<PAGE>
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[LOGO OF VANGUARD
VARIABLE INSURANCE A Member of The Vanguard Group
FUND APPEARS HERE]
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PROSPECTUS--APRIL 29, 1996; REVISED SEPTEMBER 25, 1996
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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 nine 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. AN INVESTMENT
IN THE PORTFOLIO IS NEITHER INSURED NOR GUARANTEED 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 PORTFOLIO seeks to
duplicate the total return of publicly-traded, investment
grade fixed-income securities as represented by a broad in-
vestment grade bond index. The HIGH YIELD BOND PORTFOLIO
seeks to provide a high level of current income by invest-
ing in a diversified portfolio of high-yielding, lower
quality corporate debt securities (commonly referred to as
"junk bonds"). The BALANCED PORTFOLIO seeks to provide cap-
ital growth and a reasonable level of current income by in-
vesting 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 princi-
pally in dividend-paying equity securities. The EQUITY IN-
DEX 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 appre-
ciation by investing in equity securities of companies
based in the United States. The SMALL COMPANY GROWTH PORT-
FOLIO seeks to provide long term growth in capital by in-
vesting primarily in equity securities of small companies
deemed to have favorable prospects for growth. Dividend in-
come is expected to be incidental. The INTERNATIONAL PORT-
FOLIO seeks to provide long-term capital appreciation by
investing in equity securities of companies based outside
the United States. There is no assurance that a Portfolio
will achieve its objective. Shares of the Fund are neither
insured nor guaranteed by any agency of the U.S. Govern-
ment, including the FDIC.
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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.
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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 April 29, 1996, and has been incor-
porated 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.................................................. 6
Yield and Total Return ............................................... 9
Investment Objectives................................................. 10
Investment Policies................................................... 11
<CAPTION>
Page
<S> <C>
Investment Risks...................................................... 16
Who Should Invest..................................................... 22
Implementation of Policies............................................ 23
Investment Limitations................................................ 29
Management of the Fund................................................ 29
Investment Advisers................................................... 31
<CAPTION>
Page
<S> <C>
Dividends, Capital Gains and Taxes.................................... 36
The Share Price of Each Portfolio..................................... 36
General Information................................................... 38
Shareholder Guide..................................................... 38
</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 nine Portfolios -- a money market portfo-
lio, a high-grade bond portfolio, a high-yield bond portfo-
lio, a balanced portfolio, an equity index portfolio, an
equity income portfolio, a growth portfolio, a small com-
pany growth portfolio 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.
HIGH YIELD BOND PORTFOLIO -- seeks to provide a high level
of current income by investing in a diversified portfolio
of lower quality, high-yielding corporate debt securities
(commonly referred to as "junk bonds").
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.
SMALL COMPANY GROWTH PORTFOLIO -- seeks to provide long
term growth in capital by investing primarily in equity se-
curities of small companies deemed to have favorable pros-
pects 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.
2
<PAGE>
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 High-Yield Bond
Portfolio is similar to the High Yield Corporate Portfolio
of the Vanguard Fixed Income Securities Fund; the Balanced
Portfolio is similar to Vanguard/Wellington Fund; the Eq-
uity Index Portfolio is similar to the 500 Portfolio of
Vanguard Index Trust; the Equity Income Portfolio is simi-
lar to the Vanguard Equity Income Fund; the Growth Portfo-
lio is similar to the Vanguard U.S. Growth Portfolio; the
Small Company Growth Portfolio is similar to the Vanguard
Explorer Fund; and the International Portfolio is similar
to the Vanguard International Growth Portfolio. Because of
differences in the investments held and additional admin-
istrative and insurance costs associated with insurance
company separate accounts, the Portfolios' investment per-
formances will differ from the performances of the corre-
sponding Vanguard funds.
There is no assurance that a Portfolio will achieve its
stated objective. PAGE 10
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The MONEY MARKET PORTFOLIO is exposed primarily to credit
INVESTMENT RISKS 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 mini-
mize such risk by investing in top-rated money market in-
struments.
The HIGH-GRADE BOND PORTFOLIO is subject primarily to in-
terest rate and credit risk. The Portfolio, like the Leh-
man Brothers Aggregate Bond Index (the "Lehman Bond In-
dex") it seeks to match, is expected to maintain an aver-
age weighted maturity between 8 and 10 years. As a result,
interest rate risk -- i.e., the potential for a decline in
the market value of the Portfolio's fixed income securi-
ties due to rising interest rates -- may range from moder-
ate to high. Credit risk, however, should be nominal,
since the Portfolio invests primarily in highly rated
bonds and mortgage-backed securities.
The HIGH YIELD BOND PORTFOLIO is subject primarily to
credit risk and interest rate risk. The medium- and low-
grade bonds held by the Portfolio are considered specula-
tive because, since they are often issued by smaller, less
creditworthy companies or by highly leveraged (indebted)
firms, they are generally less able than more financially
stable firms to make scheduled payments of interest and
principal. The credit risks of bonds issued under such
circumstances are substantial. Interest rate risk is the
potential for a decline in the market value of the Portfo-
lio's fixed income securities due to rising
interest rates.
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
3
<PAGE>
periods when stock prices generally rise and periods when
stock prices generally decline.
The SMALL COMPANY GROWTH PORTFOLIO is also exposed to the
stock market risk present in the Equity Income, Equity In-
dex and Growth Portfolios. In addition, small company
stocks, which are this Portfolio's primary investments,
have historically been more volatile in price than the
stock market as a whole.
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 16
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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 90 distinct portfolios and total assets in
excess of $190 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 29
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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 30
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The Investment Advisers to the nine Portfolios in the Fund
are listed below:
INVESTMENT
ADVISERS
<TABLE>
<CAPTION>
PORTFOLIO INVESTMENT ADVISER
--------- ------------------
<S> <C>
Money Market Portfolio Vanguard's Fixed Income Group
High-Grade Bond
Portfolio Vanguard's Fixed Income Group
Equity Index Portfolio Vanguard's Core Management Group
Balanced Portfolio Wellington Management Company
Equity Income Portfolio Newell Associates
High Yield Bond
Portfolio Wellington Management Company
Growth Portfolio Lincoln Capital Management Company
Small Company Growth
Portfolio Granahan Investment Management, Inc.
International Portfolio Schroder Capital Management International, Inc.
</TABLE>
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DIVIDENDS AND The Portfolios distribute dividends and capital gains ac-
CAPITAL GAINS cording to the schedule outlined below:
<TABLE>
<CAPTION>
CAPITAL GAINS,
PORTFOLIO DIVIDEND DISTRIBUTIONS IF ANY
--------- ------------------------ --------------
<S> <C> <C>
Money Market Portfolio Monthly (declared daily) None
High-Grade Bond Portfolio Monthly (declared daily) Annually
Equity Index Portfolio Quarterly Annually
Balanced Portfolio Quarterly Annually
Equity Income Portfolio Quarterly Annually
High Yield Bond Portfolio Monthly (declared daily) Annually
Growth Portfolio Annually Annually
Small Company Growth
Portfolio Annually Annually
International Portfolio Annually Annually
</TABLE>
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4
<PAGE>
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. PAGE 36
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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 38
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5
<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, together with the remaining portions of the
Fund's 1995 Annual Report to Shareholders, 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 1995 Annual Report
to Shareholders. For a more complete discussion of the
Fund's performance, please see the Fund's 1995 Annual Re-
port 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. Please note that fi-
nancial highlights for the High Yield Bond and Small Com-
pany Growth Portfolios are not reported because these Port-
folios had not commenced operations prior to the date of
this Prospectus.
<TABLE>
<CAPTION>
-----------------------------------------
MONEY MARKET PORTFOLIO
-----------------------------------------
MAY 2+ TO
YEAR ENDED SEPT. 30, SEPT. 30,
1995 1994 1993 1992 1991
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<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF
PERIOD............................ $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
------ ------ ------ ------ ------
INVESTMENT OPERATIONS
Net Investment Income............. .056 .035 .030 .040 .023
Net Realized and Unrealized Gain
(Loss) on Investments............ -- -- -- -- --
------ ------ ------ ------ ------
TOTAL FROM INVESTMENT OPERATIONS.. .056 .035 .030 .040 .023
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DISTRIBUTIONS
Dividends from Net Investment
Income........................... (.056) (.035) (.030) (.040) (.023)
Distributions from Realized
Capital Gains.................... -- -- -- -- --
------ ------ ------ ------ ------
TOTAL DISTRIBUTIONS............... (.056) (.035) (.030) (.040) (.023)
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NET ASSET VALUE, END OF PERIOD..... $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
- -------------------------------------------------------------------------------
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TOTAL RETURN....................... 5.77% 3.63% 3.05% 4.11% 2.35%**
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RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period
(Millions)........................ $ 218 $ 171 $ 114 $ 71 $ 27
Ratio of Expenses to Average Net
Assets............................ .23% .23% .29% .33% .34%*
Ratio of Net Investment Income to
Average Net Assets................ 5.66% 3.66% 3.00% 3.90% 5.50%*
Portfolio Turnover Rate............ N/A N/A N/A N/A N/A
</TABLE>
* Annualized.
** Not Annualized.
+ Commencement of operations.
6
<PAGE>
<TABLE>
<CAPTION>
---------------------------------------------
HIGH-GRADE BOND PORTFOLIO
---------------------------------------------
APRIL 29+ TO
YEAR ENDED SEPT. 30, SEPT. 30,
1995 1994 1993 1992 1991
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<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF
PERIOD.......................... $ 9.82 $10.94 $10.64 $10.24 $10.00
------ ------ ------ ------ ------
INVESTMENT OPERATIONS
Net Investment Income........... .663 .619 .636 .705 .299
Net Realized and Unrealized Gain
(Loss) on Investments.......... .650 (.966) .349 .427 .240
------ ------ ------ ------ ------
TOTAL FROM INVESTMENT
OPERATIONS..................... 1.313 (.347) .985 1.132 .539
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DISTRIBUTIONS
Dividends from Net Investment
Income......................... (.663) (.619) (.636) (.705) (.299)
Distributions from Realized
Capital Gains.................. -- (.154) (.049) (.027) --
------ ------ ------ ------ ------
TOTAL DISTRIBUTIONS............. (.663) (.773) (.685) (.732) (.299)
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NET ASSET VALUE, END OF PERIOD... $10.47 $ 9.82 $10.94 $10.64 $10.24
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TOTAL RETURN..................... 13.83% (3.31)% 9.64% 11.47% 5.48%**
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RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period
(Millions)...................... $ 120 $ 80 $ 85 $ 52 $ 16
Ratio of Expenses to Average Net
Assets.......................... .29% .24% .29% .32% .40%*
Ratio of Net Investment Income to
Average Net Assets.............. 6.58% 5.98% 5.92% 6.66% 6.89%*
Portfolio Turnover Rate.......... 29% 46% 73% 31% 9%
</TABLE>
* Annualized.
** Not Annualized.
+ Commencement of operations.
<TABLE>
<CAPTION>
------------------------------------------
BALANCED PORTFOLIO
------------------------------------------
MAY 23+ TO
YEAR ENDED SEPT. 30, SEPT. 30,
1995 1994 1993 1992 1991
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<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF
PERIOD............................ $11.33 $11.58 $10.83 $10.25 $10.00
------ ------ ------ ------ ------
INVESTMENT OPERATIONS
Net Investment Income............. .51 .46 .50 .51 .19
Net Realized and Unrealized Gain
(Loss) on Investments............ 2.07 (.16) .97 .52 .06
------ ------ ------ ------ ------
TOTAL FROM INVESTMENT OPERATIONS.. 2.58 .30 1.47 1.03 .25
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DISTRIBUTIONS
Dividends from Net Investment
Income........................... (.50) (.39) (.69) (.45) --
Distributions from Realized
Capital Gains.................... (.08) (.16) (.03) -- --
------ ------ ------ ------ ------
TOTAL DISTRIBUTIONS............... (.58) (.55) (.72) (.45) --
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NET ASSET VALUE, END OF PERIOD..... $13.33 $11.33 $11.58 $10.83 $10.25
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TOTAL RETURN....................... 23.65% 2.67% 14.10% 10.29% 2.50%**
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RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period
(Millions)........................ $ 280 $ 230 $ 191 $ 76 $ 13
Ratio of Expenses to Average Net
Assets............................ .36% .34% .39% .42% .51%*
Ratio of Net Investment Income to
Average Net Assets................ 4.25% 4.11% 4.45% 4.77% 5.24%*
Portfolio Turnover Rate............ 26% 42% 41% 15% 3%
</TABLE>
* Annualized.
** Not Annualized.
+ Commencement of operations.
7
<PAGE>
<TABLE>
<CAPTION>
--------------------------------------------
EQUITY INDEX PORTFOLIO
--------------------------------------------
APRIL 29+ TO
YEAR ENDED SEPT. 30, SEPT. 30,
1995 1994 1993 1992 1991
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<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF
PERIOD........................... $12.47 $12.37 $11.32 $10.45 $10.00
------ ------ ------ ------ ------
INVESTMENT OPERATIONS
Net Investment Income............ .33 .31 .34 .26 .08
Net Realized and Unrealized Gain
(Loss) on Investments........... 3.26 .12 1.07 .85 .37
------ ------ ------ ------ ------
TOTAL FROM INVESTMENT OPERATIONS. 3.59 .43 1.41 1.11 .45
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DISTRIBUTIONS
Dividends from Net Investment
Income.......................... (.29) (.23) (.34) (.24) --
Distributions from Realized
Capital Gains................... (.08) (.10) (.02) -- --
------ ------ ------ ------ ------
TOTAL DISTRIBUTIONS.............. (.37) (.33) (.36) (.24) --
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NET ASSET VALUE, END OF PERIOD.... $15.69 $12.47 $12.37 $11.32 $10.45
- --------------------------------------------------------------------------------
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TOTAL RETURN...................... 29.51% 3.53% 12.68% 10.74% 4.50%**
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RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period
(Millions)....................... $ 276 $ 186 $ 165 $ 85 $ 24
Ratio of Expenses to Average Net
Assets........................... .28% .24% .29% .32% .45%*
Ratio of Net Investment Income to
Average Net Assets............... 2.53% 2.60% 2.63% 2.84% 3.22%*
Portfolio Turnover Rate........... 2% 7% 16% 1% 5%
</TABLE>
* Annualized.
** Not Annualized.
+ Commencement of operations.
<TABLE>
<CAPTION>
---------------------
INTERNATIONAL
PORTFOLIO
---------------------
YEAR ENDED JUNE 3+ TO
SEPT. 30, SEPT. 30,
1995 1994
- --------------------------------------------------------------------------------
<S> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD.................... $10.31 $10.00
------ ------
INVESTMENT OPERATIONS
Net Investment Income.................................. .16 .05
Net Realized and Unrealized Gain (Loss) on Investments. .99 .26
------ ------
TOTAL FROM INVESTMENT OPERATIONS....................... 1.15 .31
- --------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income................... (.06) --
Distributions from Realized Capital Gains.............. -- --
------ ------
TOTAL DISTRIBUTIONS.................................... (.06) --
- --------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD.......................... $11.40 $10.31
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
TOTAL RETURN............................................ 11.21% 3.10%**
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions).................... $ 90 $ 63
Ratio of Expenses to Average Net Assets................. .54% .30%*
Ratio of Net Investment Income to Average Net Assets.... 1.67% 1.91%*
Portfolio Turnover Rate................................. 27% 0%
</TABLE>
* Annualized.
** Not Annualized.
+ Commencement of operations.
8
<PAGE>
<TABLE>
<CAPTION>
--------------------------- ---------------------------
EQUITY INCOME PORTFOLIO GROWTH PORTFOLIO
--------------------------- ---------------------------
YEAR ENDED JUNE 7+ TO YEAR ENDED JUNE 7+ TO
SEPT. 30, SEPT. 30, SEPT. 30, SEPT. 30,
1995 1994 1993 1995 1994 1993
- -----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE,
BEGINNING OF PERIOD.... $10.05 $10.57 $10.00 $ 10.79 $10.26 $10.00
------ ------ ------ ------- ------ ------
INVESTMENT OPERATIONS
Net Investment Income.. .46 .45 .14 .16 .14 .04
Net Realized and
Unrealized Gain (Loss)
on Investments........ 2.02 (.63) .54 3.26 .46 .22
------ ------ ------ ------- ------ ------
TOTAL FROM INVESTMENT
OPERATIONS............ 2.48 (.18) .68 3.42 .60 .26
- -----------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net
Investment Income..... (.48) (.33) (.11) (.11) (.07) --
Distributions from
Realized Capital
Gains................. (.05) (.01) -- -- -- --
------ ------ ------ ------- ------ ------
TOTAL DISTRIBUTIONS.... (.53) (.34) (.11) (.11) (.07) --
- -----------------------------------------------------------------------------------
NET ASSET VALUE, END OF
PERIOD................. $12.00 $10.05 $10.57 $14.10 $10.79 $10.26
- -----------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------
TOTAL RETURN............ 25.69% (1.64)% 6.81%** 32.02% 5.87% 2.60%**
- -----------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of
Period (Millions)...... $ 91 $ 68 $ 50 $ 162 $ 82 $ 36
Ratio of Expenses to
Average Net Assets..... .39% .34% .39%* .47 .38% .43%*
Ratio of Net Investment
Income to Average Net
Assets................. 4.28% 4.57% 4.30%* 1.64% 1.55% 1.63%*
Portfolio Turnover Rate. 10% 18% 2% 32% 34% 10%
</TABLE>
* Annualized.
** Not Annualized.
+ Commencement of operations.
- --------------------------------------------------------------------------------
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
9
<PAGE>
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 nine distinct Portfolios--a money market
NINE DISTINCT portfolio, a high-grade bond portfolio, a high-yield bond
PORTFOLIOS portfolio, a balanced portfolio, an equity index portfolio,
an equity income portfolio, a growth portfolio, a small
company growth portfolio and an international portfolio:
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 HIGH YIELD BOND PORTFOLIO seeks to provide a high level
of current income by investing in below-investment grade
fixed-income securities (commonly referred to as "junk
bonds").
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, SMALL COMPANY GROWTH AND INTERNATIONAL PORTFO-
LIOS seek to provide long-term capital appreciation.
There is no assurance that a Portfolio will achieve its
stated objective.
- --------------------------------------------------------------------------------
10
<PAGE>
INVESTMENT The nine 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 tutions, nonfinancial corporations, and the U.S. Govern-
HIGH-QUALITY ment, state and municipal governments and their agencies or
MONEY 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 Credit
Banks, Federal Intermediate Credit Bank, Federal Na-
tional Mortgage Association, Federal Financing Bank,
the Tennessee Valley Authority, and others. Such "agen-
cy" 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, the money market may invest up to 10% of its
assets in securities that are illiquid.
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.
11
<PAGE>
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 September 30, 1995, these four
classes represented the following proportions of the Port-
folio's total market value:
<TABLE>
<S> <C>
U.S. Treasury and agency
securities 38%
Corporate debt obligations 29%
Foreign U.S. dollar obligations 4%
Mortgage-backed securities 29%
</TABLE>
Since 1991, the effective average weighted maturity of the
Portfolio has ranged from a high of 13.0 years to a low of
7.4 years; it was 8.5 years on September 30, 1995.
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 HIGH YIELD The HIGH YIELD BOND PORTFOLIO will invest in a diversified
BOND PORTFOLIO portfolio of high-yielding corporate debt securities (so-
INVESTS IN called "junk bonds"). Under normal circumstances, at least
LOW-QUALITY, 80% of the Portfolio's assets will be invested in high-
HIGH-RISK BONDS yield corporate debt obligations rated at least B by
Moody's or Standard & Poor's or, if unrated, of comparable
quality as determined by the Portfolio's adviser. Not more
than 20% of the Portfolio's assets may be invested in debt
securities rated less than B or unrated, and convertible
securities and preferred stocks. The Portfolio may invest
up to 25% of its assets in cash reserves and U.S. Govern-
ment securities, repurchase agreements collateralized by
U.S. Treasury or U.S. Government agency securities under
unusual market conditions for temporary defensive measures.
The High Yield Bond Portfolio will not invest in securities
that, at the time of initial investment, are rated less
than Caa by Moody's or CCC by Standard & Poor's. Securities
that are subsequently downgraded in quality below Caa or
CCC may continue to be held by the Portfolio, and will be
sold only if the Portfolio's adviser believes it would be
advantageous to do so. In addition, the credit quality of
unrated securities purchased by the Portfolio must be, in
the opinion of the Portfolio's adviser, at least equivalent
to a Caa rating by Moody's or a CCC rating by Standard &
Poor's.
Securities rated less than Baa by Moody's or BBB by Stan-
dard & Poor's are classified as non-investment grade secu-
rities. Such securities carry a high degree of risk and are
considered speculative by the major credit rating agencies.
The following are excerpts from the Moody's and Standard &
Poor's definitions of speculative grade debt obligations:
12
<PAGE>
Moody's: Ba-rated bonds have "speculative elements,"
their future "cannot be considered assured," and protec-
tion of principal and interest is "moderate" and "not
well safeguarded." B-rated bonds "lack characteristics of
a desirable investment" and the assurance of interest or
principal payments "may be small." Caa-rated bonds are
"of poor standing" and "may be in default" or may have
"elements of danger with respect to principal or inter-
est."
Standard & Poor's: BB-rated bonds have "less near-term
vulnerability to default" than B- or CCC-rated securities
but face "major ongoing uncertainties . . . which may
lead to inadequate capacity" to pay interest or princi-
pal. B-rated bonds have a "greater vulnerability to de-
fault" than BB-rated bonds and the ability to pay inter-
est or principal will likely be impaired by adverse busi-
ness conditions. CCC-rated bonds have a "currently iden-
tifiable vulnerability to default" and, without favorable
business conditions, will be unable to repay interest and
principal.
Credit quality in the high-yield bond market can change
suddenly and unexpectedly, and even recently-issued ratings
may not fully reflect the actual risks posed by a particu-
lar high-yield security. For these reasons, it is the High-
Yield Bond Portfolio's policy not to rely primarily on rat-
ings issued by established credit rating agencies, but to
use such ratings in conjunction with the adviser's own in-
dependent and ongoing review of credit quality.
Although the High Yield Bond Portfolio has no present plans
to do so, it may invest up to 5% of its assets in non-in-
come-producing high-yield securities -- such as zero coupon
bonds, which pay interest only at maturity, or payment-in-
kind bonds, which pay interest in the form of additional
securities.
The High Yield Corporate Portfolio may also hold asset-
backed securities, as well as U.S. dollar denominated debt
securities issued by foreign governments, their agencies
and instrumentalities, supranational entities and companies
located outside the U.S. The Portfolio may also invest in
bond (interest rate) futures and options to a limited ex-
tent. See "Implementation of Policies" for a description of
these investment practices of the Portfolio.
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.
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), securities issued by the U.S. Government, its
agencies and instrumentalities, including Government Na-
tional Mortgage Association ("GNMA") mortgage pass-through
certificates, asset-backed securities, as well as U.S. dol-
lar denominated debt securities issued by foreign govern-
ments, their agencies and instrumentalities, supranational
entities and companies located outside the U.S. The Portfo-
lio may also hold short-term fixed income securities of the
type authorized for the Money Market Portfolio as cash re-
serves.
13
<PAGE>
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 1995, reinvested dividend
income accounted for approximately 23% 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.
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.
14
<PAGE>
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 SMALL The SMALL COMPANY GROWTH PORTFOLIO will invest primarily in
COMPANY GROWTH the equity securities of small companies which are deemed
PORTFOLIO to offer favorable prospects for growth in market value.
INVESTS IN SMALL These securities are primarily common stocks but may also
COMPANY STOCKS include securities convertible into common stocks.
Securities purchased by the portfolio may be issued by
small or unseasoned companies with speculative risk charac-
teristics. Dividend income paid by such securities, if any,
will ordinarily be negligible. These securities will gener-
ally be traded in established over-the-counter markets,
rather than on a national securities exchange.
The median market capitalization of the companies included
in the Portfolio--that is, the median market value of the
companies' outstanding shares--is expected to range from
$100 million to $500 million. By comparison, for companies
included in the Russell 2000 Small Company Index, a bench-
mark of the market for small company stocks, the median
market capitalization is approximately $360 million. The
median capitalization of companies in the Standard & Poor's
500 Composite Stock Price Index, a widely used measure of
the broad stock market, is approximately $13.3 billion.
In addition to investing in the equity securities of small
companies, the Portfolio may purchase stock futures con-
tracts and options to a limited extent, and may invest in
certain short-term fixed income securities. The Portfolio
is also authorized to invest, to a limited extent, in for-
eign and restricted securities, although it does not pres-
ently intend to do so. 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
15
<PAGE>
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.
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 Fund is responsible for voting the shares of all secu-
rities it holds.
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 nine 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
16
<PAGE>
instruments, money market portfolios, unlike federally-in-
sured bank deposits, are not insured or guaranteed.
THE HIGH-GRADE As mutual funds investing in bonds, the High-Grade Bond and
BOND AND HIGH High Yield Bond Portfolios are exposed to interest rate
YIELD BOND risk.
PORTFOLIOS ARE
SUBJECT TO INTEREST RATE RISK is the potential for a decline in the
INTEREST RATE value of fixed-income securities due to rising interest
RISK 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.
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
ALSO SUBJECT TO PORTFOLIO is also exposed to prepayment and credit risks.
PREPAYMENT AND
CREDIT RISKS 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
17
<PAGE>
Index. A large proportion of securities in the Index are
AAA-rated U.S. Government bonds or Government-guaranteed
mortgage-backed securities. It is anticipated that the av-
erage 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 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
because of the Portfolio's diversified holdings and the
small percentage of the Portfolio's assets likely to be in-
vested in such obligations.
THE HIGH YIELD In addition to interest rate risks, the High Yield Bond
BOND PORTFOLIO Portfolio is subject to INCOME RISK which is the potential
IS ALSO SUBJECT for a decline in the Portfolio's income due to falling mar-
TO CREDIT, ket interest rates.
INCOME AND
MANAGER RISK In addition to interest rate and income risk, the Portfolio
is exposed to a substantial degree of CREDIT RISK. Credit
risk, also known as default risk, is the possibility that a
bond issuer will fail to make timely payments of interest
or principal to the Portfolio. The credit risk of the Port-
folio depends on the quality of its investments. Reflecting
their higher risks, lower-quality bonds generally offer
higher yields (all other factors being equal).
The medium- and low-grade bonds held by the Portfolio are
considered speculative by traditional investment standards.
High-yield bonds may be issued as a consequence of corpo-
rate restructurings, such as leveraged buyouts, mergers,
acquisitions, debt recapitalizations, or similar events.
Also, high-yield bonds are often issued by smaller, less
creditworthy companies or by highly leveraged (indebted)
firms, which are generally less able than more financially
stable firms to make scheduled payments of interest and
principal. The risks posed by bonds issued under such cir-
cumstances are substantial.
In an effort to minimize credit risk, the High Yield Bond
Portfolio will diversify its holdings widely among many is-
suers. In the past, the high yields from a portfolio of
low-grade bonds have more than compensated for the higher
default rates on such securities. However, there can be no
assurance that diversification will protect the Portfolio
from widespread bond defaults brought about by a sustained
economic downturn, or that yields will continue to offset
default rates on high-yield bonds in the future. A long-
term track record on bond default rates, such as that for
investment grade corporate bonds, does not exist for the
high-yield market. It may be that future default rates on
high-yield bonds will be more widespread and higher than in
the past, especially during periods of deteriorating eco-
nomic conditions.
The share price of the High Yield Bond Portfolio will be
influenced not only by changing interest rates, but also by
the bond market's perception of credit quality and the out-
look for economic growth. When economic conditions appear
to be deteriorating, low- and medium-rated bonds may de-
cline in market value due to investors' heightened concern
over credit quality, regardless of prevailing interest
rates.
18
<PAGE>
Especially at such times, trading in the secondary market
for high-yield bonds may become thin and market liquidity
may be significantly reduced. Even under normal conditions,
the market for high-yield bonds may be less liquid than the
market for investment grade corporate bonds. There are
fewer securities dealers in the high-yield market, and pur-
chasers of high-yield bonds are concentrated among a
smaller group of securities dealers and institutional in-
vestors.
In periods of reduced market liquidity, high-yield bond
prices may become more volatile, and both the high-yield
market and the Portfolio may experience sudden and substan-
tial price declines. Also, there may be significant dispar-
ities in the prices quoted for high-yield securities by
various dealers. Under such conditions, the Portfolio may
find it difficult to value its securities accurately. The
Portfolio may also be forced to sell securities at a sig-
nificant loss in order to meet shareholder redemptions.
Under unusual circumstances, the Portfolio may hold a sig-
nificant portion of its assets in U.S. Government obliga-
tions and cash reserves for temporary defensive purposes.
Besides credit and liquidity concerns, prices for high-
yield bonds may be affected by legislative and regulatory
developments. For example, from time to time, Congress has
considered legislation to restrict or eliminate the corpo-
rate tax deduction for interest payments or to regulate
corporate restructurings such as takeovers or mergers. Such
legislation may significantly depress the prices of out-
standing high-yield bonds.
Overall, investors should expect that the High Yield Bond
Portfolio may fluctuate in price independently of the broad
bond market and prevailing interest rate trends, and that
price volatility at times may be very high, especially as a
result of credit concerns, market liquidity, and antici-
pated or actual legislative and regulatory changes.
Finally, the investment adviser manages the Portfolio ac-
cording to the traditional methods of "active" investment
management, which involve the buying and selling of securi-
ties based upon economic, financial and market analysis and
investment judgment. MANAGER RISK refers to the possibility
that the Portfolio's investment adviser may fail to execute
the Portfolio's investment strategy effectively. As a re-
sult, the Portfolio may fail to achieve its stated objec-
tive.
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.
19
<PAGE>
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 involve 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, SMALL COMPANY GROWTH AND
INCOME, EQUITY GROWTH PORTFOLIOs are subject to stock MARKET RISK--i.e.,
INDEX, GROWTH the possibility that common stock prices will decline over
AND SMALL short or even extended periods. The U.S. stock market tends
COMPANY GROWTH to be cyclical, with periods when stock prices generally
PORTFOLIOS ARE rise and periods when stock prices generally decline.
SUBJECT TO STOCK
MARKET RISK 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
1995, as measured by the S&P 500 Index:
AVERAGE ANNUAL U.S. STOCK MARKET RETURNS (1926-1995) 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 +12.5 +10.3 +10.7 +10.7
</TABLE>
As shown, common stocks have provided annual total returns
(capital appreciation plus dividend income) averaging
+10.7% for all 10-year periods from 1926 to 1995. Average
annual returns may not be useful for forecasting future re-
turns in any particular period, as stock market returns are
quite volatile from year to year.
THE SMALL Small company stocks, which are the Small Company Growth
COMPANY GROWTH Portfolio's primary investments, have historically been
PORTFOLIO STOCKS more volatile in price than the stock market as a whole.
MAY BE MORE Among the likely reasons for the greater price volatility
VOLATILE THAN of small company stocks are the less certain growth pros-
LARGE COMPANY pects of smaller firms, a low degree of liquidity in the
STOCKS markets for small company stocks, and the small to negligi-
ble dividends generally paid by small companies. Besides
exhibiting greater volatility, small company stocks have at
times fluctuated in value independently of the broad stock
market.
Investors should therefore expect that small company stocks
(and hence the Portfolio's investments) may be more vola-
tile than the stocks of more established companies. In ad-
dition, investors should recognize that small company
stocks may rise or fall in value independently of the broad
stock market.
20
<PAGE>
THE EQUITY The investment advisers manage the Equity Income, Growth
INCOME, GROWTH and Small Company Growth Portfolios according to the tradi-
AND SMALL tional methods of "active" investment management, which in-
COMPANY GROWTH volve the buying and selling of securities based upon eco-
PORTFOLIOS ARE nomic, financial and market analysis and investment judg-
SUBJECT TO ment. 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 1995, as
measured by the Morgan Stanley Capital International Eu-
rope, Australia, Far East (EAFE) Index:
AVERAGE ANNUAL INTERNATIONAL STOCK MARKET RETURNS (1969-
1995) OVER VARIOUS TIME HORIZONS
<TABLE>
<CAPTION>
1 YEAR 5 YEARS 10 YEARS 20 YEARS
------ ------- -------- --------
<S> <C> <C> <C> <C>
Best +69.9% +36.5% +22.8% +16.3%
Worst -23.2% +1.5% +7.0% +12.0%
Average +15.3% +14.2% +16.2% +14.9%
</TABLE>
As shown, international (non-U.S.) stocks have provided an-
nual total returns averaging +16.2% for all 10-year periods
from 1969 to 1995. Note, however, that the period from 1969
to 1995 was a favorable one for foreign stock market in-
vesting. As a result, the figures on total return and stock
market volatility are provided here only as a guide to po-
tential 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 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.
21
<PAGE>
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 involve 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 High Yield Bond
Portfolio is designed for aggressive investors seeking a
high level of income and who are willing to take substan-
tial risks in pursuit of potentially higher rewards. The
Equity Index, Growth, Small Company Growth and Interna-
tional Portfolios are intended for investors who are seek-
ing the potentially higher returns of common stocks and who
can tolerate sudden, often substantial, fluctuations in the
value of their investment. The International Portfolio in-
vestor should be cognizant of the unique risks of interna-
tional investing, including their exposure to currency
fluctuations. In general, there can be no assurance that a
Portfolio will achieve its stated objective.
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
22
<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 nine 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.
23
<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 September 30, 1995, over
5,300 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 interest
rate risk weighting of the four major classes in the In-
dex -- U.S. Treasury and agency securities, corporate and
foreign dollar-denominated debt, and mortgage-backed secu-
rities. For example, if U.S. Treasury and agency securities
represent 60% of the Index risk, then approximately 60% of
the Portfolio's risk will also be invested in such securi-
ties. As the Portfolio grows, these classes will be further
delineated along the lines of sector, term to maturity,
coupon, and credit rating. For example, within the corpo-
rate debt class, all long-term, low coupon AA-rated utility
bonds might be represented 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
24
<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 HIGH YIELD The High Yield Bond Portfolio may own restricted securities
BOND PORTFOLIO to a limited extent. Restricted securities are securities
MAY OWN which are not freely marketable or which are subject to re-
RESTRICTED strictions upon sale under the Securities Act of 1933. The
SECURITIES Portfolio may invest up to 15% of its net assets in re-
stricted securities. (Included within this 15% limit are
restricted securities and other securities for which price
quotations are not readily available.)
THE HIGH YIELD The High Yield Bond Portfolio may hold securities of for-
BOND PORTFOLIO eign issuers, but all such securities must be denominated
MAY INVEST IN in U.S. dollars. Securities of foreign issuers may trade in
SECURITIES OF U.S. or foreign securities markets. Securities of foreign
FOREIGN ISSUERS issuers may involve investment risks that are different
from those of domestic issuers. Such risks include the ef-
fect of foreign economic policies and conditions, future
political and economic developments, and the possible impo-
sition of exchange controls or other foreign governmental
restrictions on foreign debt issuers. There may also be
less publicly available information about a foreign issuer
than a domestic issuer of securities. Foreign issuers are
generally not subject to the uniform accounting, auditing
and financial reporting standards that apply to domestic
issuers. Also, foreign debt markets may be characterized by
lower liquidity, greater price volatility and higher trans-
action costs. Additionally, it may be difficult to obtain
or enforce a legal judgment in a foreign court.
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 47% 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 September
30, 1995, the five largest companies in
25
<PAGE>
the Index were: General Electric (2.51%), AT&T (2.42%),
Exxon (2.08%), Coca Cola Co. (2.02%) and Philip Morris
(1.63%). The largest industry categories were telephone
companies (8.6%), banks (6.3%), pharmaceutical companies
(5.8%), international oil companies (5.6%), and medical
supply & services (4.0%).
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.
THE SMALL The Small Company Growth Portfolio is authorized to invest
COMPANY GROWTH up to 10% of its assets in foreign securities and up to 15%
PORTFOLIO MAY of its assets in restricted or illiquid securities. Howev-
INVEST IN er, the Portfolio currently has no intentions to own either
FOREIGN AND foreign or restricted securities.
RESTRICTED
STOCKS
THE SMALL Although it normally seeks to remain substantially invested
COMPANY GROWTH in equity securities, the Small Company Growth Portfolio
PORTFOLIO MAY may invest for temporary purposes in certain short-term
INVEST IN fixed income securities. Such securities may be used to in-
SHORT-TERM FIXED vest uncommitted cash balances, to maintain liquidity to
INCOME meet shareholder redemptions, or to take a temporary defen-
SECURITIES sive position against potential stock market declines.
These securities include: obligations to the United States
Government and its agencies or instrumentalities; commer-
cial paper; bank certificates of deposit and bankers' ac-
ceptances; and repurchase agreements collateralized by
these securities.
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
26
<PAGE>
securities. They simply establish an exchange rate at a fu-
ture 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 currency increase.
EIGHT PORTFOLIOS All Portfolios except the Money Market Portfolio may lend
MAY LEND THEIR their investment securities to qualified institutional in-
SECURITIES vestors for the purpose of realizing additional income.
Loans of securities by a Portfolio will be collateralized
by cash, letters of credit, or securities issued or guaran-
teed by the U.S. Government or its agencies. The collateral
will equal at least 100% of the current market value of the
loaned securities. In keeping with statutory restrictions,
securities lending will not exceed 33 1/3% of a Portfolio's
assets.
TWO PORTFOLIOS Each Portfolio of the Fund retains the right to sell secu-
ARE EXPECTED TO rities irrespective of how long they have been held. Be-
HAVE LOW cause of their "passive" investment management approach,
TURNOVER RATES 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 High Yield Bond, Balanced, Eq-
uity Income, Growth, Small Company 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 securities 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.
DERIVATIVE Derivatives are instruments whose values are linked to or
INVESTING derived from an underlying security or index. The most com-
mon and conventional types of derivative securities are
futures and options.
MONEY MARKET The Portfolio invests only in derivative securities such as
PORTFOLIO floating rate instruments with returns derived directly
from standard, U.S. dollar-denominated short-term taxable
interest rate benchmarks such as short-term LIBOR rates,
Federal Reserve Daily Federal Funds Effective Rate and U.S.
Treasury Bill auction results. The Portfolio neither uses
derivatives to apply leverage, nor does it invest in
futures or options.
27
<PAGE>
EIGHT PORTFOLIOS All Portfolios except the Money Market Portfolio may invest
MAY USE FUTURES in futures contracts and options, but only to a limited ex-
CONTRACTS AND tent. The Portfolios may enter into futures contracts pro-
OPTIONS vided that not more than 5% of its assets are required as a
futures contract deposit; in addition, the Portfolios 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 com-
mon fund management strategies: to maintain cash reserves
while simulating full investment, to facilitate trading, to
reduce transaction costs, or to seek higher investment re-
turns when a specific futures contract is priced more at-
tractively than other futures contracts or the underlying
security or index.
The Portfolios may use futures contracts for bona fide
"hedging" purposes. In executing a hedge, a manager sells,
for example, stock index futures to protect against a de-
cline in the stock market. As such, if the market drops,
the value of the futures position will rise, thereby off-
setting the decline in value of the Portfolios' stock hold-
ings.
The High-Grade Bond Portfolio may also invest in other con-
ventional derivatives designed to replicate the risk/return
characteristics of a conventional fixed income note or
bond. Such derivatives would be managed, in both structure
and concentration, to adhere to the Portfolio's investment
policy restrictions as to market and credit risk.
The High-Grade Bond Portfolio also invests in a relatively
conservative class of collateralized mortgage obligations
(CMOs) which feature a high degree of cash flow predict-
ability and less vulnerability to mortgage prepayment risk.
To reduce credit risk, Vanguard purchases these classes of
collateralized mortgage obligations issued only by agencies
of the U.S. Government or privately-issued collateralized
mortgage obligations that carry high-quality investment-
grade ratings.
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 bonds held by a Portfolio
CERTAIN RISKS 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 po-
sition prior to its maturity date. The risk of imperfect
correlation will be minimized by investing in those con-
tracts whose price fluctuations are expected to resemble
those of the Portfolio's underlying securities. The risk
that a Portfolio will be unable to close out a futures po-
sition will be minimized by entering into such transactions
on a national exchange with an active and liquid secondary
market.
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.
- --------------------------------------------------------------------------------
28
<PAGE>
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 (or through reverse
repurchase agreements) and only as a temporary or emer-
gency 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 re-
paid prior to the purchase of additional portfolio se-
curities;
(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, provided that: (i) this limitation
does not apply to obligations issued or guaranteed by
the U.S. Government or its agencies or instrumentali-
ties; (ii) utility companies will be divided according
to their services (for example, gas, gas transmission,
electric, electric and gas, and telephone will each be
considered a separate industry); and (iii) financial
service companies will be classified according to the
end users of their services (for example, automobile
finance, bank finance, and diversified finance will be
considered as separate industries); and
(f) invest more than 5% of its assets in the securities of
companies that have a continuous operating history of
less than three years.
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.
- --------------------------------------------------------------------------------
The Fund is a member of The Vanguard Group of Investment
MANAGEMENT OF Companies, a family of more than 30 investment companies
THE FUND with more than 90 distinct portfolios and assets in excess
of $190 billion. Through their jointly-owned subsidiary,
VANGUARD The Vanguard Group, Inc. ("Vanguard"), the Fund and the
ADMINISTERS AND other funds in the Group obtain at cost virtually all of
DISTRIBUTES THE their corporate management, administrative, shareholder ac-
FUND 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 1995,
the average expense ratio (annual costs including advisory
fees divided by total net assets) for the Vanguard funds
amounted to approximately .31% compared to an average of
1.11% for the mutual fund industry (data provided by Lipper
Analytical Services).
29
<PAGE>
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 the Fund and choose its Of-
ficers. A list of the Trustees and Officers of the Fund and
a statement of their present positions and principal occu-
pations 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.
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 charges paid by seven of the Portfolios during the fis-
cal year ended September 30, 1995 for management and advi-
sory services, distribution, marketing and other expenses,
as a percentage of average net assets, are detailed below.
<TABLE>
<CAPTION>
MANAGEMENT
& ADVISORY EXTERNAL MARKETING
SERVICES INVESTMENT AND TOTAL
PROVIDED BY ADVISORY OTHER DISTRIBUTION OPERATING
PORTFOLIO VANGUARD SERVICES EXPENSES EXPENSES EXPENSES
--------- ----------- ---------- -------- ------------ ---------
<S> <C> <C> <C> <C> <C>
Money Market............ 0.17% 0.03% 0.03% 0.23%
High-Grade Bond......... 0.21% 0.06% 0.02% 0.29%
Equity Index............ 0.24% 0.02% 0.02% 0.28%
Balanced................ 0.22% 0.10% 0.02% 0.02% 0.36%
Equity Income........... 0.22% 0.10% 0.05% 0.02% 0.39%
Growth.................. 0.26% 0.15% 0.04% 0.02% 0.47%
International........... 0.28% 0.15% 0.09% 0.02% 0.54%
</TABLE>
The High-Yield Bond and Small Company Growth Portfolios
were not in operation as of the date of this prospectus
and, therefore, do not have historical expense data. Van-
guard developed annual operating expense estimates for
these two Portfolios for their first full year, which are
outlined below:
<TABLE>
<CAPTION>
MANAGEMENT
& ADVISORY EXTERNAL MARKETING
SERVICES INVESTMENT AND TOTAL
PROVIDED BY ADVISORY OTHER DISTRIBUTION OPERATING
PORTFOLIO VANGUARD SERVICES EXPENSES EXPENSES EXPENSES
--------- ----------- ---------- -------- ------------ ---------
<S> <C> <C> <C> <C> <C>
High Yield Bond......... 0.22% 0.06% 0.02% 0.02% 0.32%
Small Company Growth.... 0.22% 0.15% 0.02% 0.02% 0.41%
</TABLE>
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 the Total Bond Market Portfo-
lio of the Vanguard Bond Index Fund; the High-Yield Bond
Portfolio is similar to the High Yield Corporate Portfolio
of the Vanguard Fixed Income Securities Fund; the
30
<PAGE>
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; the Small
Company Growth Portfolio is similar to the Vanguard Ex-
plorer Fund and the International Portfolio is similar to
Vanguard International Growth Portfolio. Because of differ-
ences in the investments held and additional administrative
and insurance costs associated with insurance company sepa-
rate 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
FIVE INDEPENDENT Management Group provides advisory services to the Equity
INVESTMENT Index Portfolio.
ADVISERS MANAGE
THE FUND'S The Fund's six other Portfolios employ external investment
INVESTMENTS advisers as follows:
<TABLE>
<CAPTION>
PORTFOLIO INDEPENDENT INVESTMENT ADVISER
--------- ------------------------------
<S> <C>
Balanced................ Wellington Management Company
High Yield Bond......... Wellington Management Company
Equity Income........... Newell Associates
Growth.................. Lincoln Capital Management
Small Company Growth.... Granahan Investment Management, Inc.
International........... Schroder Capital Management International, Inc.
</TABLE>
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 $66
billion as of December 31, 1995. The High-Grade Bond Port-
folio of the Fund is not actively managed, but is instead
administered by the Fixed Income Group using computerized,
quantitative techniques. The Fixed
31
<PAGE>
Income Group is supervised 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,
Vanguard Institutional Index Fund, the Aggressive Growth
Portfolio of Vanguard Horizon Fund, a portion of
Vanguard/Windsor II, a portion of Vanguard/Morgan Growth
Fund and several indexed separate accounts. Total indexed
assets under management as of December 31, 1995, were $33
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 five independent investment advisers. Wel-
lington Management Company ("WMC"), 75 State Street, Bos-
ton, MA 02109, serves as investment adviser to the Fund's
Balanced and High-Yield Bond Portfolios. Newell Associates
("Newell"), 525 University Avenue, Palo Alto, CA 94301, is
adviser to the Equity Income Portfolio. Lincoln Capital
Management Company ("Lincoln"), 200 South Wacker Drive,
Chicago, IL 60606, serves as the adviser to the Growth
Portfolio. Granahan Investment Management, Inc.
("Granahan"), 275 Wyman Street, Waltham, MA 02154, provides
advisory services to the Small Company Growth Portfolio.
Schroder Capital Management International, Inc. ("Schroder
Capital"), 787 Seventh Avenue, New York, NY 10019, serves
as the adviser to the International Portfolio. Under advi-
sory agreements with the Fund, WMC, Newell, Lincoln,
Granahan and Schroder Capital manage the investment and re-
investment of the assets of the High Yield Bond and Bal-
anced, Equity Income, Growth, Small Company Growth and
32
<PAGE>
International Portfolios, respectively, and continuously
review, supervise and administer each Portfolio's invest-
ment 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 tions, and individuals. Among the clients of WMC are more
AS ADVISER TO than 10 of the investment companies of The Vanguard Group.
THE BALANCED AND As of September 30, 1995, WMC held discretionary management
HIGH YIELD BOND authority with respect to more than $104 billion of assets.
PORTFOLIOS WMC and its predecessor organizations have provided advi-
sory services to investment companies since 1933 and to in-
vestment counseling clients since 1960.
Ernst H. von Metzsch, Senior Vice President of WMC, serves
as portfolio manager of the Balanced Portfolio. Mr. von
Metzsch is assisted by Paul D. Kaplan, Senior Vice Presi-
dent of WMC. Mr. von Metzsch who has served in this capac-
ity since September 1995 and Mr. Kaplan who has served in
this capacity since March 1994, are supported by research
and other investment services provided by the professional
staff of WMC. Mr. von Metzsch and Mr. Kaplan have been em-
ployed by WMC for 22 and 18 years, respectively.
To compensate WMC for advisory services for the Balanced
Portfolio, the Fund pays WMC a basic advisory fee at the
end of each fiscal quarter, calculated by applying a quar-
terly rate, based on the following annual percentage rates,
to the average month-end net assets of the Balanced Portfo-
lio 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, 1995, the total
advisory fees paid by the Fund to WMC for managing the Bal-
anced Portfolio represented an effective annual rate of .10
of 1% of its average net assets.
Earl E. McEvoy, Senior Vice President of WMC, serves as
portfolio manager of the High Yield Bond Portfolio. Mr. Mc-
Evoy is supported by research and other investment services
provided by the professional staff of WMC. Mr. McEvoy has
been serving as portfolio manager for the High Yield Corpo-
rate Portfolio of the Vanguard Fixed Income Securities Fund
since 1984.
33
<PAGE>
To compensate WMC for its advisory services for the High
Yield Bond Portfolio, the Fund pays WMC an advisory fee
calculated by applying an annual rate of .06% to the aver-
age month-end net assets of the High-Yield Bond Portfolio
for the quarter.
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 that relative yield is an excel-
lent guide to relative value. Newell, formed in 1986, is a
California corporation in which a controlling interest is
owned by its Directors and Officers: Roger D. Newell, Rob-
ert A. Huret and Alan E. Rothenberg. As of September 30,
1995, Newell's assets under management were approximately
$1.1 billion. Mr. Newell has been responsible for oversee-
ing the implementation of the firm's strategy for the Eq-
uity 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, 1995,
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,
SERVES AS currently provides investment counseling services to a
ADVISER TO THE limited number of clients, most of which are institutional
GROWTH PORTFOLIO clients, such as pension funds. Currently, Lincoln holds
discretionary management authority with respect to
approximately $32.7 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 24 and 11 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, 1995, 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.
GRANAHAN SERVES Granahan is a professional investment advisory firm founded
AS ADVISER TO in 1985. As of December 31, 1995, Granahan held discretion-
THE SMALL ary management authority with respect to approximately $813
COMPANY GROWTH million in assets. John J. Granahan is portfolio manager of
PORTFOLIO the assets of the Small Company Growth Portfolio. Mr.
Granahan has been serving as portfolio manager of the Van-
guard Explorer Fund since February 1990. Prior to that, he
served as portfolio manager of Vanguard Explorer II from
its inception in June 1985 through its merger with the
34
<PAGE>
Explorer Fund in February 1990. Mr. Granahan also served as
portfolio manager of Explorer Fund from January 1972 to
September 1979 while employed at WMC.
The Fund pays Granahan a basic advisory fee at the end of
each fiscal quarter, calculated by applying a quarterly
rate, based on an annual percentage rate of 0.15% to the
average month-end net assets of the Portfolio for the quar-
ter.
The basic advisory fee is increased or decreased by apply-
ing an adjustment formula based on the investment perfor-
mance of the Portfolio relative to the investment record of
the Russell 2000 Small Company Index.
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 management services, with Group funds
under management currently in excess of $102 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 27 years.
The Portfolio pays Schroder Capital a basic advisory fee at
the end of each fiscal quarter, calculated by applying a
quarterly rate, based on an annual percentage rate of
0.125%, to the average month-end net assets of the Portfo-
lio. This basic advisory fee is increased or decreased by
applying an adjustment formula based on the investment per-
formance of the Portfolio relative to the investment record
of the Morgan Stanley Capital International Europe, Austra-
lia, Far East Index ("EAFE") over the preceding 36-month
period. During the period June 3, 1994 (commencement of the
Portfolio's operations) to September 30, 1995, the total
advisory fees paid by the Fund to Schroder Capital repre-
sented an effective annual rate of .15% of 1% of average
net assets of the International Portfolio.
The investment advisory agreements authorize WMC, Newell,
Lincoln, Granahan and Schroder (with approval of the Fund's
Board of Trustees) to select the brokers or dealers that
will execute the purchases and sales of portfolio securi-
ties 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 considered in making these determi-
nations. The Fund has authorized the advisers to pay higher
commissions in recognition of brokerage services felt nec-
essary to the achievement of better execution, provided the
advisers believe this to be in the best interests of the
Portfolio and the Fund.
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
35
<PAGE>
same advisory contract terms where a contract has been as-
signed 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 of the Fund which
shall include substantially the information concerning the
adviser that would have normally been included in a proxy
statement.
- --------------------------------------------------------------------------------
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, High-Grade Bond and High Yield Bond
Portfolios are accrued daily and distributed monthly. The
DIVIDENDS AND Balanced, Equity Index and Equity Income Portfolios will
CAPITAL GAINS distribute dividends each quarter while the Growth, Small
MAY ACCUMULATE Company Growth and International Portfolios distribute div-
FREE OF FEDERAL idends annually. Capital gains distributions, if any, from
INCOME TAX the Portfolios will be made annually.
All dividend and capital gains distributions from a Portfo-
lio 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 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
36
<PAGE>
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
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 regularly traded in the over-the-counter market
for which market quotations are readily available will be
valued at the latest quoted bid price. Other assets and se-
curities for which no quotations are readily available will
be valued in a manner determined in good faith by the Board
of Trustees to reflect their fair value.
To help determine its daily share price, each Portfolio
calculates the value of its foreign securities in U.S. dol-
lars. The Portfolios use the daily exchange rate employed
by Morgan Stanley Capital International (MSCI) in the cal-
culation of its own indexes. MSCI determines this exchange
rate either before or after
37
<PAGE>
the close of a foreign securities market. If MSCI's ex-
change rate is not available, the Portfolios use a rate ac-
cording to policies set by the Portfolio's Board of Trust-
ees.
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. Short-term instruments (those with re-
maining maturities of 60 days or less) are valued at cost,
plus or minus any amortized discount or premium, which ap-
proximates market. 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 nine 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; Chase Manhattan Bank,
N.A., New York, NY for the High Yield Bond Portfolio; State
Street Bank and Trust Company, Boston, MA, for the Equity
Income, Growth, and Small Company Growth Portfolios; and
Morgan Stanley Trust Company for the International Portfo-
lio. The Vanguard Group, Inc., Valley Forge, PA, serves as
the Fund's Transfer and Dividend Disbursing Agent. Price
Waterhouse LLP, serves as independent accountants for the
Fund and will audit its financial statements annually. The
Fund is not involved in any litigation.
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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.
38
<PAGE>
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 de-
termines that a specific purchase acceptance would be det-
rimental to the best interest of the Fund's shareholders,
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.
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39
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<PAGE>
[LOGO OF VANGUARD
VARIABLE ANNUITY PLAN
APPEARS HERE]
[LOGO OF THE VANGUARD GROUP APPEARS HERE]
PROVIDIAN LIFE & HEALTH INSURANCE COMPANY
A subsidiary of Providian Corporation PROSPECTUS
P064 092596
