from a bank, and only as a tempo-
rary or emergency measure and in no event in excess of
15% of the market value of a Portfolio's assets. Money
borrowed in excess of 5% of a Portfolio's total assets
will be repaid prior to the purchase of additional
portfolio securities;
22
<PAGE>
(d) pledge, mortgage, or hypothecate any of its assets to
an extent greater than 5% of the value of its total as-
sets;
(e) invest more than 25% of the value of its total assets
in any one industry.
These investment limitations are considered at the time in-
vestment securities are purchased. The limitations de-
scribed here and in the Statement of Additional Information
may be changed only with the approval of a majority of the
Fund's shareholders.
- --------------------------------------------------------------------------------
MANAGEMENT OF The Fund is a member of The Vanguard Group of Investment
THE FUND Companies, a family of more than 30 investment companies
with more than 80 distinct portfolios and assets in excess
VANGUARD of $130 billion. Through their jointly-owned subsidiary,
ADMINISTERS AND The Vanguard Group, Inc. ("Vanguard"), the Fund and the
DISTRIBUTES THE other funds in the Group obtain at cost virtually all of
FUND their corporate management, administrative, shareholder ac-
counting and distribution services. Vanguard also provides
investment advisory services on an at-cost basis to certain
Vanguard funds. As a result of Vanguard's unique corporate
structure, the Vanguard funds have costs substantially
lower than those of most competing mutual funds. In 1993,
the average expense ratio (annual costs including advisory
fees divided by total net assets) for the Vanguard funds
amounted to approximately .30% compared to an average of
1.02% for the mutual fund industry (data provided by Lipper
Analytical Services).
The Officers of the Fund manage its day-to-day operations
and are responsible to the Fund's Board of Directors. The
Directors set broad policies for the Fund and choose its
Officers. A list of the Directors and Officers of the Fund
and a statement of their present positions and principal
occupations during the past five years can be found in the
Statement of Additional Information.
Vanguard employs a supporting staff of management and ad-
ministrative personnel needed to provide the requisite
services to the funds and also furnishes the funds with
necessary office space, furnishings, and equipment. Each
fund pays its share of Vanguard's total expenses, which are
allocated among the funds under methods approved by the
Board of Trustees (Directors) of each fund. In addition,
each fund bears its own direct expenses, such as legal, au-
diting, and custodial fees.
The charge to the Fund for management and advisory services
provided by Vanguard during the fiscal year ended September
30, 1994, was .18%, .17% and .20% of average net assets for
the Money Market, High-Grade Bond and Equity Index Portfo-
lios, respectively. The charge to the Balanced, Equity In-
come, Growth and International Portfolios for management
services provided by Vanguard was .20%, .17%, .18% and .06%
of average net assets of the Balanced, Equity Income,
Growth and International Portfolios, respectively, and the
charge for investment advisory services provided the Port-
folios by Wellington Management Company, Newell Associates,
Lincoln Capital Management and Schroder Capital was .10%,
.10%, .15% and .17%, respectively, of each Portfolio's av-
erage net assets. A charge of .05%, .07%, .04%, .04%, .07%,
.05% and .07% was also paid by the Money Market, High-Grade
Bond, Balanced, Equity Index, Equity Income, Growth and In-
ternational Portfolios, respectively, to Vanguard for oth-
er expenses.
23
<PAGE>
Vanguard also provides distribution and marketing services
to the Vanguard funds. The Funds are available on a no-load
basis (i.e., there are no sales commissions or 12b-1 fees).
However, each fund bears its share of the Group's distribu-
tion costs.
The charge to the Fund for distribution and marketing serv-
ices provided by Vanguard during the fiscal year ended Sep-
tember 30, 1994, was .03%, .02%, .02% and .02% of average
net assets for the Money Market, High-Grade Bond, Balanced
and Equity Index Portfolios, respectively. The distribution
and marketing expenses for both the Equity Income and
Growth Portfolios were .01% and .01%.
The investment objectives and policies of the Fund's Port-
folios are similar to those of other Vanguard funds. The
Money Market Portfolio of the Fund is similar to the Prime
Portfolio of Vanguard Money Market Reserves; the High-Grade
Bond Portfolio is similar to Vanguard Bond Index Fund; the
Balanced Portfolio is similar to Vanguard Wellington Fund;
the Equity Index Portfolio is similar to the 500 Portfolio
of Vanguard Index Trust; the Equity Income Portfolio is
similar to Vanguard Equity Income Fund; the Growth Portfo-
lio is similar to Vanguard U.S. Growth Portfolio and the
International Portfolio is similar to Vanguard Interna-
tional Growth Portfolio. Because of differences in the in-
vestments held and additional administrative and insurance
costs associated with insurance company separate accounts,
the Portfolios' investment performance will differ from the
performance of the corresponding Vanguard funds.
Shares of the Fund's Portfolios may be sold to registered
separate accounts of insurance companies affiliated or not
affiliated with Vanguard, offering variable annuity and
variable life products. At present, none of the Portfolios
foresees any disadvantages arising out of the fact that
each Portfolio offers its shares to separate accounts of
various insurance companies to serve as an investment vehi-
cle for their variable separate accounts. However, a mate-
rial conflict could arise between the interest of the dif-
ferent participating separate accounts. The Fund's Board of
Trustees intends to monitor events in order to identify any
material irreconcilable conflicts that may possibly arise
and to determine which action, if any, should be taken in
response to such conflicts of interest. If such conflicts
were to occur, one or more insurance companies' separate
accounts might be required to withdraw its investments in
one or more Portfolios, or shares of another Portfolio may
be substituted by the Fund. As a result, a Portfolio might
be forced to sell a portion of its securities at a disad-
vantageous price. In the event of such a material conflict,
the affected insurance companies agree to take any neces-
sary steps, including removing its separate account from
the Fund if required by law, to resolve the matter.
- --------------------------------------------------------------------------------
INVESTMENT Vanguard provides investment advisory services on an at-
ADVISERS cost basis to three Portfolios of the Fund: Vanguard's
Fixed Income Group provides advisory services to the Money
VANGUARD AND Market and High-Grade Bond Portfolios, and Vanguard's Core
FOUR INDEPENDENT Management Group provides advisory services to the Equity
INVESTMENT Index Portfolio. Wellington Management Company, Newell As-
ADVISERS MANAGE sociates and Lincoln Capital Management serve as indepen-
THE FUND'S dent investment advisers to the Balanced, Equity Income and
INVESTMENTS Growth Portfolios, respectively. The Interna-
24
<PAGE>
tional Portfolio employs Schroder Capital Management Inter-
national, Inc. as the adviser.
Vanguard's Fixed Income Group provides investment advisory
services to more than 40 Vanguard money market, bond, and
balanced portfolios, both taxable and tax-exempt. Total as-
sets under management by the Fixed Income Group were $54.9
billion as of August 31, 1994. The High-Grade Bond Portfo-
lio of the Fund is not actively managed, but is instead ad-
ministered by the Fixed Income Group using computerized,
quantitative techniques. The Fixed Income Group is super-
vised by the Officers of the Fund. Ian A. MacKinnon, Senior
Vice President of Vanguard, has been in charge of the Group
since its inception in 1981.
Vanguard's Core Management Group also provides investment
advisory services to Vanguard Index Trust, Vanguard Inter-
national Equity Index Fund, Vanguard Balanced Index Fund
and several indexed separate accounts. Total indexed assets
under management as of June 30, 1994, were $18.3 billion.
The Fund's Equity Index Portfolio is not actively managed,
but is instead administered by the Core Management Group
using computerized, quantitative techniques. The Group is
supervised by the Fund's Officers.
Vanguard's investment management staff is also responsible
for the allocation of principal business and portfolio bro-
kerage and the negotiation of commissions. For the Money
Market Portfolio, the purchase and sale of investment secu-
rities will ordinarily be principal transactions. Portfolio
securities will normally be purchased directly from the is-
suer or from an underwriter or market maker for the securi-
ties. There will usually be no brokerage commissions paid
by the Money Market Portfolio for such purchases. Purchases
from underwriters of securities will include a commission
or concession paid by the issuer to the underwriter, and
purchases from dealers serving as market makers will in-
clude a dealer's mark-up.
In placing portfolio transactions, Vanguard's advisory
staff uses its best judgment to choose the broker most ca-
pable of providing the brokerage services necessary to ob-
tain the best available price and most favorable execution
at the lowest commission rate. The full range and quality
of brokerage services available are considered in making
these determinations. In selecting broker-dealers to exe-
cute securities transactions for the Portfolios, considera-
tion will be given to such factors as: the price of the se-
curity; the rate of the commission; the size and difficulty
of the order; the reliability, integrity, financial condi-
tion, general execution, and operational capabilities of
competing broker-dealers; and the brokerage and research
services provided to the Fund.
The Fund employs four independent investment advisers. Wel-
lington Management Company ("WMC"), 75 State Street, Bos-
ton, MA 02109, serves as investment adviser to the Fund's
Balanced Portfolio. Newell Associates ("Newell"), 525 Uni-
versity Avenue, Palo Alto, CA 94301, is adviser to the Eq-
uity Income Portfolio. Lincoln Capital Management Company
("Lincoln"), 200 South Wacker Drive, Chicago, IL 60606,
serves as the adviser to the Growth Portfolio. Schroder
Capital Management International, Inc. ("Schroder Capi-
tal"), 787 Seventh Avenue, New York, NY 10019, serves as
the adviser to
25
<PAGE>
the International Portfolio. Under advisory agreements with
the Fund, WMC, Newell, Lincoln and Schroder Capital manage
the investment and reinvestment of the assets of the Bal-
anced, Equity Income, Growth and International Portfolios,
respectively, and continuously review, supervise and admin-
ister each Portfolio's investment program. The advisers
discharge their responsibilities subject to the control of
the Officers and Trustees of the Fund.
WELLINGTON WMC is a professional investment advisory firm that glob-
MANAGEMENT ally provides services to investment companies, institu-
COMPANY SERVES AS tions, and individuals. Among the clients of WMC are more
ADVISER TO THE than 10 of the investment companies of The Vanguard Group.
BALANCED As of October 31, 1994, WMC held discretionary management
PORTFOLIO authority with respect to more than $80 billion of assets.
WMC and its predecessor organizations have provided advi-
sory services to investment companies since 1933 and to in-
vestment counseling clients since 1960.
Vincent Bajakian, Senior Vice President of WMC, serves as
portfolio manager of the Balanced Portfolio. Mr. Bajakian
is assisted by Paul D. Kaplan, Senior Vice President of
WMC. Mr. Bajakian who has served in this capacity since the
Balanced Portfolio's inception and Mr. Kaplan who has
served in this capacity since March 1994, are supported by
research and other investment services provided by the pro-
fessional staff of WMC. Mr. Bajakian and Mr. Kaplan have
been employed by WMC for 35 and 17 years, respectively.
The Fund pays WMC a basic advisory fee at the end of each
fiscal quarter, calculated by applying a quarterly rate,
based on the following annual percentage rates, to the av-
erage month-end net assets of the Balanced Portfolio for
the quarter:
<TABLE>
<CAPTION>
NET ASSETS RATE
--------------- -----
<S> <C>
Up to $500 million 0.10%
Over $500 million 0.05%
</TABLE>
The basic advisory fee may be increased or decreased by ap-
plying an adjustment formula based on the investment per-
formance of the Balanced Portfolio relative to the invest-
ment record of a "Combined Index," 65% of which shall be
comprised of the Standard & Poor's Composite Stock Price
Index and 35% of which shall be comprised of the Salomon
Brothers High Grade Corporate Bond Index. The basic fee may
be increased or decreased under the formula by an amount
equal to .015% per annum (.00375% per quarter) of the first
$500 million of the average month-end assets of the Fund,
and .010% per annum (.0025% per quarter) of the average
month-end assets over $500 million. For additional informa-
tion on the advisory fees paid by the Fund, please see the
Statement of Additional Information.
During the fiscal year ended September 30, 1994, the total
advisory fees paid by the Fund to WMC represented an effec-
tive annual rate of .10 of 1% of average net assets of the
Balanced Portfolio.
NEWELL The principal investment officer of Newell, Roger D.
ASSOCIATES Newell, has managed equity portfolios for more than 25
SERVES AS years, employing an income-oriented equity strategy since
ADVISER TO THE 1975. The approach is based upon an analysis of how a
EQUITY INCOME stock's yield, relative to the market, varies over time.
PORTFOLIO Newell's strategy asserts
26
<PAGE>
that relative yield is an excellent guide to relative val-
ue. Newell, formed in 1986, is a California corporation in
which a controlling interest is owned by its Directors and
Officers: Roger D. Newell, Robert A. Huret and Alan E.
Rothenberg. As of June 30, 1994, Newell's assets under man-
agement were approximately $1.2 billion. Mr. Newell has
been responsible for overseeing the implementation of the
firm's strategy for the Equity Income Portfolio since its
inception.
The Fund pays Newell an advisory fee at the end of each
fiscal quarter, calculated by applying a quarterly rate,
based on an annual percentage rate of .10%, to the average
month-end net assets of the Equity Income Portfolio for the
quarter. During the fiscal year ended September 30, 1994,
the total advisory fees paid by the Fund to Newell repre-
sented an effective annual rate of .10 of 1% of average net
assets of the Equity Income Portfolio.
LINCOLN CAPITAL Lincoln, an investment advisory firm founded in 1967, cur-
SERVES AS rently provides investment counseling services to a limited
ADVISER TO THE number of clients, most of which are institutional clients,
GROWTH PORTFOLIO such as pension funds. Currently, Lincoln holds discretion-
ary management authority with respect to approximately
$25.2 billion in assets.
Lincoln employs a team of investment professionals who each
participate in investment strategy formulation and issue
selection. Client equity portfolios are highly similar in
terms of their stock composition. The individuals responsi-
ble for overseeing the implementation of the firm's strat-
egy for the Growth Portfolio, who have served in this ca-
pacity since the Portfolio's inception, are J. Parker Hall
III, President of Lincoln, and David M. Fowler, Vice Presi-
dent of Lincoln. Mr. Hall and Mr. Fowler have been employed
by Lincoln for 23 and 10 years, respectively.
The Fund pays Lincoln an advisory fee calculated by apply-
ing an annual rate of .15% to the average net assets of the
Growth Portfolio. During the fiscal year ended September
30, 1994, the total advisory fees paid by the Fund to Lin-
coln, represented an effective annual rate of .15 of 1% of
average net assets of the Growth Portfolio.
The investment advisory agreements authorize WMC, Newell
and Lincoln (with approval of the Fund's Board of Trustees)
to select the brokers or dealers that will execute the pur-
chases and sales of portfolio securities for each Portfolio
and direct the advisers to use their best efforts to obtain
the best available price and most favorable execution with
respect to all transactions for the Portfolio. The full
range and quality of brokerage services available are con-
sidered in making these determinations. The Fund has autho-
rized the advisers to pay higher commissions in recognition
of brokerage services felt necessary to the achievement of
better execution, provided the advisers believe this to be
in the best interests of the Portfolio and the Fund.
SCHRODER CAPITAL Schroder Capital is a wholly-owned subsidiary of Schroders
SERVES AS PLC. Schroders PLC is the holding company parent of a large
ADVISER TO THE worldwide group of banks and financial service companies
INTERNATIONAL (referred to as "The Schroder Group") with associated com-
PORTFOLIO panies and branch and representative offices located in
twenty-four countries. The Schroder Group specializes in
providing investment manage-
27
<PAGE>
ment services, with Group funds under management currently
in excess of $82 billion.
Richard Foulkes, Executive Vice President of Schroder Capi-
tal, serves as Portfolio Manager of the International Port-
folio. He is supported by research teams in twelve offices
world wide and by four teams of regional specialists in the
London office. Mr. Foulkes has been employed by Schroder
Capital for 17 years.
The Portfolio pays Schroder Capital a basic advisory fee at
the end of each quarter, calculated by applying an annual
percentage rate of 0.125% to the average month-end net as-
sets of the Portfolio. This basic advisory fee is increased
or decreased by applying an adjustment formula based on the
investment performance of the Portfolio relative to the in-
vestment record of the Morgan Stanley Capital International
Europe, Australia, Far East Index ("EAFE") over the preced-
ing 36-month period. During the period June 3, 1994 (com-
mencement of the Portfolio's operations) to September 30,
1994, the total advisory fees paid by the Fund to Schroder
Capital represented an effective annual rate of .13% of 1%
of average net assets of the International Portfolio.
The investment advisory agreement with Schroder Capital au-
thorizes the adviser to select brokers or dealers to exe-
cute purchases and sales of the Portfolio's securities, and
directs the adviser to use its best efforts to obtain the
best available price and most favorable execution with re-
spect to all transactions.
The Portfolio has authorized Schroder Capital to pay higher
commissions in recognition of brokerage services felt nec-
essary for the achievement of better execution, provided
the investment adviser believes this to be in the best in-
terest of the Portfolio. Although the Portfolio does not
market its shares through intermediary brokers or dealers,
the Portfolio may place orders for the Portfolio with qual-
ified broker-dealers who recommend the Portfolio to cli-
ents, if the Officers of the Fund believe that the quality
of the transaction and the commission are comparable to
what they would be with other qualified brokerage firms.
The Fund's Board of Trustees may, without the approval of
shareholders, provide for: (a) the employment of a new in-
vestment adviser pursuant to the terms of a new advisory
agreement either as a replacement for an existing adviser
or as an additional adviser; (b) a change in the terms of
an advisory agreement; and (c) the continued employment of
an existing adviser on the same advisory contract terms
where a contract has been assigned because of a change in
control of the adviser. Any such change will only be made
upon not less than 30 days' prior written notice to share-
holders of the Fund which shall include substantially the
information concerning the adviser that would have normally
been included in a proxy statement.
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28
<PAGE>
DIVIDENDS, Each Portfolio expects to distribute substantially all of
CAPITAL GAINS its ordinary income and capital gains each year. Dividends
AND TAXES for the Money Market and High-Grade Bond Portfolios are ac-
crued daily and distributed monthly. The Balanced, Equity
DIVIDENDS AND Index and Equity Income Portfolios will distribute divi-
CAPITAL GAINS dends each quarter while the Growth and International Port-
MAY ACCUMULATE folios distribute dividends annually. Capital gains distri-
FREE OF FEDERAL butions, if any, from the High-Grade Bond, Balanced, Equity
INCOME TAX Index, Equity Income, Growth and International Portfolios
will be made annually.
All dividends and capital gains distributions from a Port-
folio will be automatically reinvested in additional shares
of the Portfolio.
Each Portfolio of the Fund intends to continue to qualify
for taxation as a "regulated investment company" under the
Internal Revenue Code so that it will not be subject to
federal income tax to the extent its income is distributed
to its shareholders. In addition, each Portfolio intends to
qualify under the Internal Revenue Code with respect to the
diversification requirements related to the tax-deferred
status of insurance company separate accounts.
Shares of the Portfolios must be purchased through variable
life insurance or variable annuity contracts. As a result,
it is anticipated that any dividend or capital gains dis-
tributions from a Portfolio of the Fund will be exempt from
current taxation if left to accumulate within a variable
life insurance or variable annuity contract. The Fund is
managed without regard to tax ramifications. Withdrawals
from such contracts may be subject to ordinary income tax
plus a 10% penalty tax if made before age 59 1/2.
The tax status of your investment in the Fund depends upon
the features of your variable life insurance or variable
annuity contract. For further information, please refer to
the prospectus of the insurance company separate account
that offers your contract.
- --------------------------------------------------------------------------------
THE SHARE PRICE Each Portfolio's share price or "net asset value" per share
OF EACH is calculated daily at the close of regular trading of the
PORTFOLIO New York Stock Exchange (generally 4:00 p.m. Eastern time).
Each Portfolio determines its net asset value per share by
subtracting the Portfolio's liabilities (including accrued
expenses and dividends payable) from the total value of the
Portfolio's investments and other assets and dividing the
result by the total outstanding shares of the Portfolio.
For the purpose of calculating the Money Market Portfolio's
net asset value per share, securities are valued by the
"amortized cost" method of valuation, which does not take
into account unrealized gains or losses. This involves val-
uing an instrument at its cost and thereafter assuming a
constant amortization to maturity of any discount or premi-
um, regardless of the impact of fluctuating interest rates
on the market value of the instrument. While this method
provides certainty in valuation, it may result in periods
during which value, as determined by amortized cost, is
higher or lower than the price the Portfolio would receive
if it sold the instrument.
The use of amortized cost and the maintenance of the Money
Market Portfolio's per share net asset value at $1.00 is
based on its election to operate under the provisions of
Rule 2a-7 under the Investment Company Act of 1940. As a
29
<PAGE>
condition of operating under that rule, the Money Market
Portfolio must maintain a dollar-weighted average portfolio
maturity of 90 days or less, purchase only instruments hav-
ing remaining maturities of 13 months or less, and invest
only in securities that are determined by the Trustees to
present minimal credit risks and that are of high quality
as determined by any major rating service, or in the case
of any instrument not so rated, considered by the Trustees
to be of comparable quality.
The Trustees have also agreed to establish procedures rea-
sonably designed, taking into account current market condi-
tions and the Money Market Portfolio's investment objec-
tive, to stabilize the net asset value per share as com-
puted for the purposes of sales and redemptions at $1.00.
These procedures include periodic review, as the Trustees
deem appropriate and at such intervals as are reasonable in
light of current market conditions, of the relationship be-
tween the amortized cost value per share and a net asset
value per share based upon available indications of market
value. In such a review, investments for which market quo-
tations are readily available are valued at the most recent
bid price or quoted yield equivalent for such securities or
for securities of comparable maturity, quality and type as
obtained from one or more of the major market makers for
the securities to be valued. Other investments and assets
are valued at fair value, as determined in good faith by
the Trustees.
For the other Portfolios of the Fund, securities that are
listed on a securities exchange are valued at the latest
quoted sale prices as of 4:00 p.m. on the day the valuation
is made. Price information on listed securities is taken
from the exchange where the security is primarily traded.
Listed securities not traded on the valuation date for
which market quotations are available are valued at the
mean between the bid and asked prices. Unlisted securities
are valued at the latest bid price.
Securities listed on a foreign exchange, as well as Ameri-
can Depository Receipts ("ADRs"), which are traded on U.S.
exchanges are valued at the latest quoted sales price
available before the time when assets are valued. All
prices of listed securities are taken from the exchange
where the security is primarily traded. Securities regu-
larly traded in the over-the-counter market for which mar-
ket quotations are readily available will be valued at the
latest quoted bid price. Securities may be valued on the
basis of prices provided by a pricing service when such
prices are believed to reflect the fair market value of
such securities. Other assets and securities for which no
quotations are readily available will be valued in a manner
determined in good faith by the Board of Trustees to re-
flect their fair value.
For purpose of determining the Portfolio's net asset value
per share, all assets and liabilities, initially expressed
in foreign currencies, will be translated into U.S. dollars
using the quoted daily exchange rates determined by an ex-
ternal currency pricing agent as of 4:00 p.m. London time.
This officially quoted daily exchange rate may be deter-
mined prior to or after the close of a particular foreign
securities market. If such quotations are not available as
of the close of the Exchange, the rate of exchange will be
determined in accordance with policies established in good
faith by the Board of Trustees.
30
<PAGE>
Securities, particularly bonds and other fixed-income secu-
rities, may be valued on the basis of prices provided by a
pricing service when such prices are believed to reflect
the fair market value of such securities. The prices pro-
vided by a pricing service may be determined without regard
to bid or last sale prices of each security but take into
account institutional size transactions in similar groups
of securities as well as any developments related to spe-
cific securities. Other securities, including restricted
securities for which no quotations are readily available,
are valued at fair value as determined in good faith by the
Board of Trustees.
- --------------------------------------------------------------------------------
GENERAL Vanguard Variable Insurance Fund is a Pennsylvania business
INFORMATION trust. The Declaration of Trust permits the Trustees to is-
sue an unlimited number of shares of beneficial interest,
without par value, from an unlimited number of classes of
shares. Currently the Fund is offering seven classes of
shares (known as "Portfolios").
Shares of each Portfolio when issued are fully paid and
non-assessable; participate equally in dividends, distribu-
tions and net assets; are entitled to one vote per share;
have pro rata liquidation rights; and do not have pre-
emptive rights. Also, shares of the Fund have non-cumula-
tive voting rights, meaning that the holders of more than
50% of the shares voting for the election of the Trustees
can elect all of the Trustees if they so choose.
Annual meetings of shareholders will not be held except as
required by the Investment Company Act of 1940 and other
applicable law. An annual meeting will be held to vote on
the removal of a Trustee or Trustees of the Fund if re-
quested in writing by the holders of not less than 10% of
the outstanding shares of the Fund.
All securities and cash are held by CoreStates Bank, N.A.,
Philadelphia, PA, for the Money Market, High-Grade Bond,
Balanced and Equity Index Portfolios; State Street Bank and
Trust Company, Boston, MA, for the Equity Income and Growth
Portfolios; and Morgan Stanley Trust Company for the Inter-
national Portfolio. The Vanguard Group, Inc., Valley Forge,
PA, serves as the Fund's Transfer and Dividend Disbursing
Agent. Price Waterhouse LLP, serves as independent accoun-
tants for the Fund and will audit its financial statements
annually. The Fund is not involved in any litigation.
- --------------------------------------------------------------------------------
SHAREHOLDER Investors may not purchase shares of the Portfolios direct-
GUIDE ly, but only through variable life insurance and variable
annuity contracts offered through the separate accounts of
SEE THE various insurance companies. Refer to the prospectus for
INSURANCE the insurance company's separate account for information on
PROSPECTUS FOR how to purchase a variable life insurance or variable annu-
DETAILS ity contract and how to select specific Portfolios of the
Fund as investment options for your contract.
Investments in a Portfolio are credited to an insurance
company's separate account once they have been received by
Vanguard.
If the Board of Trustees determines that continued offering
of shares would be detrimental to the best interests of the
Fund's shareholders, the Fund may suspend the offering of
shares for a period of time. If the Board of Trustees
31
<PAGE>
determines that a specific purchase acceptance would be
detrimental to the best interest of the Fund's sharehold-
ers, the Fund may reject such a purchase request.
If you wish to redeem monies from the Fund, please refer to
the instructions provided in the prospectus for the insur-
ance company's separate account. Shares of a Portfolio may
be redeemed on any business day. The redemption price of
shares will be at the next-determined net asset value per
share. Redemption proceeds will be wired to the administra-
tor for distribution to the contract owner generally on the
day following receipt of the redemption request, but no
later than seven business days. Contract owners will re-
ceive a check from the administrator for the redemption
amount.
The Fund may suspend the redemption right or postpone pay-
ment at times when the New York Stock Exchange is closed or
under any emergency circumstances as determined by the
United States Securities and Exchange Commission.
If the Board of Trustees determines that it would be detri-
mental to the best interests of the Fund's remaining share-
holders to make payment in cash, the Fund may pay redemp-
tion proceeds in whole or in part by a distribution in kind
of readily marketable securities.
- --------------------------------------------------------------------------------
32
<PAGE>
(ART)
- ---------------------
THE VANGUARD GROUP
OF INVESTMENT
COMPANIES
Vanguard Financial Center
P.O. Box 2600
Valley Forge, PA 19482
VANGUARD VARIABLE ANNUITY
INVESTOR INFORMATION
1-800-522-5555
VANGUARD VARIABLE
ANNUITY CENTER
1-800-462-2391
(ART)
JANUARY 10, 1995
<PAGE>
PART B
VANGUARD VARIABLE INSURANCE FUND
STATEMENT OF ADDITIONAL INFORMATION
JANUARY 10, 1995
This Statement is not a prospectus, but should be read in conjunction with the
Fund's current Prospectus (dated January 10, 1995). To obtain the Prospectus
please write to the Fund or contact the insurance company sponsoring the accom-
panying variable life insurance or variable annuity contract.
<TABLE>
<CAPTION>
TABLE OF CONTENTS PAGE
----------------- ----
<S> <C>
Investment Objective and Policies........................................ 1
Investment Limitations................................................... 5
Purchase of Shares....................................................... 6
Redemption of Shares..................................................... 6
Calculation of Yield..................................................... 6
Yield and Total Return................................................... 7
Management of the Fund................................................... 8
Investment Advisory Services............................................. 10
Portfolio Transactions................................................... 15
Performance Measures..................................................... 17
Financial Statements..................................................... 21
Appendix--Description of Securities and Ratings.......................... 21
</TABLE>
INVESTMENT OBJECTIVE AND POLICIES
REPURCHASE AGREEMENTS
Each Portfolio of the Fund may invest in repurchase agreements with commercial
banks, brokers or dealers to generate income from its excess cash balances. A
repurchase agreement is an agreement under which a Portfolio acquires a money
market instrument (generally a security issued by the U.S. Government or an
agency thereof, a banker's acceptance or a certificate of deposit) from a Fed-
eral Reserve member bank with minimum assets of at least $2 billion or a regis-
tered securities dealer, subject to resale to the seller at an agreed upon
price and date (normally, the next business day). A repurchase agreement may be
considered a loan collateralized by securities. The resale price reflects an
agreed upon interest rate effective for the period the instrument is held by a
Portfolio and is unrelated to the interest rate on the underlying instrument.
In these transactions, the securities acquired by a Portfolio (including ac-
crued interest earned thereon) must have a total value in excess of the value
of the repurchase agreement and are held by the Fund's custodian bank until re-
purchased. In addition, the Fund's Board of Trustees will monitor each Portfo-
lio's repurchase agreement transactions generally and will establish guidelines
and standards for review of the creditworthiness of any bank, broker or dealer
party to a repurchase agreement with a Portfolio of the Fund. No more than an
aggregate of 15% (10% for the Money Market Portfolio) of a Portfolio's assets,
at the time of investment, will be invested in repurchase agreements having ma-
turities longer than seven days and securities subject to legal or contractual
restrictions on resale, or for which there are no readily available market quo-
tations.
The use of repurchase agreements involves certain risks. For example, if the
other party to the agreement defaults on its obligation to repurchase the un-
derlying security at a time when the value of the security has declined, a
Portfolio may incur a loss upon disposition of the security. If the other party
to the agreement becomes insolvent and subject to liquidation or reorganization
under the Bankruptcy Code or other laws, a court may determine that the under-
lying security is collateral for a loan by the Portfolio not within the control
of the Portfolio and therefore the Portfolio may not be able to substantiate
its interest in the underlying
<PAGE>
security and may be deemed an unsecured creditor of the other party to the
agreement. While the Fund's management acknowledges these risks, it is expected
that they can be controlled through careful monitoring procedures.
LENDING OF SECURITIES
Each Portfolio of the Fund (except for the Money Market Portfolio) may lend
its securities to qualified institutional investors who need to borrow securi-
ties in order to complete certain transactions, such as covering short sales,
avoiding failures to deliver securities or completing arbitrage operations. By
lending its portfolio securities, a Portfolio attempts to increase its net in-
vestment income through the receipt of interest on the loan. Any gain or loss
in the market price of the securities loaned that might occur during the term
of the loan would be for the account of the Portfolio. The Portfolio may lend
its portfolio securities to qualified brokers, dealers, banks or other finan-
cial institutions, so long as the terms, the structure and the aggregate amount
of such loans are not inconsistent with the Investment Company Act of 1940, or
the Rules and Regulations or interpretations of the Securities and Exchange
Commission (the "Commission") thereunder, which currently require that (a) the
borrower pledge and maintain with the Portfolio collateral consisting of cash,
a letter of credit issued by a domestic U.S. bank, or securities issued or
guaranteed by the United States Government having at all times not less than
100% of the value of the securities loaned, (b) the borrower add to such col-
lateral whenever the price of the securities loaned rises (i.e. the borrower
"marks to the market" on a daily basis), (c) the loan be made subject to termi-
nation by the Portfolio at any time and (d) the Portfolio receive reasonable
interest on the loan (which may include the Portfolio's investing any cash col-
lateral in interest bearing short-term investments), any distribution on the
loaned securities and any increase in their market value. Loan arrangements
made by a Portfolio will comply with all other applicable regulatory require-
ments, including the rules of the New York Stock Exchange, which presently re-
quire the borrower, after notice, to redeliver the securities within the normal
settlement time of five business days. All relevant facts and circumstances,
including the creditworthiness of the broker, dealer or institution, will be
considered in making decisions with respect to the lending of securities, sub-
ject to review by the Fund's Board of Directors.
FUTURES CONTRACTS AND OPTIONS
Each Portfolio of the Fund (except the Money Market Portfolio) may enter into
futures contracts, options, and options on futures contracts to maintain cash
reserves while remaining fully invested, to facilitate trading or to reduce
transactions costs. Futures contracts provide for the future sale by one party
and purchase by another party of a specified amount of a specific security at a
specified future time and at a specified price. Futures contracts which are
standardized as to maturity date and underlying financial instrument are traded
on national futures exchanges. Futures exchanges and trading are regulated un-
der the Commodity Exchange Act by the Commodity Futures Trading Commission
("CFTC"), a U.S. Government agency.
Although futures contracts by their terms call for actual delivery or accept-
ance of the underlying securities, in most cases the contracts are closed out
before the settlement date without the making or taking of delivery. Closing
out an open futures position is done by taking an opposite position ("buying" a
contract which has previously been "sold," or "selling" a contract previously
purchased) in an identical contract to terminate the position. Brokerage com-
missions are incurred when a futures contract is bought or sold.
Futures traders are required to make a good faith margin deposit in cash or
government securities with a broker or custodian to initiate and maintain open
positions in futures contracts. A margin deposit is intended to assure comple-
tion of the contract (delivery or acceptance of the underlying security) if it
is not terminated prior to the specified delivery date. Minimal initial margin
requirements are established by the futures exchange and may be changed. Bro-
kers may establish deposit requirements which are higher than the exchange min-
imums. Futures contracts are customarily purchased and sold on margin which may
range upward from less than 5% of the value of the contract being traded.
2
<PAGE>
After a futures contract position is opened, the value of the contract is
marked to market daily. If the futures contract price changes to the extent
that the margin on deposit does not satisfy margin requirements, payment of ad-
ditional "variation" margin will be required. Conversely, change in the con-
tract value may reduce the required margin, resulting in a repayment of excess
margin to the contract holder. Variation margin payments are made to and from
the futures broker for as long as the contract remains open. The Fund may earn
interest income on its margin deposits.
Traders in futures contracts may be broadly classified as either "hedgers" or
"speculators." Hedgers use the futures markets primarily to offset unfavorable
changes in the value of securities otherwise held for investment purposes or
expected to be acquired by them. Speculators are less inclined to own the secu-
rities underlying the futures contracts which they trade, and use futures con-
tracts with the expectation of realizing profits from fluctuations in the
prices of underlying securities. The Portfolios of the Fund intend to use
futures contracts only for bona fide hedging purposes.
Regulations of the CFTC applicable to the Portfolios of the Fund require that
all of its futures transactions constitute bona fide hedging transactions. The
Portfolios of the Fund will only sell futures contracts to protect securities
they own against price declines or purchase contracts to protect against an in-
crease in the price of securities they intend to purchase. As evidence of this
hedging interest, the Portfolios of the Fund expect that approximately 75% of
their futures contract purchases will be "completed," that is, equivalent
amounts of related securities will have been purchased or are being purchased
by the Portfolios upon sale of open futures contracts.
Although techniques other than the sale and purchase of futures contracts
could be used to control a Portfolio's exposure to market fluctuations, the use
of futures contracts may be a more effective means of hedging this exposure.
While a Portfolio will incur commission expenses in both opening and closing
out futures positions, these costs are lower than transaction costs incurred in
the purchase and sale of the underlying securities.
RESTRICTIONS ON THE USE OF FUTURES CONTRACTS AND OPTIONS
A Portfolio of the Fund will not enter into futures contracts transactions to
the extent that, immediately thereafter, the sum of its initial margin deposits
on open contracts exceeds 5% of the market value of the Portfolio's total as-
sets. In addition, each Portfolio will not enter into futures contracts to the
extent that its outstanding obligations to purchase securities under these con-
tracts would exceed 20% of the Portfolio's total assets. Assets committed to
futures contracts or options will be held in a segregated account at the Fund's
custodian bank.
RISK FACTORS IN FUTURES TRANSACTIONS
Positions in futures contracts may be closed out only on an exchange which
provides a secondary market for such futures. However, there can be no assur-
ance that a liquid secondary market will exist for any particular futures con-
tract at any specific time. Thus, it may not be possible to close a futures po-
sition. In the event of adverse price movements, a Portfolio would continue to
be required to make daily cash payments to maintain its required margin. In
such situations, if a Portfolio has insufficient cash it may have to sell port-
folio securities to meet daily margin requirements at a time when it may be
disadvantageous to do so. In addition, a Portfolio may be required to make de-
livery of the instruments underlying future contracts it holds. The inability
to close options and futures positions also could have an adverse impact on the
ability to effectively hedge it.
The Portfolios will minimize the risk that it will be unable to close out a
futures contract by only entering into futures which are traded on national
futures exchanges and for which there appears to be a liquid secondary market.
3
<PAGE>
The risk of loss in trading futures contracts in some strategies can be sub-
stantial, due both to the low margin deposits required, and the extremely high
degree of leverage involved in futures pricing. As a result, a relatively small
price movement in a futures contract may result in immediate and substantial
loss (as well as gain) to the investor. For example, if at the time of pur-
chase, 10% of the value of the futures contract is deposited as margin, a sub-
sequent 10% decrease in the value of the futures contract would result in a to-
tal loss of the margin deposit, before any deduction for the transaction costs,
if the account were then closed out. A 15% decrease would result in a loss
equal to 150% of the original margin deposit if the contract were closed out.
Thus, a purchase or sale of a futures contract may result in losses in excess
of the amount invested in the contract. However, because the futures strategies
of the Portfolios are engaged in only for hedging purposes, the Adviser does
not believe that the Portfolios are subject to the risks of loss frequently as-
sociated with futures transactions. A Portfolio would presumably have sustained
comparable losses if, instead of the futures contract, it had invested in the
underlying financial instrument and sold it after the decline.
Utilization of futures transactions by a Portfolio does involve the risk of
imperfect or no correlation where the securities underlying futures contracts
have different maturities than the portfolio securities being hedged. It is
also possible that a Portfolio could both lose money on futures contracts and
also experience a decline in value of its portfolio securities. There is also
the risk of loss by the fund of margin deposits in the event of bankruptcy of a
broker with whom a Portfolio has an open position in a futures contract or re-
lated option.
Most futures exchanges limit the amount of fluctuation permitted in futures
contract prices during a single trading day. The daily limit establishes the
maximum amount that the price of a futures contract may vary either up or down
from the previous day's settlement price at the end of a trading session. Once
the daily limit has been reached in a particular type of contract, no trades
may be made on that day at a price beyond that limit. The daily limit governs
only price movement during a particular trading day and therefore does not
limit potential losses, because the limit may prevent the liquidation of unfa-
vorable positions. Futures contract prices have occasionally moved to the daily
limit for several consecutive trading days with little or no trading, thereby
preventing prompt liquidation of future positions and subjecting some futures
traders to substantial losses.
FEDERAL TAX TREATMENT OF FUTURES CONTRACTS
A Portfolio is required for Federal income tax purposes to recognize as income
for each taxable year its net unrealized gains and losses on certain futures
contracts as of the end of the year as well as those actually realized during
the year. In most cases, any gain or loss recognized with respect to a futures
contract is considered to be 60% long-term capital gain or loss and 40% short-
term capital gain or loss, without regard to the holding period of the con-
tract. Furthermore, sales of futures contracts which are intended to hedge
against a change in the value of securities held by a Portfolio may affect the
holding period of such securities and, consequently, the nature of the gain or
loss on such securities upon disposition. A Portfolio may be required to defer
the recognition of losses on futures contracts to the extent of any unrecog-
nized gains on related positions held by the Portfolio.
In order for a Portfolio to continue to qualify for Federal income tax treat-
ment as a regulated investment company, at least 90% of its gross income for a
taxable year must be derived from qualifying income; i.e., dividends, interest,
income derived from loans of securities, gains from the sale of securities or
foreign currencies, or other income derived with respect to its business of in-
vesting in such securities or currencies. In addition, gains realized on the
sale or other disposition of securities held for less than three months must be
limited to less than 30% of a Portfolio's annual gross income. It is antici-
pated that any net gain realized from the closing out of futures contracts will
be considered gain from the sale of securities and therefore be qualifying in-
come for purposes of the 90% requirement. In order to avoid realizing excessive
gains on securities held less than three months, a Portfolio may be required to
defer the closing out of futures contracts beyond the time when it would other-
wise be advantageous to do so. It is anticipated that unrealized gains on
futures contracts, which have been open for less than three months as of the
end of a Portfolio's fiscal year and which are recognized for tax purposes,
will not be considered gains on sales of securities held less than three months
for the purpose of the 30% test.
4
<PAGE>
Each Portfolio of the Fund will distribute to shareholders annually any net
capital gains which have been recognized for Federal income tax purposes (in-
cluding unrealized gains at the end of a Portfolio's fiscal year) on futures
transactions. Such distributions will be combined with distributions of capital
gains realized on a Portfolio's other investments and shareholders will be ad-
vised on the nature of the payments.
INVESTMENT LIMITATIONS
The following restrictions and fundamental policies cannot be changed without
approval of the holders of a majority of the outstanding shares of the Fund (as
defined in the Investment Company Act of 1940). Each Portfolio of the Fund may
not under any circumstances:
(1) invest in commodities or purchase real estate; although each Portfolio
may purchase securities of companies which deal in real estate or inter-
est therein, and the High-Grade Bond, Equity Index, Equity Income,
Growth, International and Balanced Portfolios may purchase and sell
futures contracts and options transactions to the extent provided under
"Restrictions on the Use of Futures Contracts and Options";
(2) purchase securities on margin or sell securities short; except that the
deposit or payment by a Portfolio of initial or variation margin in or-
der to engage in a futures contract will not be considered the purchase
of a security on margin;
(3) lend money to any person except (i) by purchasing bonds, debentures or
similar obligations (including repurchase agreements, which are either
publicly distributed or purchased by institutional investors), and (ii)
as provided under "Lending of Securities";
(4) purchase more than 10% of the outstanding voting securities of any com-
pany;
(5) with respect of 75% of a Portfolio's assets, purchase securities of any
issuer (except obligations of the United States Government and its in-
strumentalities) if, as a result, more than 5% of the Portfolio's total
assets would be invested in the securities of such issuer;
(6) borrow money, except from a bank and only as a temporary or emergency
measure and in no event in excess of 15% of the market value of a Port-
folio's assets. Money borrowed in excess of 5% of a Portfolio's total
assets will be repaid prior to the purchase of additional portfolio se-
curities;
(7) pledge, mortgage, or hypothecate any of its assets to an extent greater
than 5% of the value of its total assets;
(8) engage in the business of underwriting securities issued by other per-
sons, except to the extent that the Fund may technically be deemed to be
an underwriter under the Securities Act of 1933, as amended, in dispos-
ing of portfolio securities;
(9) purchase or otherwise acquire any security if, as a result, more than
15% (10% with respect to the Money Market Portfolio) of its net assets
would be invested in securities that are illiquid;
(10) invest for the purpose of controlling management of any company;
(11) invest in securities of other investment companies, except as they may
be acquired as a part of a merger, consolidation or acquisition of as-
sets or otherwise to the extent permitted by Section 12 of the 1940 Act.
The Fund will invest only in investment companies which have investment
objectives and investment policies consistent with those of the Fund;
(12) invest more than 25% of the value of its total assets in any one indus-
try; or
(13) invest in put, call, straddle or spread options or in interest in oil,
gas or other mineral exploration or development programs, except as set
forth in limitation number "1", above.
Notwithstanding these limitations, the Fund may own all or any portion of the
securities of, or make loans to, or contribute to the costs or other financial
requirements of any company which will be wholly-owned by the Fund and one or
more other investment companies and is primarily engaged in the business of
providing, at-cost, management, administrative, distribution or related serv-
ices to the Fund and other investment companies. See "Management of the Fund."
The above mentioned investment limitations are considered at the time invest-
ment securities are purchased.
5
<PAGE>
PURCHASE OF SHARES
Each Portfolio of the Fund reserves the right in its sole discretion (i) to
suspend the offerings of its shares, (ii) to reject purchase orders when in the
judgment of management such rejection is in the best interest of the Portfolio,
and (iii) to reduce or waive the minimum for initial and subsequent investments
for certain fiduciary accounts or under circumstances where certain economies
can be achieved in sales of the Portfolio's shares.
REDEMPTION OF SHARES
The Fund may suspend redemption privileges or postpone the date of payment (i)
during any period that the New York Stock Exchange is closed, or trading on the
Exchange is restricted as determined by the United States Securities and Ex-
change Commission (the "Commission"), (ii) during any period when an emergency
exists as defined by the rules of the Commission as a result of which it is not
reasonably practicable for the Fund to dispose of securities owned by it, or
fairly to determine the value of its assets, and (iii) for such other periods
as the Commission may permit.
The Fund has made an election with the Commission to pay in cash all redemp-
tions requested by any shareholder of record limited in amount during any 90
day period to the lesser of $250,000 or 1% of the net assets of the Fund at the
beginning of such period. Such commitment is irrevocable without the prior ap-
proval of the Commission. Redemptions in excess of the above limits may be paid
in whole or in part, in investment securities or in cash, as the Trustees may
deem advisable; however, payment will be made wholly in cash unless the Trust-
ees believe that economic or market conditions exist which would make such a
practice detrimental to the best interests of the Fund. If redemptions are paid
in investment securities, such securities will be valued as set forth in the
Prospectus under "The Share Price of Each Portfolio" and a redeeming share-
holder would normally incur brokerage expenses if he converted these securities
to cash.
No charge is made by the Fund for redemptions. Any redemption may be more or
less than the shareholder's cost depending on the market value of the securi-
ties held by the Fund.
CALCULATION OF YIELD (MONEY MARKET PORTFOLIO)
The current yield of the Fund's Money Market Portfolio is calculated daily on
a base period return of a hypothetical account having a beginning balance of
one share for a particular period of time (generally 7 days). The return is de-
termined by dividing the net change (exclusive of any capital changes) in such
account by its average net asset value for the period, and then multiplying it
by 365/7 to get the annualized current yield. The calculation of net change re-
flects the value of additional shares purchased with the dividends by the Port-
folio, including dividends on both the original share and on such additional
shares. An effective yield, which reflects the effects of compounding and rep-
resents an annualization of the current yield with all dividends reinvested,
may also be calculated for the Portfolio by adding 1 to the net change, raising
the sum to the 365/7 power, and subtracting 1 from the result.
Set forth below is an example, for purposes of illustration only, of the cur-
rent and effective yield calculations for the Money Market Portfolio for the 7
day base period ending September 30, 1994.
<TABLE>
<CAPTION>
MONEY MARKET
PORTFOLIO
------------
9/30/94
------------
<S> <C>
Value of account at beginning of period......................... $1.00000
Value of same account at end of period* 1.00092
--------
Net Change in account value..................................... $ .00092
========
</TABLE>
- --------
* Exclusive of any capital changes.
6
<PAGE>
<TABLE>
<CAPTION>
MONEY MARKET
PORTFOLIO
------------
9/30/94
------------
<S> <C>
Annualized Current Net Yield
(Net Change X 365/7) / average net asset value.................. 4.79%
=======
Effective Yield
[(Net Change) + 1]/365/7/ -1.................................... 4.91%
=======
Average Weighted Maturity of investments........................ 41 days
=======
</TABLE>
The net asset value of a share of the Money Market Portfolio is $1.00 and it
is not expected to fluctuate. However, the yield of the Portfolio will fluctu-
ate. The annualization of a week's dividend is not a representation by the
Portfolio as to what an investment in the Portfolio will actually yield in the
future. Actual yields will depend on such variables as investment quality, av-
erage maturity, the type of instruments the Portfolio invests in, changes in
interest rates on instruments, changes in the expenses of the Portfolio and
other factors. Yields are one basis investors may use to analyze the Portfolio
and other investment vehicles; however, yields of other investment vehicles may
not be comparable because of the factors set forth in the preceding sentence,
differences in the time periods compared, and differences in the methods used
in valuing portfolio instruments, computing net asset value and calculating
yield.
YIELD AND TOTAL RETURN
The yield of each Portfolio of the Fund (except the Money Market Portfolio)
for the 30-day period ended September 30, 1994, is set forth below. Yields are
calculated daily for each Portfolio. Premiums and discounts on asset-backed se-
curities are not amortized. The Equity Income and Growth Portfolios had no op-
erations during the Period.
<TABLE>
<S> <C>
High-Grade Bond Portfolio.............................................. 7.39%
Balanced Portfolio..................................................... 4.66%
Equity Index Portfolio................................................. 2.78%
Equity Income Portfolio................................................ 4.83%
Growth Portfolio....................................................... 1.73%
International Portfolio................................................ N/A
</TABLE>
The average annual total return of each Portfolio of the Fund (except the
Money Market Portfolio) for one year and the period since inception, is set
forth below:
<TABLE>
<CAPTION>
YEAR ENDED SINCE
9/30/94 INCEPTION
---------- ---------
<S> <C> <C>
High-Grade Bond Portfolio............................... -3.31% 6.65%*
Balanced Portfolio...................................... 2.67% 8.73%*
Equity Index Portfolio.................................. 3.53% 9.17%*
Equity Income Portfolio................................. -1.64% 3.82%*+
Growth Portfolio........................................ 5.98% 6.57%*+
International Portfolio................................. 3.10%*+
</TABLE>
- --------
* Since Inception:
Equity Index Portfolio and High-Grade Bond Portfolio--April 29, 1991
Balanced Portfolio--May 23, 1991
Equity Income Portfolio and Growth Portfolio--June 7, 1993
International Portfolio--June 3, 1994
+ Cumulative.
Total return is computed by finding the average compounded rates of return
over the periods set forth above that would equate an initial amount invested
at the beginning of the periods to the ending redeemable value of the invest-
ment.
7
<PAGE>
MANAGEMENT OF THE FUND
TRUSTEES AND OFFICERS
The Officers of the Fund manage its day-to-day operations and are responsible
to the Fund's Board of Trustees. The Trustees set broad policies for each of
the Fund's Portfolios and choose the Fund's Officers. The following is a list
of Trustees and Officers of the Fund and a statement of their present positions
and principal occupations during the past five years. The mailing address of
the Trustees and Officers of the Fund is Post Office Box 876, Valley Forge, PA
19482.
JOHN C. BOGLE, Chairman, ALFRED M. RANKIN, JR.,
Chief Executive Officer and Trustee
Trustee * Chairman, President, and
Chairman, Chief Executive Chief Executive Officer of
Officer, and Director of The NACCO Industries, Inc.; Di-
Vanguard Group, Inc. and of rector of The BFGoodrich
each of the investment com- Company. The Standard Prod-
panies in The Vanguard ucts Company and The Reli-
Group; Director of The Mead ance Electric Company.
Corporation and General Ac-
cident Insurance. JOHN C. SAWHILL, Trustee
President and Chief Execu-
JOHN J. BRENNAN, President & tive Officer, The Nature
Trustee * Conservancy; formerly, Di-
President and Director of rector and Senior Partner,
The Vanguard Group, Inc. and McKinsey & Co.; President,
of each of the investment New York University; Direc-
companies in The Vanguard tor of Pacific Gas and Elec-
Group. tric Company and NACCO In-
dustries.
ROBERT E. CAWTHORN, Trustee,
Chairman and Chief Executive JAMES O. WELCH, JR., Trustee
Officer, Rhone-Poulenc Retired Chairman of Nabisco
Rorer, Inc.; Director of Sun Brands, Inc. and retired
Company, Inc. Vice Chairman and Director
of RJR Nabisco; Director of
BARBARA BARNES HAUPTFUHRER, TECO Energy, Inc.
Trustee
Director of The Great Atlan- J. LAWRENCE WILSON, Trustee
tic and Pacific Tea Company, Chairman and Chief Executive
Raytheon Company, Knight- Officer of Rohm & Haas Com-
Ridder, Inc., Massachusetts pany; Director of Cummins
Mutual Life Insurance Co., Engine Company; Trustee of
and ALCO Standard Corp. and Vanderbilt University and
Trustee Emerita of Wellesley the Culver Educational Foun-
College. dation.
BRUCE K. MACLAURY, Trustee RAYMOND J. KLAPINSKY,
President, The Brookings In- Secretary *
stitution; Director of Amer- Senior Vice President and
ican Express Bank, Ltd., The Secretary of The Vanguard
St. Paul Companies, Inc., Group, Inc.; Secretary of
and Scott Paper Co. each of the investment com-
panies in The Vanguard
BURTON G. MALKIEL, Trustee Group.
Chemical Bank Chairman's
Professor of Economics, RICHARD F. HYLAND,
Princeton University; Direc- Treasurer *
tor of Prudential Insurance Treasurer of The Vanguard
Co. of America, Amdahl Cor- Group, Inc. and of each of
poration, Baker Fentress & the investment companies in
Co., The Jeffrey Co., and The Vanguard Group.
Southern New England Commu-
nications Company. KAREN E. WEST, Controller *
Vice President of The Van-
guard Group, Inc.; Control-
ler of each of the invest-
ment companies in The Van-
guard Group.
--------
* Officers of the Fund are
"interested persons" as
defined in the Investment
Company Act of 1940.
THE VANGUARD GROUP
Vanguard Variable Insurance Fund is a member of The Vanguard Group of Invest-
ment Companies, which consists of more than 30 investment companies offering
more than 80 distinct investment portfolios.
8
<PAGE>
Through their jointly-owned subsidiary, The Vanguard Group, Inc. ("Vanguard"),
the Fund and the other Funds in the Group obtain at cost virtually all of their
corporate management, administrative and distribution services. Vanguard also
provides investment advisory services on an at-cost basis to certain Vanguard
Funds.
Vanguard employs a supporting staff of management and administrative personnel
needed to provide the requisite services to the Funds and also furnishes the
Funds with necessary office space, furnishings and equipment. Each Fund pays
its share of Vanguard's total expenses which are allocated among the Funds un-
der methods approved by the Board of Trustees (Directors) of each Fund. In ad-
dition, each Fund bears its own direct expenses such as legal, auditing and
custodian fees.
The Fund's Officers are also Officers and employees of Vanguard. No Officer or
employee owns, or is permitted to own, any securities of any external adviser
for the Funds.
The Vanguard Group was established and operates under a Funds' Service Agree-
ment which was approved by the shareholders of each of the Funds. The amounts
which each of the Funds have invested are adjusted from time to time in order
to maintain the proportionate relationship between each Fund's relative net as-
sets and its contribution to Vanguard's capital. At September 30, 1994, the
Fund had contributed capital of $136,000 to Vanguard (included in other assets)
representing .7% of Vanguard's capitalization. The Funds' Service agreement
provides as follows: (a) each Vanguard Fund may invest up to .40% of its cur-
rent net assets in Vanguard, and (b) there is no other limitation on the amount
that each Vanguard Fund may contribute to Vanguard's capitalization.
MANAGEMENT. Corporate management and administrative services include: (1) ex-
ecutive staff; (2) accounting and financial; (3) legal and regulatory; (4)
shareholder account maintenance; (5) monitoring and control of custodian rela-
tionships; (6) shareholder reporting; and (7) review and evaluation of advisory
and other services provided to the Funds by third parties. During the fiscal
year ended September 30, 1994, the Fund's allocated share of Vanguard's actual
net costs of operation relating to management and administrative services (in-
cluding transfer agency) totaled approximately $1,356,000.
DISTRIBUTION. Vanguard provides all distribution and marketing activities for
the Funds in the Group. Vanguard Marketing Corporation, a wholly-owned subsidi-
ary of The Vanguard Group, Inc., acts as Sales Agent for the shares of the
Funds in connection with any sales made directly to investors in the states of
Florida, Missouri, New York, Ohio, Texas and such other states as it may be re-
quired.
The principal distribution expenses are for advertising, promotional materials
and marketing personnel. Distribution services may also include organizing and
offering to the public, from time to time, one or more new investment companies
which will become members of the Group. The Directors and Officers of Vanguard
determine the amount to be spent annually on distribution activities, the man-
ner and amount to be spent on each Fund, and whether to organize new investment
companies.
One-half of the distribution expenses of a marketing and promotional nature is
allocated among the Funds based upon relative net assets. The remaining one-
half of those expenses is allocated among the Funds based upon each Fund's
sales for the preceding 24 months relative to the total sales of the Funds as a
Group; provided, however, that no Fund's aggregate quarterly rate of contribu-
tion for distribution expenses of a marketing and promotional nature shall ex-
ceed 125% of average distribution expense rate for the Group, and that no Fund
shall incur annual distribution expenses in excess of 20/100 of 1% of its aver-
age month-end net assets. During the fiscal year ended September 30, 1994, the
Fund paid approximately $132,000 of the Group's distribution and marketing ex-
penses, which represented an effective annual rate of 1/100 of 1% of the Fund's
average net assets.
INVESTMENT ADVISORY SERVICES. Vanguard also provides investment advisory serv-
ices to Vanguard Bond Index Fund, Vanguard Municipal Bond Fund, Vanguard Money
Market Reserves, the Short- and Intermediate-Term Corporate Portfolios, Short-,
Intermediate- and Long-Term U.S. Treasury and Short-
9
<PAGE>
Term Federal Portfolios of Vanguard Fixed Income Securities Fund, Vanguard Cal-
ifornia Tax-Free Fund, Vanguard New York Insured Tax-Free Fund, Vanguard New
Jersey Tax-Free Fund, Vanguard Pennsylvania Tax-Free Fund, Vanguard Ohio Tax-
Free Fund, Vanguard Florida Tax-Free Fund, Vanguard Institutional Money Market
Portfolio, Vanguard Index Trust, Vanguard Balanced Index Fund, Vanguard Inter-
national Equity Index Fund, Vanguard Tax-Managed Fund, Vanguard Admiral Funds,
a portion of Vanguard/Windsor II, a portion of Vanguard/Morgan Growth Fund and
several indexed separate accounts. These services are provided on an at-cost
basis from a money management staff employed directly by Vanguard. The compen-
sation and other expenses of this staff are paid by the Funds utilizing these
services. During the period ended September 30, 1992, and the fiscal years
ended September 30, 1993 and 1994, the Fund paid approximately $5,000, $42,000,
and $65,000 of Vanguard's expenses relating to investment advisory services.
REMUNERATION OF TRUSTEES AND OFFICERS. The Fund pays each Trustee, who is not
also an Officer, an annual fee plus travel and other expenses incurred in at-
tending Board meetings. The Fund's Officers and employees are paid by Vanguard
which, in turn, is reimbursed by the Fund and each other Fund in the Group, for
its proportionate share of Officers' and employees' salaries and retirement
benefits. During the year ended September 30, 1994 the Fund's proportionate
share of remuneration paid to all officers of the Fund, as a group, was approx-
imately $30,864.
Under its retirement plan, Vanguard contributes annually an amount equal to
10% of each Officer's annual compensation plus 7% of that part of the officer's
compensation during the year, if any, that exceeds the Social Security Taxable
Wage Base then in effect. Under its thrift plan, all eligible Officers are per-
mitted to make pre-tax contributions in an amount equal to 4% of total compen-
sation which are matched by Vanguard on a 100% basis. Directors who are not Of-
ficers are paid an annual fee based on the number of years of service on the
board, up to fifteen years of service, upon retirement. The fee is equal to
$1,000 for each year of service and each investment company member of The Van-
guard Group contributes a proportionate amount of this fee based on its rela-
tive net assets. This fee is paid, subsequent to a Director's retirement, for a
period of ten years or until the death of a retired Director. The Fund's pro-
portionate share of retirement contributions made by Vanguard under its retire-
ment and thrift plans on behalf of all officers of the Fund, as a group, during
the 1994 fiscal year was approximately $4,221.
INVESTMENT ADVISORY SERVICES
The Money Market, High-Grade Bond and Equity Index Portfolios of the Fund re-
ceive investment advisory services on an "internalized," at-cost basis from an
experienced investment management staff employed directly by Vanguard. The in-
vestment management staff is supervised by the senior Officers of the Fund.
Vanguard's Fixed Income Group provides advisory services for the Money Market
and High-Grade Bond Portfolios and Vanguard's Core Management Group provides
advisory services to the Equity Index Portfolio.
Vanguard's investment management staff is also responsible for the allocation
of principal business and portfolio brokerage and the negotiation of commis-
sions. For the Money Market Portfolio, the purchase and sale of investment se-
curities will ordinarily be principal transactions. Portfolio securities will
normally be purchased directly from the issuer or from an underwriter or market
maker for the securities. There will usually be no brokerage commissions paid
by the Money Market Portfolio for such purchases. Purchases from underwriters
of securities will include a commission or concession paid by the issuer to the
underwriter, and purchases from dealers serving as market makers will include a
dealer's mark-up.
In placing portfolio transactions, Vanguard's advisory staff uses its best
judgment to choose the broker most capable of providing the brokerage services
necessary to obtain the best available price and most favorable execution at
the lowest commission rate. The full range and quality of brokerage services
available are considered in making these determinations. In selecting broker-
dealers to execute securities transactions
10
<PAGE>
for the Portfolios, consideration will be given to such factors as: the price
of the security; the rate of the commission; the size and difficulty of the or-
der; the reliability, integrity, financial condition, general execution, and
operational capabilities of competing broker-dealers; and the brokerage and re-
search services provided to the Fund.
The investment policies of each of the Portfolios may lead to frequent changes
in investments, particularly in periods of rapidly fluctuating interest rates.
A change in securities held by a Portfolio is known as "portfolio turnover" and
may involve the payment by the Portfolio of dealer mark-ups, underwriting com-
missions, and other transaction costs on the sales of securities as well as on
the reinvestment of the proceeds in other securities. The annual portfolio
turnover rate for the Portfolios is set forth under the heading "Financial
Highlights" in the Vanguard Variable Insurance Fund Prospectus. The portfolio
turnover rate is not a limiting factor when management deems it desirable to
sell or purchase securities. It is impossible to predict whether or not the
portfolio turnover rates in future years will vary significantly from the rates
in recent years.
THE BALANCED PORTFOLIO INVESTMENT ADVISORY AGREEMENT
The Fund employs Wellington Management Company ("WMC") under an investment ad-
visory agreement dated April 29, 1991 to manage the investment and reinvestment
of the assets included in the Fund's Balanced Portfolio and to continuously re-
view, supervise and administer the Balanced Portfolio's investment program. WMC
discharges its responsibilities subject to the control of the officers and
Trustees of the Fund.
The Fund pays WMC a Basic Fee at the end of each fiscal quarter, calculated by
applying a quarterly rate, based on the following annual percentage rates, to
the Portfolio's average month-end net assets for the quarter:
<TABLE>
<CAPTION>
NET ASSETS RATE
---------- -----
<S> <C>
First $500 million.................................................... .100%
Over $500 million..................................................... .050%
</TABLE>
The Basic Fee, as provided above, shall be increased or decreased by an amount
equal to .015% per annum (.00375% per quarter) of the first $500 million of the
average month-end assets of the Fund, and .010% per annum (.0025% per quarter)
of the average month-end assets over $500 million, if the Fund's investment
performance for the thirty-six months preceding the end of the quarter is six
percentage points or more above or below, respectively the investment record of
a "Combined Index", 65% of which shall be comprised of the Standard & Poor's
500 Composite Stock Price Index (the "Stock Index") and 35% of which shall be
comprised of the Salomon Brothers High Grade Corporate Bond Index (the "Bond
Index").
For the purpose of determining the fee adjustment for investment performance,
as described above, the net assets of the Fund shall be averaged over the same
period as the investment performance of the Fund and the investment record of
the Combined Index are computed. The "investment performance" of the Fund for
the period, expressed as a percentage of the Fund's net asset value per share
at the beginning of the period shall be the sum of: (i) the change in the
Fund's net asset value per share during such period; (ii) the value of the
Fund's cash distributions per share having an ex-dividend date occurring within
the period; and (iii) the per share amount of capital gains taxes paid or ac-
crued during such period by the Fund for undistributed realized long-term capi-
tal gains.
The "investment record" of the Stock Index for the period, expressed as a per-
centage of the Stock Index level at the beginning of the period, shall be the
sum of (i) the change in the level of the Stock Index during the period and
(ii) the value, computed consistently with the Stock Index, of cash distribu-
tions having an ex-dividend date occurring within the period made by companies
whose securities comprise the Stock Index. The "investment record" of the Bond
Index for the period, expressed as a percentage of the Bond Index level
11
<PAGE>
at the beginning of such period shall be the sum of (i) the change in the level
of the Bond Index during the period and (ii) the value of the interest accrued
or paid on the bonds included in the Bond Index, assuming the reinvestment of
such interest on a monthly basis. Computation of these two components as the
Combined Index shall be made on the basis of 65% in the Stock Index and 35% in
the Bond Index at the beginning of each quarter.
In April, 1972, the Securities and Exchange Commission ("SEC") issued Release
No. 7113 under the Investment Company Act of 1940 to call attention to direc-
tors and investment advisers to certain factors which must be considered in
connection with investment company incentive fee arrangements. One of these
factors is to "avoid basing significant fee adjustments upon random or insig-
nificant differences" between the investment performance of a fund and that of
the particular index with which it is being compared. The Release provides that
"preliminary studies (of the SEC staff) indicate that as a "rule of thumb' the
performance difference should be at least ^ 10 percentage points" annually be-
fore the maximum performance adjustment may be made. However, the Release also
states that "because of the preliminary nature of these studies, the Commission
is not recommending, at this time, that any particular performance difference
exist before the maximum fee adjustment may be made." The Release concludes
that the directors of a fund "should satisfy themselves that the maximum per-
formance adjustment will be made only for performance differences that can rea-
sonably be considered "significant'." The Board of Trustees of Vanguard Vari-
able Insurance Fund has fully considered the SEC Release and believes that the
performance adjustments as included in the above mentioned agreement is appro-
priate, although not within the ^ 10 percentage point per year range suggested
in the Release. Under the proposed investment advisory agreement between Van-
guard Variable Insurance Fund and WMC, the maximum performance adjustment is
made at a difference of ^ 6 percentage points from the performance of the index
over a thirty-six month period, which would effectively be the equivalent of
approximately ^ 2 percentage points difference per year.
The present agreement continues until April 30, 1995. The agreement is renew-
able thereafter, for successive one-year periods, only if each renewal is spe-
cifically approved by a vote of the Fund's Board of Trustees, including the af-
firmative votes of a majority of the Trustees who are not parties to the con-
tract or "interested persons" (as defined in the Investment Company Act of
1940) of any such party, cast in person at a meeting called for the purpose of
considering such approval. In addition, the question of continuance of the
agreement may be presented to the shareholders of the Fund, in such event con-
tinuance shall be effected only if approved by the affirmative vote of a major-
ity of the outstanding voting securities of the Fund. The agreement is automat-
ically terminated if assigned, and may be terminated without penalty at any
time (1) either by vote of the Board of Trustees of the Fund or by vote of its
outstanding voting securities on 60 days' written notice to WMC, or (2) by WMC
upon 90 days' written notice to the Fund.
Because WMC provides only investment advisory services to the Balanced Portfo-
lio of the Fund and has no control over the Fund's expenses, WMC has not under-
taken to guarantee expenses of the Fund. The Officers of the Fund have worked
out alternative arrangements with state authorities which do not require an ex-
pense guarantee. During the fiscal years ended September 30, 1992, September
30, 1993, and September 30, 1994 the Fund paid investment advisory fees of ap-
proximately $46,000, $137,000, and $226,000 respectively, to WMC.
DESCRIPTION OF WMC. WMC is a Massachusetts general partnership of which the
following persons are managing partners: Robert W. Doran, Duncan M. McFarland,
and John B. Neff.
THE GROWTH PORTFOLIO INVESTMENT ADVISORY AGREEMENT
The Fund entered into an investment advisory agreement with Lincoln Capital
Management Company (Lincoln) on June 1, 1993, under which Lincoln manages the
investment and reinvestment of the assets included in the Fund's Growth Portfo-
lio and continuously reviews, supervises and administers the Fund's Growth
Portfolio. Lincoln will invest or reinvest such assets only in U.S. securities.
Lincoln discharges its responsibilities subject to the control of the Officers
and Trustees of the Fund. Under this agreement the Fund
12
<PAGE>
pays Lincoln an advisory fee at the end of each fiscal quarter, calculated by
applying an annual rate of .15% to the Portfolio's average net assets.
The agreement with Lincoln continues until May 31, 1995. The agreement is re-
newable thereafter, for successive one year periods, only if each renewal is
specifically approved by a vote of the Fund's Board of Trustees, including the
affirmative votes of a majority of the directors who are not parties to the
agreement or "interested persons" (as defined in the Investment Company Act of
1940) of any such party, cast in person at a meeting called for the purpose of
considering such approval. In addition, the question of continuance of the
agreement may be presented to the shareholders of the Growth Portfolio; in such
event continuance shall be effected only if approved by the affirmative vote of
a majority of the outstanding voting securities of the Growth Portfolio. The
agreement is automatically terminated if assigned, and may be terminated with-
out penalty at any time (1) either by vote of the Board of Trustees or by vote
of the outstanding voting securities of the Portfolio on sixty (60) days' writ-
ten notice to Lincoln, or (2) by Lincoln upon ninety (90) days' written notice
to the Fund. During the period June 7, 1993 through September 30, 1993, and the
fiscal year ended September 30, 1994, the Fund paid investment advisory fees of
approximately $14,000, and $99,000 to Lincoln.
DESCRIPTION OF LINCOLN
Lincoln is an Illinois corporation in which a controlling interest is held by
the following persons: John W. Croghan, Chairman; J. Parker Hall III, Presi-
dent; Kenneth R. Meyer, Executive Vice President; and Timothy H. Ubben, Execu-
tive Vice President.
THE EQUITY INCOME PORTFOLIO INVESTMENT ADVISORY AGREEMENT
The Fund employs Newell Associates, 525 University Avenue, Palo Alto, Califor-
nia 94301 ("Newell") under an investment advisory agreement dated as of June 1,
1993, to manage the investment and reinvestment of the assets of the Equity In-
come Portfolio and to continuously review, supervise and administer the Portfo-
lio's investment program. Newell discharges its responsibilities subject to the
control of the officers and Trustees of the Fund.
The Fund pays Newell an advisory fee at the end of each fiscal quarter, calcu-
lated by applying a quarterly rate, based on an annual percentage rate of .10%,
to the average month-end net assets of the Portfolio for the quarter.
The agreement will continue until May 31, 1995, and will be renewable thereaf-
ter for successive one-year periods, only if each renewal is specifically ap-
proved by a vote of the Fund's Board of Trustees, including the affirmative
votes of a majority of the Trustees who are not parties to the contract or "in-
terested persons" (as defined in the Investment Company Act of 1940) of any
such party, cast in person at a meeting called for the purpose of considering
such approval. In addition, the question of continuance shall be effected only
if approved by the affirmative vote of a majority of the outstanding voting se-
curities of the Fund. The agreement is automatically terminated if assigned,
and may be terminated without penalty at any time (1) either by vote of the
Board of Trustees of the Fund or by vote of its outstanding voting securities
on 60 days' written notice to the Adviser, or (2) by the Adviser upon 90 days'
written notice to the Fund. During the period June 7, 1993 through September
30, 1993, and the fiscal year ended September 30, 1994 the Fund paid investment
advisory fees of approximately $12,000, and $68,000 to Newell.
DESCRIPTION OF THE ADVISER
Newell is a California corporation of which 90% of its outstanding shares are
owned by its directors and officers. The directors of the corporation and the
offices they currently hold are: Roger D. Newell, Chairman & President, Robert
A. Huret, Vice Chairman and Alan E. Rothenberg, Director.
13
<PAGE>
THE INTERNATIONAL PORTFOLIO INVESTMENT ADVISORY AGREEMENT
The Fund has entered into an investment advisory agreement dated as of June
1, 1994 with Schroder Capital Management, Inc. ("Schroder Capital") under which
Schroder Capital, through its Schroder Capital Management International, Lon-
don, England, branch, supervises and administers the International Portfolio's
investment program. In this regard, it is the responsibility of Schroder Capi-
tal to make decisions relating to the International Portfolio's investment in
foreign securities and to place the International Portfolio's purchase and sale
orders for such securities. Schroder Capital will invest or reinvest the assets
of the International Portfolio only in foreign (non-U.S.) securities. Schroder
Capital discharges its responsibilities subject to the control of the Officers
and Directors of the Fund.
As compensation for the services rendered by Schroder Capital under the
agreement, the Fund pays Schroder Capital at the end of each of the Fund's fis-
cal quarters, a Basic Fee calculated by applying an annual percentage rate of
0.125% to the average value of the month-end net assets of the International
Portfolio for the quarter.
The Basic Fee, as provided above, shall be increased or decreased by applying
an adjustment formula based on the investment performance of the International
Portfolio relative to that of the Morgan Stanley Capital International Europe,
Australia, Far East Index ("EAFE") as follows:
<TABLE>
<CAPTION>
THREE YEAR PERFORMANCE ANNUAL INCENTIVE (+)/
DIFFERENTIAL VS. EAFE PENALTY (-) FEE RATE
---------------------- ---------------------
<S> <C>
+12% or above.................... +0.0500%
Between +6% and +12%............. +0.0250%
Between +6% and -6%.............. -0-
Between -6% and -12%............. -0.0250%
-12% or below.................... -0.0500%
</TABLE>
The incentive/penalty fee adjustment will not be fully operable until the
quarter ending June 30, 1997, and, until that date, will be calculated accord-
ing to certain transition rules. From June 1, 1994 through March 31, 1995, the
incentive/penalty fee will not be operable. For quarters ending after this pe-
riod, the incentive/penalty fee adjustment will be computed based on a compari-
son of the investment performance of the Portfolio and that of the EAFE Index
over the number of months that have elapsed between July 1, 1994 and the end of
the quarter for which the fee is computed.
For the purpose of determining the fee adjustment for investment performance,
as described above, the net assets of the International Portfolio are averaged
over the same period as the investment performance of the International Portfo-
lio and the investment record of the EAFE Index are computed.
The investment performance of the International Portfolio for such period,
expressed as a percentage of the net asset value per share of the International
Portfolio at the beginning of such period, shall be the sum of: (i) the change
in the net asset value per share of the International Portfolio during such pe-
riod; (ii) the value of the cash distributions per share of the International
Portfolio accumulated to the end of such period; and (iii) the value of capital
gains taxes per share paid or payable by the International Portfolio on undis-
tributed realized long-term capital gains accumulated to the end of such peri-
od. For this purpose, the value of distributions per share of realized capital
gains, of dividends per share paid from investment income and of capital gains
taxes per share paid or payable on undistributed realized long-term capital
gains shall be treated as reinvested in shares of the International Portfolio
at the net asset value per share in effect at the close of business on the rec-
ord date for the payment of such distributions and dividends and the date on
which provision is made for such taxes, after giving effect to such distribu-
tions, dividends and taxes. The investment record of the EAFE Index for any pe-
riod, expressed as a percentage of the EAFE Index level at the beginning of
such period, shall be the sum of (i) the change in the level of the EAFE Index
during such period and (ii) the value, computed consistently with the EAFE In-
dex, of cash distributions made by companies whose securities comprise the EAFE
Index accumulated to the end of such period. For this purpose cash distribu
14
<PAGE>
tions on the securities which comprise the EAFE Index shall be treated as rein-
vested in the EAFE Index at least as frequently as the end of each calendar
quarter following the payment of the dividend. The foregoing notwithstanding,
any computation of the investment performance of the International Portfolio
and the investment record of the EAFE index shall be in accordance with any
then applicable rules of the Securities and Exchange Commission.
The Directors believe that the EAFE Index is an appropriate standard against
which the investment performance of the Fund's International Growth Portfolio
can be measured. The EAFE Index is the only index available which covers the
major international markets outside North America. The weighting of securities
in the EAFE Index is based on each stock's relative total market value, that
is, its market price per share times the number of shares outstanding.
The agreement with Schroder Capital continues until May 31, 1996. The agree-
ment may be terminated prior to that date, or continued after May 31, 1996, in
accordance with the same provisions applicable to the Fund's agreement with
Lincoln. During the period June 3, 1994 through September 30, 1994, the Fund
paid investment advisory fees of approximately $21,000 to Schroder Capital.
DESCRIPTION OF SCHRODER CAPITAL
Schroder Capital Management International ("Schroder Capital"), is the London
branch office of Schroder Capital. Schroder Capital is a wholly-owned subsidi-
ary of Schroders Incorporated, One State Street, New York, New York.
Schroders PLC is the holding company parent of a large world-wide group of
banks and financial service companies (referred to as "The Schroder Group")
with associated companies and branch and representative offices located in sev-
enteen countries.
The Schroder Group specializes in providing investment management services,
with Group funds under management currently in excess of $80 billion. Schroder
Capital Management International was established in London in 1979 to manage
international portfolios for U.S. institutions.
Pursuant to an order of the Securities and Exchange Commission granting
exemptive relief from the Investment Company Act of 1940, the Fund's Board of
Directors may, without the approval of shareholders, provide for:
A. The employment of a new investment adviser pursuant to the terms of a new
advisory agreement, either as a replacement for an existing adviser or as an
additional adviser.
B. A change in the terms of an advisory agreement.
C. The continued employment of an existing adviser on the same advisory con-
tract terms where a contract has been assigned because of a change in control
of the adviser.
Any such change will only be made upon not less than 30 days' prior written
notice to shareholders, which shall include the information concerning the ad-
viser that would have normally been included in a proxy statement.
PORTFOLIO TRANSACTIONS
The investment advisory agreements authorize WMC, Lincoln, Newell and Schroder
Capital (the "Advisers") (with the approval of the Fund's Board of Trustees) to
select the brokers or dealers that will execute the purchases and sales of
portfolio securities for the Balanced, Growth, Equity Income and International
Portfolios of the Fund and directs the Advisers to use their best efforts to
obtain the best available price and most favorable execution as to all transac-
tions for the Balanced, Growth, Equity Income and International
15
<PAGE>
Portfolios. The Advisers have undertaken to execute each investment transac-
tion at a price and commission which provides the most favorable total cost or
proceeds reasonably obtainable under the circumstances.
In placing portfolio transactions for their respective Portfolios, the Advis-
ers will use their best judgment to choose the broker most capable of provid-
ing the brokerage services necessary to obtain best available price and most
favorable execution. The full range and quality of brokerage services avail-
able will be considered in making these determinations. In those instances
where it is reasonably determined that more than one broker can offer the bro-
kerage services needed to obtain the best available price and most favorable
execution, consideration may be given to those brokers which supply investment
research and statistical information and provide other services in addition to
execution services to the Balanced, Growth, Equity Income and International
Portfolios of the Fund and/or the Advisers. The Advisers consider such infor-
mation useful in the performance of its obligations under the agreement but is
unable to determine the amount by which such services may reduce its expenses.
The investment advisory agreements also incorporate the concepts of Section
28(e) of the Securities Exchange Act of 1934 by providing that, subject to the
approval of the Fund's Board of Trustees, the Advisers may cause the Balanced,
Growth and Equity Income Portfolios of the Fund to pay a broker-dealer which
furnishes brokerage and research services a higher commission than that which
might be charged by another broker-dealer for effecting the same transaction;
provided that such commission is deemed reasonable in terms of either that
particular transaction or the overall responsibilities of the Advisers to
their respective Portfolios and the other Funds in the Group.
Currently, it is the Fund's policy that the Advisers may at times pay higher
commissions in recognition of brokerage services felt necessary for the
achievement of better execution of certain securities transactions that other-
wise might not be available. The Advisers will only pay such higher commis-
sions if they believe this to be in the best interest of the Balanced, Growth,
Equity Income and International Portfolios of the Fund. Some brokers or deal-
ers who may receive such higher commissions in recognition of brokerage serv-
ices related to execution of securities transactions are also providers of re-
search information to the Advisers and/or the Balanced, Growth, Equity Income
and International Portfolios of the Fund. However, the Advisers have informed
the Fund that they will not pay higher commission rates specifically for the
purpose of obtaining research services.
Since the Fund does not market its shares through intermediary brokers or
dealers, it is not the Fund's practice to allocate brokerage or principal
business on the basis of sales of its shares which may be through such firms.
However, the Fund may place portfolio orders with qualified broker-dealers who
recommend the Fund to other clients, or who act as agent in the purchase of
the Fund's shares for their clients, and may, when a number of brokers and
dealers can provide comparable best price and execution on a particular trans-
action, consider the sale of Fund shares by a broker or dealer in selecting
among qualified broker-dealers.
Some securities considered for investment by the Balanced, Growth, Equity In-
come and International Portfolios of the Fund may also be appropriate for
other Funds and/or clients served by the Advisers. If purchase or sale of se-
curities consistent with the investment policies of the Balanced, Growth, Eq-
uity Income and International Portfolios of the Fund and one or more of these
other Funds or clients served by the Advisers are considered at or about the
same time, transactions in such securities will be allocated among the several
Funds and clients in a manner deemed equitable by the Advisers.
During the fiscal years ended September 30, 1992, 1993, and 1994 the Fund
paid approximately $60,647, $202,063 and $388,822 in brokerage commissions.
16
<PAGE>
PERFORMANCE MEASURES
Each of the investment company members of The Vanguard Group, including Van-
guard Variable Insurance Fund, may from time to time, use one or more of the
following unmanaged indexes for comparative performance purposes.
STANDARD & POOR'S 500 COMPOSITE STOCK PRICE INDEX--is a well diversified list
of 500 companies representing the U.S. Stock Market.
WILSHIRE 5000 EQUITY INDEXES--consists of nearly 5,000 common equity securi-
ties, covering all stocks in the U.S. for which daily pricing is available.
WILSHIRE 4500 EQUITY INDEX--consists of all stocks in the Wilshire 5000 except
for the 500 stocks in the Standard & Poor's 500 Index.
RUSSELL 3000 STOCK INDEX--a diversified portfolio of over 3,000 common stocks
accounting for over 90% of the market value of publicly traded stocks in the
U.S.
RUSSELL 2000 STOCK INDEX--a subset of approximately 2,000 of the smallest
stocks contained in the Russell 3000; a widely used benchmark for small capi-
talization common stocks.
MORGAN STANLEY CAPITAL INTERNATIONAL EAFE INDEX--is an arithmetic, market val-
ue-weighted average of the performance of over 900 securities listed on the
stock exchanges of countries in Europe, Australia and the Far East.
GOLDMAN SACHS 100 CONVERTIBLE BOND INDEX--currently includes 67 bonds and 33
preferreds. The original list of names was generated by screening for convert-
ible issues of 100 million or greater in market capitalization. The index is
priced monthly.
SALOMON BROTHERS GNMA INDEX--includes pools of mortgages originated by private
lenders and guaranteed by the mortgage pools of the Government National Mort-
gage Association.
SALOMON BROTHERS HIGH GRADE CORPORATE BOND INDEX--consists of publicly issued,
non-convertible corporate bonds rated AA or AAA. It is a value-weighted, total
return index, including approximately 800 issues with maturities of 12 years or
greater.
SALOMON BROTHERS BROAD INVESTMENT-GRADE BOND--is a market-weighted index that
contains over 4,800 individually priced investment-grade corporate bonds rated
BBB or better, U.S. Treasury/agency issues and mortgage passthrough securities.
LEHMAN LONG-TERM TREASURY BOND--is composed of all bonds covered by the
Shearson Lehman Hutton Treasury Bond Index with maturities of 10 years or
greater.
MERRILL LYNCH CORPORATE & GOVERNMENT BOND--consists of over 4,500 U.S. Trea-
sury, Agency and investment grade corporate bonds.
LEHMAN CORPORATE (BAA) BOND INDEX--all publicly offered fixed-rate, nonconvert-
ible domestic corporate bonds rated Baa by Moody's, with a maturity longer than
1 year and with more than $25 million outstanding. This index includes over
1,000 issues.
BOND BUYER MUNICIPAL INDEX (20-YEAR) BOND--is a yield index on current-coupon
high grade general-obligation municipal bonds.
STANDARD & POOR'S PREFERRED INDEX--is a yield index based upon the average
yield of four high grade, non- callable preferred stock issues.
17
<PAGE>
NASDAQ INDUSTRIAL INDEX--is composed of more than 3,000 industrial issues. It
is a value-weighted index calculated on price change only and does not include
income.
COMPOSITE INDEX--70% Standard & Poor's 500 Index and 30% NASDAQ Industrial In-
dex.
COMPOSITE INDEX--35% Standard & Poor's 500 Index and 65% Salomon Brothers High
Grade Bond Index.
COMPOSITE INDEX--65% Standard & Poor's 500 Index and 35% Salomon Brothers High
Grade Bond Index.
LIPPER SMALL COMPANY GROWTH FUND AVERAGE--the average performance of small com-
pany growth funds as defined by Lipper Analytical Services, Inc. Lipper defines
a small company growth fund as a fund that by prospectus or portfolio practice,
limits its investments to companies on the basis of the size of the company.
From time to time, Vanguard may advertise using the average performance and/or
the average expense ratio of the small company growth funds. (This fund cate-
gory was first established in 1982. For years prior to 1982, the results of the
Lipper Small Company Growth category were estimated using the returns of the
Funds that constituted the Group at its inception.)
LIPPER BALANCED FUND AVERAGE--An industry benchmark of average balanced funds
with similar investment objectives and policies, as measured by Lipper Analyti-
cal Services, Inc.
LIPPER NON-GOVERNMENT MONEY MARKET FUND AVERAGE--An industry benchmark of aver-
age non-government money market funds with similar investment objectives and
policies, as measured by Lipper Analytical Services, Inc.
LIPPER GOVERNMENT MONEY MARKET FUND AVERAGE--An industry benchmark of average
government money market funds with similar investment objectives and policies,
as measured by Lipper Analytical Services, Inc.
LIPPER VARIABLE INVESTMENT PRODUCT PERFORMANCE ANALYSIS--A monthly publication
that lists variable annuity and variable life separate accounts, and provides
information on assets, asset rankings, unit values (month-end), performance and
performance rankings.
VARDS AVERAGE CONTRACT EXPENSE--tables that list the average total expenses of
variable annuity contracts sold in the United States. The average is based upon
a hypothetical $25,000 investment in each variable annuity contract covered by
the study.
MORNINGSTAR'S BENCHMARK-VARIABLE ANNUITY--average total expenses of variable
annuity contracts sold in the United States. With respect to the contract
charges, Morningstar lists a dollar amount which Vanguard converts to basis
points for comparison. This conversion is based on a $25,000 investment in a
variable annuity.
LEHMAN BROTHERS AGGREGATE BOND INDEX--is a market weighted index that contains
over 4,000 individually priced investment grade corporate bonds rated BBB- or
better, U.S. Treasury/agency issues, and mortgage pass-through securities and
has a market value of over $4 trillion.
18
<PAGE>
[LOW-COST ADV. GRAPH]
19
<PAGE>
[INSERT TAX ADVANTAGE CHART]
The chart shows the potential value of the Plan's tax-deferred advantage over
the average taxable Vanguard mutual fund. The assumptions are that you had in-
vested $25,000 each in the Vanguard Variable Annuity Plan and in a taxable Van-
guard mutual fund on the same day. (The average expenses for the Plan are
0.83% + $25 versus 0.31% for the average Vanguard mutual fund.) Twenty years
later, assuming an annual growth rate of 8% for both, your Vanguard mutual fund
investment after taxes (based on a 31% tax bracket in each year of investment)
would be valued at $70,309; your pre-tax Vanguard Variable Annuity Plan assets
would equal $98,744. If you were to withdraw your Plan assets at the end of the
20th year of investment, however, your after-tax distribution, based on a 31%
tax bracket, would be $75,883, over $5,500 greater than the balance available
under the non-tax-deferred investment.
20
<PAGE>
FINANCIAL STATEMENTS
The Fund's Financial Statements for the year ended September 30, 1994, includ-
ing the financial highlights, appearing in the 1994 Vanguard Variable Insurance
Fund Annual Report to Shareholders and the report thereon of Price Waterhouse
LLP, independent accountants, also appearing therein, are incorporated by ref-
erence in this Statement of Additional Information. The Fund's 1994 Annual Re-
port to Shareholders is enclosed with this Statement of Additional Information.
For a more complete discussion of the Fund's performance, please see the Fund's
1994 Annual Report to Shareholders, which may be obtained without charge.
APPENDIX -- DESCRIPTION OF SECURITIES AND RATINGS
A-1 AND PRIME-1 COMMERCIAL PAPER RATINGS
Commercial paper rated A-1 by Standard & Poor's has the following characteris-
tics: (1) liquidity ratios are adequate to meet cash requirements; (2) long-
term senior debt is rated "A" or better; (3) the issuer has access to at least
two additional channels of borrowing; (4) basic earnings and cash flow have an
upward trend with allowance made for unusual circumstances; (5) typically, the
issuer's industry is well established and the issuer has a strong position
within the industry; and (6) the reliability and quality of management are un-
questioned. Relative strength or weakness of the above factors determine
whether the issuer's commercial paper is A-1, A-2, or A-3. The rating Prime-1
is the highest commercial paper rating assigned by Moody's. Among the factors
considered by Moody's in assigning ratings are the following: (1) evaluation of
the management of the issuer; (2) economic evaluation of the issuer's industry
or industries and the appraisal of speculative-type risks which may be inherent
in certain areas; (3) evaluation of the issuer's products in relation to compe-
tition and customer acceptance; (4) liquidity; (5) amount and quality of long-
term debt; (6) trend of earnings over a period of ten years; (7) financial
strength of a parent company and the relationships which exist with the issuer;
and (8) recognition by the management of obligations which may be present or
may arise as a result of public interest questions and preparations to meet
such obligations.
VARIABLE AMOUNT MASTER DEMAND NOTES
Variable amount master demand notes are demand obligations that permit the in-
vestment of fluctuating amounts at varying market rates of interest pursuant to
an arrangement between the issuer and a commercial bank acting as agent for the
payees of such notes, whereby both parties have the right to vary the amount of
the outstanding indebtedness on the notes. Because variable amount master de-
mand notes are direct lending arrangements between a lender and a borrower, it
is not generally contemplated that such instruments will be traded, and there
is no secondary market for these notes, although they are redeemable (and thus
immediately repayable by the borrower) at face value, plus accrued interest, at
any time. In connection with a Portfolio's investment in variable amount master
demand notes, Vanguard's investment management staff will monitor, on an ongo-
ing basis, the earning power, cash flow and other liquidity ratios of the issu-
er, and the borrower's ability to pay principal and interest on demand.
21
<PAGE>
BOND RATINGS
Excerpts from Moody's Investors Service, Inc. description of its four highest
preferred bond ratings:
Aaa--judged to be of the best quality. Aa--judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known
as high-grade bonds. A--possess many favorable investment attributes and are to
be considered as "upper-medium-grade obligations". Baa--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 unreli-
able over any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
Moody's applies numerical modifiers 1, 2 and 3 in each generic rating classi-
fication from Aa through B. The modifier 1 indicates that the obligation ranks
in the higher end of its generic rating category; the modifier 2 indicates a
mid-range ranking; and 3 indicates a ranking in the lower end of that generic
rating category.
Excerpts from Standard & Poor's Corporation description of its four highest
bond ratings:
AAA--highest rating assigned. Capacity to pay interest and repay principal is
extremely strong. AA--a very strong capacity to pay interest and repay princi-
pal and differs from the highest rated issues only in small degree. 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 eco-
nomic conditions than debt in higher rated categories. BBB--regarded as having
an adequate capacity to pay interest and repay principal. Whereas it normally
exhibits adequate protection parameters, adverse economic conditions or chang-
ing circumstances are more likely to lead to a weakened capacity to pay inter-
est and repay principal for debt in this category than in higher rated catego-
ries.
Standard & Poor's may apply indicators "+", no character and "-" to its rating
categories from AA to CCC. The indicators show relative standing within the ma-
jor rating categories.
22
