<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT (NO. 33-32216) UNDER THE SECURITIES ACT OF 1933
PRE-EFFECTIVE AMENDMENT NO.
POST-EFFECTIVE AMENDMENT NO. 18
AND
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
AMENDMENT NO. 21
VANGUARD VARIABLE INSURANCE FUND
(EXACT NAME OF REGISTRANT AS SPECIFIED IN DECLARATION OF TRUST)
P.O. BOX 2600, VALLEY FORGE, PA 19482
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
REGISTRANT'S TELEPHONE NUMBER (610) 669-1000
R. GREGORY BARTON, ESQUIRE
P.O. BOX 876
VALLEY FORGE, PA 19482
APPROXIMATE DATE OF PROPOSED PUBLIC OFFERING:
AS SOON AS PRACTICABLE AFTER THIS REGISTRATION STATEMENT BECOMES EFFECTIVE.
IT IS PROPOSED THAT THIS FILING BECOME EFFECTIVE:
ON DECEMBER 29, 2000, PURSUANT TO PARAGRAPH (B) OF RULE 485.
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<PAGE>
VANGUARD(R) VARIABLE
INSURANCE FUND
December 29, 2000
This prospectus contains
financial data for the
Portfolios through the
fiscal year ended
September 30, 2000
Prospectus
MONEY MARKET PORTFOLIO
SHORT-TERM CORPORATE
PORTFOLIO
HIGH-GRADE BOND
PORTFOLIO
HIGH YIELD BOND
PORTFOLIO
BALANCED PORTFOLIO
EQUITY INCOME PORTFOLIO
DIVERSIFIED VALUE
PORTFOLIO
EQUITY INDEX PORTFOLIO
MID-CAP INDEX PORTFOLIO
GROWTH PORTFOLIO
SMALL COMPANY GROWTH
PORTFOLIO
INTERNATIONAL PORTFOLIO
REIT INDEX PORTFOLIO
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE
SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THESE
SECURITIES OR PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
[A MEMBER OF
THE VANGUARD GROUP(R) LOGO]
<PAGE>
VANGUARD VARIABLE INSURANCE FUND
Prospectus
December 29, 2000
<TABLE>
<CAPTION>
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CONTENTS
<S> <C> <C>
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1 AN INTRODUCTION TO VANGUARD 10 GROWTH PORTFOLIO 20 OVERVIEW OF THE BALANCED
VARIABLE INSURANCE FUND PORTFOLIO
11 SMALL COMPANY GROWTH
1 PORTFOLIO PROFILES PORTFOLIO 20 OVERVIEW OF THE STOCK
PORTFOLIOS
1 MONEY MARKET PORTFOLIO 12 INTERNATIONAL PORTFOLIO
27 TURNOVER RATE
2 SHORT-TERM CORPORATE
PORTFOLIO 13 REIT INDEX PORTFOLIO 28 THE PORTFOLIOS AND
VANGUARD
3 HIGH-GRADE BOND 14 MORE ON THE PORTFOLIOS
PORTFOLIO 28 INVESTMENT ADVISERS
14 MARKET RISK
4 HIGH YIELD BOND PORTFOLIO 31 TAXES
14 MANAGER RISK
5 BALANCED PORTFOLIO 31 SHARE PRICE
15 FUTURES AND OPTIONS
6 EQUITY INCOME PORTFOLIO CONTRACTS 32 FINANCIAL HIGHLIGHTS
7 DIVERSIFIED VALUE PORTFOLIO 15 OVERVIEW OF THE MONEY 39 GENERAL INFORMATION
MARKET PORTFOLIO
8 EQUITY INDEX PORTFOLIO 40 GLOSSARY
16 OVERVIEW OF THE BOND
9 MID-CAP INDEX PORTFOLIO PORTFOLIOS
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</TABLE>
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WHY READING THIS PROSPECTUS IS IMPORTANT
This prospectus explains the objective, risks, and strategies of Vanguard
Variable Insurance Fund. To highlight terms and concepts important to mutual
fund investors, we have provided "Plain Talk(R)" explanations along the way.
Reading the prospectus will help you decide which portfolio, if any, is the
right investment for you. We suggest that you keep it for future reference.
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<PAGE>
1
AN INTRODUCTION TO VANGUARD VARIABLE INSURANCE FUND
This prospectus explains the investment objectives, policies, strategies, and
risks, associated with the 13 Portfolios that make up Vanguard Variable
Insurance Fund (the Fund). The Portfolios are mutual funds used solely as
investment options for variable annuity or variable life insurance contracts
offered by insurance companies. This means that you cannot purchase shares of
the Portfolios directly, but only through such a contract as offered by an
insurance company.
After this introductory section you'll find Portfolio Profiles. Each
Profile summarizes important facts about a Portfolio, including information
about its investment objective, policies, strategies, risks, and past
performance.
The Portfolios of Vanguard Variable Insurance Fund are entirely separate
from other Vanguard mutual funds, even when they have the same investment
objectives and advisers. The Portfolios' investment performance will differ from
the performance of other Vanguard funds because of differences in the securities
held and because of administrative and insurance costs associated with separate
accounts in variable annuity and variable insurance plans.
More detailed information about the Portfolios' investment policies and
strategies is provided after the Profiles, along with information about share
pricing and Financial Highlights for each Portfolio.
A NOTE ON FEES
As an investor in any of the Portfolios, you would incur various operating
costs, including management, advisory, and distribution expenses. You also would
incur fees associated with the variable annuity or variable insurance plan
through which you invest. Detailed information about the cost of investing in a
Portfolio is presented in the "Fee Table" section of the accompanying prospectus
for the variable annuity or variable insurance plan through which Portfolio
shares are offered.
--------------------------------------------------------------------------------
PLAIN TALK ABOUT
COSTS OF INVESTING
Costs are an important consideration in choosing a mutual fund. That's because
you, as a contractholder, pay the costs of operating a portfolio, plus any
transaction costs associated with the portfolio's buying and selling of
securities. These costs can erode a substantial portion of the gross income or
capital appreciation a portfolio achieves. Even seemingly small differences in
expenses can, over time, have a dramatic effect on a portfolio's performance.
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--------------------------------------------------------------------------------
PORTFOLIO PROFILE--MONEY MARKET PORTFOLIO
--------------------------------------------------------------------------------
The following profile summarizes key features of Vanguard Variable Insurance
Fund-Money Market Portfolio.
INVESTMENT OBJECTIVE
The Money Market Portfolio seeks to provide income while maintaining liquidity
and a stable share price of $1.
INVESTMENT STRATEGIES
The Portfolio invests in high-quality, short-term money market instruments, such
as securities backed by the full faith and credit of the U.S. government,
securities issued by U.S. government agencies, or obligations issued by
corporations and financial institutions.
PRIMARY RISKS
THE PORTFOLIO'S TOTAL RETURN AND YIELD WILL FLUCTUATE, AS SHORT-TERM INTEREST
RATES FLUCTUATE. SUCH FLUCTUATIONS CAN BE WIDE. FALLING INTEREST RATES COULD
CAUSE THE PORTFOLIO'S INCOME--AND THUS ITS TOTAL RETURN--TO DECLINE. RISING
RATES COULD CAUSE THE PORTFOLIO'S INCOME AND TOTAL RETURN TO RISE. The Portfolio
is also subject to:
- Credit risk, which is the chance that the issuer of a security will fail to
pay interest and principal in a timely manner, reducing the Portfolio's
return. Credit risk should be very low for the Portfolio.
- Manager risk, which is the chance that poor security selection will cause
the Portfolio to underperform other funds with similar investment
objectives.
AN INVESTMENT IN THE PORTFOLIO IS NOT INSURED OR GUARANTEED BY THE FEDERAL
DEPOSIT INSURANCE CORPORATION OR ANY OTHER GOVERNMENT AGENCY. ALTHOUGH THE
PORTFOLIO SEEKS TO PRESERVE THE VALUE OF YOUR INVESTMENT AT $1 PER SHARE, IT IS
POSSIBLE TO LOSE MONEY BY INVESTING IN THE PORTFOLIO.
<PAGE>
2
BAR CHART AND PERFORMANCE TABLE
The following bar chart and table provide an indication of the risks of
investing in the Money Market Portfolio. The bar chart shows the Portfolio's
performance in each calendar year since inception. The table shows how the
Portfolio's average annual total returns for one and five calendar years and
since inception compare with those of a broad-based securities market index. The
Portfolio's returns are net of its expenses, but do not reflect additional fees
and expenses that are deducted by the variable annuity or variable insurance
plan through which you invest. If such fees and expenses were included in the
calculation of the Portfolio's returns, such returns would be lower. Keep in
mind that the Portfolio's past performance does not indicate how it will perform
in the future.
------------------------------------------------------------------
ANNUAL TOTAL RETURNS*
------------------------------------------------------------------
1992 3.66%
1993 3.03%
1994 4.19%
1995 5.88%
1996 5.42%
1997 5.55%
1998 5.50%
1999 5.18%
------------------------------------------------------------------
*The Portfolio's year-to-date return as of the most recent calendar
quarter ended September 30, 2000, was 4.49%.
------------------------------------------------------------------
During the period shown in the bar chart, the highest return for a calendar
quarter was 1.66% (quarter ended September 30, 2000), and the lowest return for
a quarter was 0.75% (quarter ended June 30, 1993).
--------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS FOR YEARS ENDED DECEMBER 31, 1999
--------------------------------------------------------------------------
1 YEAR 5 YEARS SINCE INCEPTION*
--------------------------------------------------------------------------
Money Market Portfolio 5.18% 5.51% 4.85%
Salomon Smith Barney 3-Month 4.74 5.20 4.67
Treasury Index
--------------------------------------------------------------------------
*May 2, 1991.
--------------------------------------------------------------------------
If you would like to know the current seven-day yield for the Portfolio,
call a Vanguard Variable Insurance Fund Associate at 1-800-522-5555.
WHO SHOULD INVEST
The Portfolio may be a suitable investment for you if:
- You wish to add a money market fund to your existing holdings, which might
also include stock and bond investments.
- You are seeking income and stability of principal.
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PORTFOLIO PROFILE--SHORT-TERM CORPORATE PORTFOLIO
--------------------------------------------------------------------------------
The following profile summarizes key features of Vanguard Variable Insurance
Fund-Short-Term Corporate Portfolio.
INVESTMENT OBJECTIVE
The Short-Term Corporate Portfolio seeks to provide a high level of income.
INVESTMENT STRATEGIES
The Portfolio invests primarily in high-quality, short-term and
intermediate-term bonds issued by corporations. The dollar-weighted average
maturity of the Portfolio's bonds is expected to range between 1 and 3 years.
The adviser seeks to add value by adjusting the Portfolio's dollar-weighted
average maturity within the 1- to 3-year range and by emphasizing sectors and
individual securities that appear to offer good value.
PRIMARY RISKS
THE PORTFOLIO'S SHARE PRICE AND YIELD, LIKE THE OVERALL SHORT-TERM BOND MARKET,
MAY FLUCTUATE WITHIN A WIDE RANGE, SO AN INVESTOR COULD LOSE MONEY OVER SHORT OR
EVEN LONG PERIODS. The Portfolio is also subject to:
- Income risk, which is the chance that falling interest rates will cause the
Portfolio's income to decline. Income risk is generally high for short-term
bonds.
- Manager risk, which is the chance that poor security selection will cause
the Portfolio to underperform other funds with similar investment
objectives.
<PAGE>
3
- Credit risk, which is the chance that a bond issuer will fail to pay
interest and principal in a timely manner, reducing the Portfolio's return.
Credit risk should be low for this Portfolio.
PERFORMANCE
The Portfolio began operations on February 9, 1999, so performance information
(including annual total returns and average annual total returns) for a full
calendar year is not yet available.
WHO SHOULD INVEST
The Portfolio may be a suitable investment for you if:
- You wish to add a bond fund to diversify your existing holdings, which
might also include other bond, stock, and money market investments.
- You are seeking a higher level of income than that generally provided by
money market instruments.
- You are willing to accept modest fluctuations in share price.
--------------------------------------------------------------------------------
PORTFOLIO PROFILE--HIGH-GRADE BOND PORTFOLIO
--------------------------------------------------------------------------------
The following profile summarizes key features of Vanguard Variable Insurance
Fund-High-Grade Bond Portfolio.
INVESTMENT OBJECTIVE
The High-Grade Bond Portfolio seeks to provide a higher level of income by
attempting to match the performance of a broad-based market index of publicly
traded, investment-grade bonds.
INVESTMENT STRATEGIES
The Portfolio invests in a sample of fixed-income and mortgage-backed securities
included in the Lehman Brothers Aggregate Bond Index. As a group, the
Portfolio's holdings will have characteristics very similar to key
characteristics of the Index, such as market-sector weightings, average coupon
interest rates, maturity, effective duration, and credit-quality. To boost its
income, the Portfolio substitutes short-term (1- to 4-year maturities) corporate
bonds equal to about 15% of its assets for U.S. Treasury securities with similar
maturities. The Portfolio attempts to remain fully invested at all times.
PRIMARY RISKS
THE PORTFOLIO'S SHARE PRICE AND TOTAL RETURN WILL FLUCTUATE, ALONG WITH RETURNS
FOR THE OVERALL BOND MARKET, WITHIN A WIDE RANGE, SO AN INVESTOR COULD LOSE
MONEY OVER SHORT OR EVEN LONG PERIODS. The Portfolio is also subject to:
- Interest rate risk, which is the chance that bond prices overall will
decline over short or even long periods due to rising interest rates.
- Prepayment risk, which is the chance that during periods of falling
interest rates, a bond issuer will repay its higher-yielding bond earlier
than scheduled. Forced to invest the unanticipated proceeds at lower rates,
the Portfolio would experience a decline in income.
- Credit risk, which is the chance that a bond issuer will fail to pay
interest and principal in a timely manner, reducing the Portfolio's return.
Credit risk should be low for the Portfolio.
- Income risk, which is the chance that falling interest rates will cause the
Portfolio's income to decline. Income risk is generally low for longer-term
bonds.
BAR CHART AND PERFORMANCE TABLE
The following bar chart and table provide an indication of the risks of
investing in the High-Grade Bond Portfolio. The bar chart shows the Portfolio's
performance in each calendar year since inception. The table shows how the
Portfolio's average annual total returns for one and five calendar years and
since inception compare with those of a broad-based bond market index. The
Portfolio's returns are net of its expenses, but do not reflect additional fees
and expenses that are deducted by the variable annuity or variable insurance
plan through which you invest. If such fees and expenses were included in the
calculation of the Portfolio's returns, such returns would be lower. Keep in
mind that the Portfolio's past performance does not indicate how it will perform
in the future.
<PAGE>
4
------------------------------------------------------------------
ANNUAL TOTAL RETURNS*
------------------------------------------------------------------
1992 6.38%
1993 9.40%
1994 -2.68%
1995 18.04%
1996 3.53%
1997 9.40%
1998 8.60%
1999 -0.80%
------------------------------------------------------------------
*The Portfolio's year-to-date return as of the most recent calendar
quarter ended September 30, 2000, was 6.82%.
------------------------------------------------------------------
During the period shown in the bar chart, the highest return for a calendar
quarter was 6.00% (quarter ended June 30, 1995), and the lowest return for a
quarter was -2.78% (quarter ended March 31, 1994).
--------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS FOR YEARS ENDED DECEMBER 31, 1999
--------------------------------------------------------------------------
1 YEAR 5 YEARS SINCE INCEPTION*
--------------------------------------------------------------------------
High-Grade Bond Portfolio -0.80% 7.57% 7.05%
Lehman Aggregate Bond Index -0.82 7.73 7.38
--------------------------------------------------------------------------
*April 29, 1991.
--------------------------------------------------------------------------
WHO SHOULD INVEST
The Portfolio may be a suitable investment for you if:
- You wish to add a low-cost, widely diversified bond fund to your existing
holdings, which might also include other bond investments as well as stock
and money market investments.
- You are seeking a higher level of income than that generally provided by
money market instruments or short-term bonds.
- You are willing to accept moderate fluctuations in share price.
--------------------------------------------------------------------------------
PORTFOLIO PROFILE--HIGH YIELD BOND PORTFOLIO
--------------------------------------------------------------------------------
The following profile summarizes key features of Vanguard Variable Insurance
Fund-High Yield Bond Portfolio.
INVESTMENT OBJECTIVE
The High Yield Bond Portfolio seeks to provide a high level of income.
INVESTMENT STRATEGIES
The Portfolio invests primarily in a diversified group of high-yielding,
higher-risk corporate bonds with medium- and lower-range credit-quality ratings,
commonly known as "junk bonds." The Portfolio emphasizes higher grades of credit
quality within the high-yield bond universe, and under normal circumstances will
invest at least 80% of its assets in issues that have received B or higher
credit ratings from independent rating agencies or in unrated securities of
comparable quality. The Portfolio may not invest more than 20% of its assets in
securities with credit ratings lower than B or that are unrated. The adviser may
consider a security's potential for capital appreciation only when it is
consistent with the objective of high and sustainable current income.
PRIMARY RISKS
THE PORTFOLIO'S SHARE PRICE AND TOTAL RETURN WILL FLUCTUATE, ALONG WITH RETURNS
FOR THE OVERALL HIGH-YIELD BOND MARKET, WITHIN A WIDE RANGE, SO AN INVESTOR
COULD LOSE MONEY OVER SHORT OR EVEN LONG PERIODS. The Portfolio is also subject
to:
- Credit risk, which is the chance that a bond issuer will fail to pay
interest and principal in a timely manner, reducing the Portfolio's return.
Credit risk is high for this Portfolio.
- Interest rate risk, which is the chance that bond prices overall will
decline over short or even long periods due to rising interest rates.
- Manager risk, which is the chance that poor security selection will cause
the Portfolio to underperform other funds with similar investment
objectives.
- Income risk, which is the chance that falling interest rates will cause the
Portfolio's income to decline. Income risk is generally moderate for
intermediate-term bonds.
<PAGE>
5
BAR CHART AND PERFORMANCE TABLE
The following bar chart and table provide an indication of the risks of
investing in the High Yield Bond Portfolio. The bar chart shows the Portfolio's
performance in each calendar year since inception. The table shows how the
Portfolio's average annual total returns for one calendar year and since
inception compare with those of a broad-based bond market index. The Portfolio's
returns are net of its expenses, but do not reflect additional fees and expenses
that are deducted by the variable annuity or variable insurance plan through
which you invest. If such fees and expenses were included in the calculation of
the Portfolio's returns, such returns would be lower. Keep in mind that the
Portfolio's past performance does not indicate how it will perform in the
future.
------------------------------------------------------------------
ANNUAL TOTAL RETURNS*
------------------------------------------------------------------
1997 12.07%
1998 4.06%
1999 2.89%
------------------------------------------------------------------
*The Portfolio's year-to-date return as of the most recent calendar
quarter ended September 30, 2000, was 1.02%.
------------------------------------------------------------------
During the period shown in the bar chart, the highest return for a calendar
quarter was 5.08% (quarter ended June 30, 1997), and the lowest return for a
quarter was -2.66% (quarter ended September 30, 1998).
--------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS FOR YEARS ENDED DECEMBER 31, 1999
--------------------------------------------------------------------------
1 YEAR SINCE INCEPTION*
--------------------------------------------------------------------------
High Yield Bond Portfolio 2.89% 7.79%
Lehman Brothers High Yield Bond Index 2.39 7.02
--------------------------------------------------------------------------
*June 3, 1996.
--------------------------------------------------------------------------
WHO SHOULD INVEST
The Portfolio may be a suitable investment for you if:
- You are seeking a high level of income and are willing to take substantial
risks in pursuit of higher returns.
- You have a long-term investment horizon--more than five years.
--------------------------------------------------------------------------------
PORTFOLIO PROFILE--BALANCED PORTFOLIO
--------------------------------------------------------------------------------
The following profile summarizes key features of Vanguard Variable Insurance
Fund-Balanced Portfolio.
INVESTMENT OBJECTIVE
The Balanced Portfolio seeks to conserve capital, while providing moderate
income and moderate long-term growth of capital and income.
INVESTMENT STRATEGIES
The Balanced Portfolio invests 60% to 70% of its assets in dividend-paying
stocks of established large and medium-sized companies that, in the adviser's
opinion, are undervalued but have improving prospects. The remaining 30% to 40%
of assets are invested primarily in high-quality, long-term corporate bonds,
with some exposure to U.S. Treasury, government agency, and mortgage-backed
bonds.
PRIMARY RISKS
THE PORTFOLIO'S TOTAL RETURN, LIKE THE PRICES OF STOCKS AND BONDS GENERALLY,
WILL FLUCTUATE WITHIN A WIDE RANGE, SO AN INVESTOR COULD LOSE MONEY OVER SHORT
OR EVEN LONG PERIODS. The Portfolio is also subject to:
- Manager risk, which is the chance that poor security selection will cause
the Portfolio to underperform other funds with similar investment
objectives.
- Investment style risk, which is the chance that returns from
large-capitalization value stocks will trail returns from other asset
classes or the overall stock market. Large-cap value stocks tend to go
through cycles of doing better--or worse--than the stock market in general.
These periods have, in the past, lasted for as long as several years.
<PAGE>
6
- Interest rate risk, which is the chance that bond prices overall will
decline over short or even long periods due to rising interest rates.
- Credit risk, which is the chance that a bond issuer will fail to pay
interest and principal in a timely manner, reducing the Portfolio's return.
Credit risk is low for the Portfolio.
BAR CHART AND PERFORMANCE TABLE
The following bar chart and table provide an indication of the risks of
investing in the Balanced Portfolio. The bar chart shows the Portfolio's
performance in each calendar year since inception. The table shows how the
Portfolio's average annual total returns for one and five calendar years and
since inception compare with those of both the Standard & Poor's 500 Index and a
composite index weighted 65% in the S&P 500 Index and 35% in a broad-based bond
market index. The Portfolio's returns are net of its expenses, but do not
reflect additional fees and expenses that are deducted by the variable annuity
or variable insurance plan through which you invest. If such fees and expenses
were included in the calculation of the Portfolio's returns, such returns would
be lower. Keep in mind that the Portfolio's past performance does not indicate
how it will perform in the future.
------------------------------------------------------------------
ANNUAL TOTAL RETURNS*
------------------------------------------------------------------
1992 7.18%
1993 13.18%
1994 -0.61%
1995 32.43%
1996 16.23%
1997 23.13%
1998 12.04%
1999 4.32%
------------------------------------------------------------------
*The Portfolio's year-to-date return as of the most recent calendar
quarter ended September 30, 2000, was 3.16%.
------------------------------------------------------------------
During the period shown in the bar chart, the highest return for a calendar
quarter was 12.06% (quarter ended June 30, 1997), and the lowest return for a
quarter was -5.23% (quarter ended September 30, 1999).
--------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS FOR YEARS ENDED DECEMBER 31, 1999
--------------------------------------------------------------------------
1 YEAR 5 YEARS SINCE INCEPTION*
--------------------------------------------------------------------------
Balanced Portfolio 4.32% 17.24% 13.14%
S&P 500 Index 21.04 28.56 19.92
Composite Stock/Bond
Index** 10.61 21.39 15.52
--------------------------------------------------------------------------
*May 23, 1991.
**Weighted 65% in the S&P 500 Index and 35% in the Lehman Brothers Long
Credit A or Better Bond Index.
--------------------------------------------------------------------------
WHO SHOULD INVEST
The Portfolio may be a suitable investment for you if:
- You wish to add a balanced fund to your existing holdings, which might also
include other stock and bond or money market investments.
- You want a simple way to invest in a relatively fixed percentage of stocks
and bonds.
- You are seeking moderate growth of your capital over the long term--at
least five years--while at the same time conserving your capital.
- You are seeking a moderate level of income.
--------------------------------------------------------------------------------
PORTFOLIO PROFILE--EQUITY INCOME PORTFOLIO
--------------------------------------------------------------------------------
The following profile summarizes key features of Vanguard Variable Insurance
Fund-Equity Income Portfolio.
INVESTMENT OBJECTIVE
The Equity Income Portfolio seeks to provide a relatively high level of current
income and the potential for long-term growth of capital and income.
INVESTMENT STRATEGIES
The Portfolio invests primarily in common stocks of well-established companies
that pay relatively high levels of dividend income and have the potential for
capital appreciation. The adviser selects stocks whose dividend yields relative
to the stock
<PAGE>
7
market are high in comparison with historical ranges. Such stocks are often
considered to be "value" stocks. In addition, the adviser looks for companies
committed to paying dividends consistently.
PRIMARY RISKS
THE PORTFOLIO'S TOTAL RETURN, LIKE STOCK PRICES GENERALLY, WILL FLUCTUATE WITHIN
A WIDE RANGE, SO AN INVESTOR COULD LOSE MONEY OVER SHORT OR EVEN LONG PERIODS.
STOCK MARKETS TEND TO MOVE IN CYCLES, WITH PERIODS OF RISING PRICES AND PERIODS
OF FALLING PRICES. The Portfolio is also subject to:
- Manager risk, which is the chance that poor security selection will cause
the Portfolio to underperform other funds with similar investment
objectives.
- Investment style risk, which is the chance that returns from high-yielding
value stocks will trail returns from other asset classes or the overall
stock market. Value stocks tend to go through cycles of doing better--or
worse--than the stock market in general. These periods have, in the past,
lasted for as long as several years.
BAR CHART AND PERFORMANCE TABLE
The following bar chart and table provide an indication of the risks of
investing in the Equity Income Portfolio. The bar chart shows the Portfolio's
performance in each calendar year since inception. The table shows how the
Portfolio's average annual total returns for one and five calendar years and
since inception compare with those of a broad-based stock market index. The
Portfolio's returns are net of its expenses, but do not reflect additional fees
and expenses that are deducted by the variable annuity or variable insurance
plan through which you invest. If such fees and expenses were included in the
calculation of the Portfolio's returns, such returns would be lower. Keep in
mind that the Portfolio's past performance does not indicate how it will perform
in the future.
------------------------------------------------------------------
ANNUAL TOTAL RETURNS*
------------------------------------------------------------------
1994 -1.24%
1995 38.90%
1996 18.69%
1997 34.39%
1998 17.62%
1999 -2.51%
------------------------------------------------------------------
*The Portfolio's year-to-date return as of the most recent calendar
quarter ended September 30, 2000, was 3.70%.
------------------------------------------------------------------
During the period shown in the bar chart, the highest return for a calendar
quarter was 13.21% (quarter ended June 30, 1997), and the lowest return for a
quarter was -8.58% (quarter ended September 30, 1999).
--------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS FOR YEARS ENDED DECEMBER 31, 1999
--------------------------------------------------------------------------
1 YEAR 5 YEARS SINCE INCEPTION*
--------------------------------------------------------------------------
Equity Income Portfolio -2.51% 20.50% 15.93%
S&P 500 Index 21.04 28.56 22.36
--------------------------------------------------------------------------
*June 7, 1993.
--------------------------------------------------------------------------
WHO SHOULD INVEST
The Portfolio may be a suitable investment for you if:
- You wish to add a value stock fund to your existing holdings, which could
include other stock investments as well as bond and money market
investments.
- You want a relatively high level of dividend income and the potential for
long-term capital appreciation.
- You are seeking to invest in a category of stocks that historically has had
below-average price volatility.
--------------------------------------------------------------------------------
PORTFOLIO PROFILE--DIVERSIFIED VALUE PORTFOLIO
--------------------------------------------------------------------------------
The following profile summarizes key features of Vanguard Variable Insurance
Fund-Diversified Value Portfolio.
INVESTMENT OBJECTIVE
The Diversified Value Portfolio seeks to provide long-term growth of capital and
a moderate level of dividend income.
<PAGE>
8
INVESTMENT STRATEGIES
The Portfolio invests primarily in common stocks of large and medium-size
companies whose stocks are considered by the adviser to be undervalued and out
of favor with investors. Such "value" stocks typically have above-average
dividend yields and/or below-average prices in relation to such financial
measures as earnings, book value, and cash flow.
PRIMARY RISKS
THE PORTFOLIO'S TOTAL RETURN, LIKE STOCK PRICES GENERALLY, WILL FLUCTUATE WITHIN
A WIDE RANGE, SO AN INVESTOR COULD LOSE MONEY OVER SHORT OR EVEN LONG PERIODS.
STOCK MARKETS TEND TO MOVE IN CYCLES, WITH PERIODS OF RISING PRICES AND PERIODS
OF FALLING PRICES. The Portfolio is also subject to:
- Manager risk, which is the chance that poor security selection will cause
the Portfolio to underperform other funds with similar investment
objectives.
- Investment style risk, which is the chance that returns from value stocks
will trail returns from other asset classes or the overall stock market.
Value stocks tend to go through cycles of doing better--or worse--than the
stock market in general. These periods have, in the past, lasted for as
long as several years.
PERFORMANCE
The Portfolio began operations on February 9, 1999, so performance information
(including annual total returns and average annual total returns) for a full
calendar year is not yet available.
WHO SHOULD INVEST
The Portfolio may be a suitable investment for you if:
- You wish to add a stock fund to your existing holdings, which could include
other stock investments as well as bond and money market investments.
- You want a stock fund employing a value approach in seeking long-term
growth in capital as well as a moderate level of dividend income.
--------------------------------------------------------------------------------
PORTFOLIO PROFILE--EQUITY INDEX PORTFOLIO
--------------------------------------------------------------------------------
The following profile summarizes key features of Vanguard Variable Insurance
Fund-Equity Index Portfolio.
INVESTMENT OBJECTIVE
The Equity Index Portfolio seeks to provide long-term growth of capital and
income by attempting to match the performance of a broad-based market index of
stocks of large U.S. companies.
INVESTMENT STRATEGIES
The Portfolio employs a "passively" managed--or index--approach, by holding all
of the stocks in the Standard & Poor's 500 Composite Stock Price Index in
roughly the same proportion to their weighting in the Index. Stocks represented
in the Index, and thus the Portfolio's holdings, are weighted according to each
stock's market capitalization (shares outstanding x share price). For example,
if a specific stock represented 2% of the S&P 500 Index, the Portfolio would
invest 2% of its assets in that company.
PRIMARY RISKS
THE PORTFOLIO'S TOTAL RETURN, LIKE STOCK PRICES GENERALLY, WILL FLUCTUATE WITHIN
A WIDE RANGE, SO AN INVESTOR COULD LOSE MONEY OVER SHORT OR EVEN LONG PERIODS.
STOCK MARKETS TEND TO MOVE IN CYCLES, WITH PERIODS OF RISING PRICES AND PERIODS
OF FALLING PRICES. The Portfolio is also subject to:
- Investment style risk, which is the chance that returns from
large-capitalization stocks will trail returns from other asset classes or
the overall stock market. Although the S&P 500 Index represents about 75%
of the market value of the entire U.S. stock market, large-cap stocks tend
to go through cycles of doing better--or worse--than the stock market in
general. These periods have, in the past, lasted for as long as several
years.
Keep in mind that an index fund has operating expenses; a market index does
not. Therefore, an index fund--while expected to track its target index as
closely as possible--will not be able to match the performance of the index
exactly.
BAR CHART AND PERFORMANCE TABLE
The following bar chart and table provide an indication of the risks of
investing in the Equity Index Portfolio. The bar chart shows the Portfolio's
performance in each calendar year since inception. The table shows how the
Portfolio's average annual total returns for one and five calendar years and
since inception compare with those of a broad-based stock market
<PAGE>
9
index. The Portfolio's returns are net of its expenses, but do not reflect
additional fees and expenses that are deducted by the variable annuity or
variable insurance plan through which you invest. If such fees and expenses were
included in the calculation of the Portfolio's returns, such returns would be
lower. Keep in mind that the Portfolio's past performance does not indicate how
it will perform in the future.
------------------------------------------------------------------
ANNUAL TOTAL RETURNS*
------------------------------------------------------------------
1992 7.36%
1993 9.77%
1994 1.14%
1995 37.37%
1996 22.86%
1997 33.17%
1998 28.68%
1999 21.05%
------------------------------------------------------------------
*The Portfolio's year-to-date return as of the most recent calendar
quarter ended September 30, 2000, was -1.62%.
------------------------------------------------------------------
During the period shown in the bar chart, the highest return for a calendar
quarter was 21.42% (quarter ended December 31, 1998), and the lowest return for
a quarter was -9.93% (quarter ended September 30, 1998).
--------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS FOR YEARS ENDED DECEMBER 31, 1999
--------------------------------------------------------------------------
1 YEAR 5 YEARS SINCE INCEPTION*
--------------------------------------------------------------------------
Equity Index Portfolio 21.05% 28.48% 19.60%
S&P 500 Index 21.04 28.56 19.86
--------------------------------------------------------------------------
*April 29, 1991.
--------------------------------------------------------------------------
WHO SHOULD INVEST
The Portfolio may be a suitable investment for you if:
- You wish to add a low-cost, large-capitalization stock index fund to your
existing holdings, which could include other stock investments as well as
bond and money market investments.
- You want the potential for long-term capital appreciation, with a moderate
level of dividend income.
--------------------------------------------------------------------------------
PORTFOLIO PROFILE--MID-CAP INDEX PORTFOLIO
--------------------------------------------------------------------------------
The following profile summarizes key features of Vanguard Variable Insurance
Fund-Mid-Cap Index Portfolio.
INVESTMENT OBJECTIVE
The Mid-Cap Index Portfolio seeks to provide long-term growth of capital by
attempting to match the performance of a broad-based market index of stocks of
medium-size U.S. companies.
INVESTMENT STRATEGIES
The Portfolio employs a "passively" managed--or index--approach, by holding the
stocks in the Standard & Poor's MidCap 400 Index in roughly the same proportion
to their weighting in the Index. Stocks represented in the Index, and thus the
Portfolio's holdings, are weighted according to each stock's market
capitalization. For example, if a specific stock represented 5% of the S&P
MidCap 400 Index, the Portfolio would invest 5% of its assets in that company.
PRIMARY RISKS
THE PORTFOLIO'S TOTAL RETURN, LIKE STOCK PRICES GENERALLY, WILL FLUCTUATE WITHIN
A WIDE RANGE, SO AN INVESTOR COULD LOSE MONEY OVER SHORT OR EVEN LONG PERIODS.
STOCK MARKETS TEND TO MOVE IN CYCLES, WITH PERIODS OF RISING PRICES AND PERIODS
OF FALLING PRICES. The Portfolio is also subject to:
- Investment style risk, which is the chance that returns from
mid-capitalization stocks will trail returns from other asset classes or
the overall stock market. Mid-cap stocks tend to go through cycles of doing
better--or worse--than the stock market in general. These periods have, in
the past, lasted for as long as several years.
Keep in mind that an index fund has operating expenses; a market index does
not. Therefore, an index fund--while expected to track its target index as
closely as possible--will not be able to match the performance of the index
exactly.
<PAGE>
10
PERFORMANCE
The Portfolio began operations on February 9, 1999, so performance information
(including annual total returns and average annual total returns) for a full
calendar year is not yet available.
WHO SHOULD INVEST
The Portfolio may be a suitable investment for you if:
- You wish to add a low-cost, mid-capitalization stock index fund to your
existing holdings, which could include other stock investments as well as
bond and money market investments.
- You want the potential for long-term capital appreciation.
--------------------------------------------------------------------------------
PORTFOLIO PROFILE--GROWTH PORTFOLIO
--------------------------------------------------------------------------------
The following profile summarizes key features of Vanguard Variable Insurance
Fund-Growth Portfolio.
INVESTMENT OBJECTIVE
The Growth Portfolio seeks to provide long-term growth of capital.
INVESTMENT STRATEGIES
The Portfolio invests in large-capitalization stocks of high-quality, seasoned
U.S. companies with records of superior growth. The Portfolio chooses companies
with strong positions in their markets, reasonable financial strength, and low
sensitivity to changing economic conditions.
PRIMARY RISKS
THE PORTFOLIO'S TOTAL RETURN, LIKE STOCK PRICES GENERALLY, WILL FLUCTUATE WITHIN
A WIDE RANGE, SO AN INVESTOR COULD LOSE MONEY OVER SHORT OR EVEN LONG PERIODS.
STOCK MARKETS TEND TO MOVE IN CYCLES, WITH PERIODS OF RISING PRICES AND PERIODS
OF FALLING PRICES. Because the Portfolio invests a higher percentage of assets
in its ten largest holdings than the average stock fund, the Portfolio is
subject to the risk that its performance may be hurt disproportionately by the
poor performance of relatively few stocks. The Portfolio is also subject to:
- Investment style risk, which is the chance that returns from
large-capitalization growth stocks will trail returns from other asset
classes or the overall stock market. Large-cap growth stocks tend to go
through cycles of doing better--or worse--than the stock market in general.
These periods have, in the past, lasted for as long as several years.
- Manager risk, which is the chance that poor security selection will cause
the Portfolio to underperform other funds with similar investment
objectives.
BAR CHART AND PERFORMANCE TABLE
The following bar chart and table provide an indication of the risks of
investing in the Growth Portfolio. The bar chart shows the Portfolio's
performance in each calendar year since inception. The table shows how the
Portfolio's average annual total returns for one and five calendar years and
since inception compare with those of a broad-based stock market index. The
Portfolio's returns are net of its expenses, but do not reflect additional fees
and expenses that are deducted by the variable annuity or variable insurance
plan through which you invest. If such fees and expenses were included in the
calculation of the Portfolio's returns, such returns would be lower. Keep in
mind that the Portfolio's past performance does not indicate how it will perform
in the future.
------------------------------------------------------------------
ANNUAL TOTAL RETURNS*
------------------------------------------------------------------
1994 4.29%
1995 38.33%
1996 26.90%
1997 26.64%
1998 40.75%
1999 22.43%
------------------------------------------------------------------
*The Portfolio's year-to-date return as of the most recent calendar
quarter ended September 30, 2000, was 6.43%.
------------------------------------------------------------------
During the period shown in the bar chart, the highest return for a calendar
quarter was 24.90% (quarter ended December 31, 1998), and the lowest return for
a quarter was -9.15% (quarter ended September 30, 1998).
<PAGE>
11
--------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS FOR YEARS ENDED DECEMBER 31, 1999
--------------------------------------------------------------------------
1 YEAR 5 YEARS SINCE INCEPTION*
--------------------------------------------------------------------------
Growth Portfolio 22.43% 30.81% 24.58%
S&P 500 Index 21.04 28.56 22.36
--------------------------------------------------------------------------
*June 7, 1993.
--------------------------------------------------------------------------
WHO SHOULD INVEST
The Portfolio may be a suitable investment for you if:
- You wish to add a fund emphasizing large-capitalization growth stocks to
your existing holdings, which could include other stock investments as well
as bond and money market investments.
- You are seeking growth of capital over the long term--at least five years.
- You are not looking for dividend income.
- You are willing to assume the above-average risk associated with investing
in a concentrated portfolio of growth stocks.
--------------------------------------------------------------------------------
PORTFOLIO PROFILE--SMALL COMPANY GROWTH PORTFOLIO
--------------------------------------------------------------------------------
The following profile summarizes key features of Vanguard Variable Insurance
Fund-Small Company Growth Portfolio.
INVESTMENT OBJECTIVE
The Small Company Growth Portfolio seeks to provide long-term growth of capital.
INVESTMENT STRATEGIES
The Portfolio invests mainly in the stocks of smaller companies (which, at the
time of purchase, typically have a market value of less than $1-$2 billion).
These companies are considered by the Portfolio's advisers to have above-average
prospects for growth, but often provide little or no dividend income.
PRIMARY RISKS
THE PORTFOLIO'S TOTAL RETURN, LIKE STOCK PRICES GENERALLY, WILL FLUCTUATE WITHIN
A WIDE RANGE, SO AN INVESTOR COULD LOSE MONEY OVER SHORT OR EVEN LONG PERIODS.
STOCK MARKETS TEND TO MOVE IN CYCLES, WITH PERIODS OF RISING PRICES AND PERIODS
OF FALLING PRICES. The Portfolio is also subject to:
- Investment style risk, which is the chance that returns from
small-capitalization growth stocks will trail returns from other asset
classes or the overall stock market. Small-cap growth stocks tend to go
through cycles of doing better--or worse--than the stock market in general.
These periods have, in the past, lasted for as long as several years.
- Manager risk, which is the chance that poor security selection will cause
the Portfolio to underperform other funds with similar investment
objectives.
BAR CHART AND PERFORMANCE TABLE
The following bar chart and table provide an indication of the risks of
investing in the Small Company Growth Portfolio. The bar chart shows the
Portfolio's performance in each calendar year since inception. The table shows
how the Portfolio's average annual total returns for one calendar year and since
inception compare with those of a broad-based stock market index. The
Portfolio's returns are net of its expenses, but do not reflect additional fees
and expenses that are deducted by the variable annuity or variable insurance
plan through which you invest. If such fees and expenses were included in the
calculation of the Portfolio's returns, such returns would be lower. Keep in
mind that the Portfolio's past performance does not indicate how it will perform
in the future.
------------------------------------------------------------------
ANNUAL TOTAL RETURNS*
------------------------------------------------------------------
1997 13.27%
1998 7.95%
1999 61.34%
------------------------------------------------------------------
*The Portfolio's year-to-date return as of the most recent calendar
quarter ended September 30, 2000, was 19.74%.
------------------------------------------------------------------
<PAGE>
12
During the period shown in the bar chart, the highest return for a calendar
quarter was 47.30% (quarter ended December 31, 1999), and the lowest return for
a quarter was -16.11% (quarter ended September 30, 1998).
--------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS FOR YEARS ENDED DECEMBER 31, 1999
--------------------------------------------------------------------------
1 YEAR SINCE INCEPTION*
--------------------------------------------------------------------------
Small Company Growth Portfolio 61.34% 20.07%
Small Company Index** 23.32 11.21
--------------------------------------------------------------------------
*June 3, 1996.
**Russell 2000 Stock Index through July 1997; Small Company Growth Fund
Stock Index, thereafter.
--------------------------------------------------------------------------
WHO SHOULD INVEST
The Portfolio may be a suitable investment for you if:
- You wish to add a small-capitalization growth stock fund to your existing
holdings, which could include other stock investments as well as bond and
money market investments.
- You are seeking growth of capital over the long term--at least five years.
- You are not looking for dividend income.
- You are willing to assume the above-average risk associated with investing
in small-cap growth stocks.
--------------------------------------------------------------------------------
PORTFOLIO PROFILE--INTERNATIONAL PORTFOLIO
--------------------------------------------------------------------------------
The following profile summarizes key features of Vanguard Variable Insurance
Fund-International Portfolio.
INVESTMENT OBJECTIVE
The International Portfolio seeks to provide long-term growth of capital.
INVESTMENT STRATEGIES
The Portfolio invests in the stocks of seasoned companies located outside of the
United States. In selecting stocks, the investment adviser evaluates foreign
markets around the world. Within markets regarded as having favorable investment
climates, the adviser selects companies with above-average growth potential
whose stocks sell at reasonable prices.
PRIMARY RISKS
THE PORTFOLIO'S TOTAL RETURN, LIKE INTERNATIONAL STOCK PRICES GENERALLY, WILL
FLUCTUATE WITHIN A WIDE RANGE, SO AN INVESTOR COULD LOSE MONEY OVER SHORT OR
EVEN LONG PERIODS. IN ADDITION TO FACING STOCK MARKET RISK, THE PORTFOLIO IS
SUBJECT TO THE RISKS ASSOCIATED WITH FOREIGN INVESTING. Among these are:
- Currency risk, which is the chance that returns will be hurt by a rise in
the value of the U.S. dollar versus foreign currencies.
- Country risk, which is the chance that a country's economy will be hurt by
political troubles, financial problems, or natural disasters.
- Manager risk, which is the chance that poor security selection will cause
the Portfolio to underperform other funds with similar investment
objectives.
BAR CHART AND PERFORMANCE TABLE
The following bar chart and table provide an indication of the risks of
investing in the International Portfolio. The bar chart shows the Portfolio's
performance in each calendar year since inception. The table shows how the
Portfolio's average annual total returns for one and five calendar years and
since inception compare with those of a broad-based international stock market
index. The Portfolio's returns are net of its expenses, but do not reflect
additional fees and expenses that are deducted by the variable annuity or
variable insurance plan through which you invest. If such fees and expenses were
included in the calculation of the Portfolio's returns, such returns would be
lower. Keep in mind that the Portfolio's past performance does not indicate how
it will perform in the future.
<PAGE>
13
------------------------------------------------------------------
ANNUAL TOTAL RETURNS*
------------------------------------------------------------------
1995 15.90%
1996 14.60%
1997 3.34%
1998 18.83%
1999 25.39%
------------------------------------------------------------------
*The Portfolio's year-to-date return as of the most recent calendar
quarter ended September 30, 2000, was -6.46%.
------------------------------------------------------------------
During the period shown in the bar chart, the highest return for a calendar
quarter was 21.12% (quarter ended December 31, 1999), and the lowest return for
a quarter was -11.96% (quarter ended September 30, 1998).
--------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS FOR YEARS ENDED DECEMBER 31, 1999
--------------------------------------------------------------------------
1 YEAR 5 YEARS SINCE INCEPTION*
--------------------------------------------------------------------------
International Portfolio 25.39% 15.38% 14.01%
MSCI EAFE Index 27.30 13.15 11.53
--------------------------------------------------------------------------
*June 3, 1994.
--------------------------------------------------------------------------
WHO SHOULD INVEST
The Portfolio may be a suitable investment for you if:
- You wish to add an international stock fund to your existing holdings,
which could include other stock investments as well as bond and money
market investments.
- You are seeking growth of capital over the long term--at least five years.
- You are not looking for income.
- You are willing to assume the additional risks (including currency and
country risk) associated with international stocks.
--------------------------------------------------------------------------------
PORTFOLIO PROFILE--REIT INDEX PORTFOLIO
--------------------------------------------------------------------------------
The following profile summarizes key features of Vanguard Variable Insurance
Fund-REIT Index Portfolio.
INVESTMENT OBJECTIVE
The REIT Index Portfolio seeks to provide a high level of income and moderate
long-term growth of capital.
INVESTMENT STRATEGIES
The Portfolio invests in the stocks of real estate investment trusts (REITs),
which own office buildings, hotels, shopping centers, and other properties. The
Portfolio employs a "passively" managed--or index--approach, by holding a mix of
securities that seeks to match the performance of the Morgan Stanley REIT Index,
a benchmark of U.S. REITs. Holdings of the Index, and thus of the Portfolio, are
weighted according to each stock's market capitalization. The Portfolio holds
each stock found in the Index in approximately the same proportion as
represented in the Index itself. For example, if a specific stock represented 2%
of the Morgan Stanley REIT Index, the Portfolio would invest 2% of its assets in
that stock.
PRIMARY RISKS
THE PORTFOLIO'S TOTAL RETURN, LIKE RETURNS ON REITS GENERALLY, WILL FLUCTUATE
WITHIN A WIDE RANGE, SO AN INVESTOR COULD LOSE MONEY OVER SHORT OR EVEN LONG
PERIODS. STOCK MARKETS TEND TO MOVE IN CYCLES, WITH PERIODS OF RISING PRICES AND
PERIODS OF FALLING PRICES. The Portfolio is also subject to:
- Real estate industry risk, which is the chance that REIT share prices or
the market value of underlying properties could fall.
- Interest rate risk, which is the chance that increases in interest rates
could hurt REIT performance.
- Income risk, which is the chance that dividends paid by REITs will decline.
Keep in mind that an index fund has operating expenses; a market index does
not. Therefore, an index fund--while expected to track its target index as
closely as possible--will not be able to match the performance of the index
exactly.
<PAGE>
14
PERFORMANCE
The Portfolio began operations on February 9, 1999, so performance information
(including annual total returns and average annual total returns) for a full
calendar year is not yet available.
WHO SHOULD INVEST
The Portfolio may be a suitable investment for you if:
- You are looking for a simple way to gain indirect exposure to the real
estate market to further diversify your existing holdings, which could
include other stock, bond, and money market investments.
- You want a stock fund that offers the potential for above-average dividend
income. (Historically, the securities that make up the Index have provided
higher dividend income than those in the S&P 500 Index.)
- You are seeking modest growth of capital over the long term--at least five
years.
MORE ON THE PORTFOLIOS
This prospectus describes risks you would face as an investor in any of the
Portfolios of Vanguard Variable Insurance Fund. It is important to keep in mind
one of the main axioms of investing: The higher the risk of losing money, the
higher the potential reward. The reverse, also, is generally true: The lower the
risk, the lower the potential reward. As you consider an investment in any
mutual fund, you should take into account your personal tolerance for daily
fluctuations in the financial markets. Look for this [FLAG] symbol throughout
the prospectus. It is used to mark detailed information about each type of risk
that you would confront as a shareholder of a Portfolio.
Each of the Portfolios follows a distinct set of investment policies and
strategies. This section explains the policies and strategies used by the
investment advisers in pursuit of each Portfolio's objective, and how the
advisers implement these policies and strategies. In addition, this section
discusses important risks faced by investors in the Portfolios.
The section begins with policy information that applies to all the
Portfolios. Next is information specific to the Money Market Portfolio, the
three bond Portfolios, the Balanced Portfolio, and the eight Portfolios that
invest in stocks.
The Fund's board of trustees, which oversees the management of the
Portfolios, may change investment strategies or policies in the interest of
shareholders.
MARKET RISK
[FLAG] EACH OF THE PORTFOLIOS IS SUBJECT TO MARKET RISK--THAT IS, FLUCTUATIONS
IN RETURNS CAUSED BY THE RISE AND FALL OF YIELDS AND PRICES WITHIN THE
OVERALL MARKETS IN WHICH EACH PORTFOLIO INVESTS.
You'll find more detail about the risks that you would face as an investor
as you read about each Portfolio on the following pages.
MANAGER RISK
Nine of the Portfolios are actively managed, meaning that their investment
advisers buy and sell securities based on research, judgment, and analysis in an
attempt to outperform the market as a whole. These nine Portfolios are the MONEY
MARKET, SHORT-TERM CORPORATE, HIGH YIELD BOND, BALANCED, EQUITY INCOME,
DIVERSIFIED VALUE, GROWTH, SMALL COMPANY GROWTH, and INTERNATIONAL PORTFOLIOS.
[FLAG] BECAUSE THEY ARE ACTIVELY MANAGED, THESE PORTFOLIOS ARE SUBJECT TO
MANAGER RISK, WHICH IS THE CHANCE THAT THEIR ADVISERS WILL DO A POOR JOB OF
SELECTING SECURITIES.
Four Portfolios--HIGH-GRADE BOND, EQUITY INDEX, MID-CAP INDEX, and REIT
INDEX--are index funds. Index funds are "passively" managed, meaning that their
investment advisers try to match, as closely as possible, the performance of an
established targeted index. Index funds do this by holding either all--or a
representative sample--of the securities in the target index. So, instead of
trying to outperform the market as a whole, index funds simply mirror what their
target indexes do, for better or worse. These Portfolios are subject to market
risk--share price fluctuations caused by the rise and fall of prices of the
overall markets in which they invest--but are not subject to manager risk.
FUTURES AND OPTIONS CONTRACTS
Except for the Money Market Portfolio, all of the Portfolios may invest to a
limited extent in futures and options contracts, which are traditional forms of
derivatives. Losses (or gains) involving futures can sometimes be
substantial--in part because a relatively small price movement in a futures
contract may result in an immediate and substantial loss (or gain) for a
Portfolio.
<PAGE>
15
The Portfolios will not use futures for speculative purposes or as leveraged
investments that magnify the gains or losses of an investment. A Portfolio's
obligation to purchase securities under futures contracts will not exceed 20% of
its total assets.
The reasons for which a Portfolio will invest in futures and options are:
- To keep cash on hand to meet shareholder redemptions or other needs while
simulating full investment in bonds or stocks.
- To reduce transaction costs, for hedging purposes, or to add value when
these investments are favorably priced.
--------------------------------------------------------------------------------
PLAIN TALK ABOUT
DERIVATIVES
A derivative is a financial contract whose value is based on (or "derived" from)
a traditional security (such as a stock or a bond), an asset (such as a
commodity like gold), or a market index (such as the S&P 500 Index). Some forms
of derivatives, such as exchange-traded futures and options on securities,
commodities, or indexes, have been trading on regulated exchanges for more than
two decades. These type of derivatives are standardized contracts that can
easily be bought and sold, and whose market values are determined and published
daily. Nonstandardized derivatives, on the other hand, tend to be more
specialized or complex, and may be harder to value. If used for speculation or
as leveraged investments, derivatives can carry considerable risks.
--------------------------------------------------------------------------------
OVERVIEW OF THE MONEY MARKET PORTFOLIO
The Portfolio's primary policy is to invest in very high-quality money market
instruments--also known as cash reserves or cash equivalents. These instruments
are considered short-term (that is, they mature in 13 months or less). The
Portfolio will maintain an average maturity of 90 days or less.
[FLAG] THE PORTFOLIO IS SUBJECT TO INCOME RISK, WHICH IS THE CHANCE THAT THE
PORTFOLIO'S DIVIDENDS (INCOME) WILL DECLINE BECAUSE OF FALLING INTEREST
RATES. BECAUSE THE PORTFOLIO'S INCOME IS BASED ON SHORT-TERM INTEREST
RATES--WHICH CAN FLUCTUATE SIGNIFICANTLY OVER SHORT PERIODS--INCOME RISK IS
EXPECTED TO BE HIGH.
Vanguard's Fixed Income Group (Vanguard), adviser to the Money Market
Portfolio, selects high-quality money market instruments. The Portfolio invests
in certificates of deposit, banker's acceptances, commercial paper, and other
money market securities rated Prime-1 by Moody's Investors Service, Inc., or A-1
by Standard & Poor's Corporation. Securities that are unrated must be issued by
a corporation with a debt rating of A3 or better by Moody's or A- or better by
Standard & Poor's. The Portfolio also invests in short-term corporate, state,
and municipal obligations rated A3 or better by Moody's or A- or better by
Standard & Poor's, and in securities issued by the U.S. Treasury and federal
government agencies and instrumentalities, such as the Federal Home Loan Bank.
--------------------------------------------------------------------------------
PLAIN TALK ABOUT
MONEY MARKET INSTRUMENTS
The term "money market instruments" refers to a variety of short-term, liquid
investments, usually with a maturity of 13 months or less. Some common types are
Treasury bills and notes, which are securities issued by the U.S. government;
commercial paper, which is a promissory note issued by a large company or
financial firm; banker's acceptances, which are credit instruments guaranteed by
a bank; and negotiable certificates of deposit, which are issued by banks in
large denominations.
--------------------------------------------------------------------------------
The Money Market Portfolio may also invest in Eurodollar and Yankee
obligations, which are certificates of deposit issued in U.S. dollars by foreign
banks and foreign branches of U.S. banks. Eurodollar and Yankee obligations have
the same risks, such as income risk and credit risk, as U.S. money market
instruments. Other risks of Eurodollar and Yankee obligations include the chance
that a foreign government will not let U.S. dollar-denominated assets leave the
country; the chance that the banks that issue Eurodollar obligations may not be
subject to the same regulations as U.S. banks; and the chance that adverse
political or economic developments will affect investments in a foreign country.
Before the Portfolio's adviser selects a Eurodollar or Yankee obligation,
however, any foreign issuer undergoes the same credit-quality analysis and tests
of financial strength as the issuers of domestic securities.
[FLAG] THE PORTFOLIO IS SUBJECT, TO A LIMITED EXTENT, TO CREDIT RISK, WHICH IS
THE CHANCE THAT THE ISSUER OF A SECURITY WILL FAIL TO PAY INTEREST AND
PRINCIPAL IN A TIMELY MANNER.
<PAGE>
16
In addition, the Portfolio may invest up to 10% of its net assets in
illiquid securities. Illiquid securities are not freely marketable or are
subject to legal restrictions on their sale.
The Portfolio also may invest, to a limited extent, in adjustable-rate
securities, which are traditional types of derivatives. As the name implies, a
floating-rate security's interest rate fluctuates periodically. Generally, the
security's yield is based on a U.S. dollar-based interest rate benchmark such as
the Federal Funds Rate, the 90-day Treasury bill rate, or the London Interbank
Offered Rate (LIBOR). These securities reset their yields on a periodic basis
and are closely correlated to changes in money market interest rates.
OVERVIEW OF THE BOND PORTFOLIOS
The SHORT-TERM CORPORATE, HIGH-GRADE BOND, and HIGH YIELD BOND PORTFOLIOS each
seek to provide a high level of income consistent with their respective
credit-quality and maturity guidelines. The Portfolios invest in various types
of fixed-income securities (or bonds).
[FLAG] EACH OF THE THREE PORTFOLIOS IS SUBJECT TO VARYING LEVELS OF INTEREST
RATE RISK--THE CHANCE THAT BOND PRICES WILL FALL WHEN INTEREST RATES RISE.
--------------------------------------------------------------------------------
PLAIN TALK ABOUT
TYPES OF BONDS
Bonds are issued (sold) by many sources: Corporations issue corporate bonds; the
federal government issues U.S. Treasury bonds; agencies of the federal
government issue agency bonds; and mortgage holders issue "mortgage-backed"
pass-through certificates such as those issued by the Government National
Mortgage Association (GNMAs). Each issuer is responsible for paying back the
bond's initial value as well as making periodic interest payments.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
PLAIN TALK ABOUT
BONDS AND INTEREST RATES
As a rule, when interest rates rise, bond prices fall. The opposite is also
true: Bond prices go up when interest rates fall. Why do bond prices and
interest rates move in opposite directions? Let's assume that you hold a bond
offering a 5% yield. A year later, interest rates are on the rise and bonds of
comparable quality and maturity are offered with a 6% yield. With
higher-yielding bonds available, you would have trouble selling your 5% bond for
the price you paid--you would probably have to lower your asking price. On the
other hand, if interest rates were falling and 4% bonds were being offered, you
would be able to sell your 5% bond for more than you paid.
--------------------------------------------------------------------------------
In general, interest rate fluctuations widen as a bond portfolio's average
maturity lengthens. The Short-Term Corporate Portfolio is expected to have a
comparatively low level of interest rate risk. The High-Grade Bond and High
Yield Bond Portfolios are expected to have a moderate level of interest rate
risk because their holdings have an intermediate-term average maturity.
Each Portfolio is also subject to credit risk--the chance that its share
price could decline if issuers of the bonds it holds experience financial
difficulties. Credit risk is expected to be low for the Short-Term Corporate and
High-Grade Bond Portfolios because they invest primarily in bonds with high
credit-quality ratings. Credit risk is expected to be high for the High Yield
Bond Portfolio because it invests primarily in bonds issued by corporations with
relatively low credit- quality ratings.
In addition, each of the bond Portfolios is subject to income risk--the
chance that dividends paid from net interest income will decline because of a
decline in overall interest rates. In general, income risk is highest for
short-term bond funds and lowest for long-term bond funds. Accordingly, the
Short-Term Corporate Portfolio is expected to have a relatively high level of
income risk.
FOREIGN BONDS
Each of the bond Portfolios may invest in bonds of foreign issuers, so long as
the securities are denominated in U.S. dollars. To the extent that it owns
foreign bonds, a Portfolio is subject to (1) country risk, which is the chance
that political events (such as a war), financial problems (such as a government
default), or natural disasters (such as an earthquake) will weaken a country's
economy and cause investments in that country to lose money; and (2) currency
risk, which is the chance that a rise in the value of the U.S. dollar versus
foreign currencies could make it difficult for a foreign bond issuer to make
payments on its dollar-denominated bonds.
<PAGE>
17
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PLAIN TALK ABOUT
CREDIT QUALITY
A bond's credit quality depends on the issuer's ability to pay interest on the
bond and, ultimately, to repay the debt. The lower the rating by one of the
independent bond-rating agencies (for example, Moody's or Standard & Poor's),
the greater the chance--in the rating agency's opinion--that the bond issuer
will default, or fail to meet its payment obligations. All things being equal,
the lower a bond's credit rating, the higher its yield should be to compensate
investors for assuming additional risk. Bonds rated in one of the four highest
rating categories are considered "investment grade."
--------------------------------------------------------------------------------
SHORT-TERM CORPORATE PORTFOLIO
The Portfolio invests primarily in a variety of high-quality--and, to a lesser
extent, medium-quality--fixed income securities. The Portfolio maintains a
dollar-weighted average maturity of between 1 and 3 years. Depending on the
outlook for interest rates, the adviser may adjust the average maturity of the
Portfolio's holdings within the target range. The adviser also may attempt to
improve the Portfolio's total return by emphasizing sectors and individual
securities that appear to offer good value.
At least 70% of the Portfolio's assets will be invested in high-grade
bonds, which are listed in one of the top three rating categories by an
independent bond-rating agency. The remaining assets may be invested in
fixed income securities listed in the fourth-highest rating category by an
independent agency. If the credit rating of a security owned by the Portfolio is
lowered, the Portfolio may continue to hold the security if the adviser
considers it advantageous to do so.
Although the Portfolio invests primarily in corporate debt securities, it
may invest in other types of instruments. The list below shows, at a glance, the
types of financial instruments that may be purchased by the Portfolio.
Explanations of each type of financial instrument follow the list.
Corporate Debt
U.S. Government and Agency Bonds
State and Municipal Bonds
Cash Reserves
Futures, Options, and Other Derivatives
Asset-Backed Securities
International Dollar-Denominated Bonds
Preferred Stocks
Convertible Securities
Collateralized Mortgage Obligations (CMOs)
Restricted or Illiquid Securities
- CORPORATE DEBT OBLIGATIONS--usually called bonds--represent loans by an
investor to a corporation.
- U.S. GOVERNMENT AND AGENCY BONDS represent loans by an investor to the U.S.
Treasury Department or a wide variety of governmental agencies and
instrumentalities. Timely payment of principal and interest on U.S.
Treasury bonds is always guaranteed by the full faith and credit of the
U.S. government; many (but not all) agency bonds have the same guarantee.
- STATE AND MUNICIPAL BONDS represent loans by an investor to a state or
municipal government, or one of their agencies or instrumentalities.
- CASH RESERVES is a blanket term that describes a variety of short-term
fixed income investments, including money market instruments, commercial
paper, bank certificates of deposit, banker's acceptances, and repurchase
agreements. Repurchase agreements represent short-term (normally overnight)
loans by the Portfolio to commercial banks or large securities dealers.
- FUTURES, OPTIONS, AND OTHER DERIVATIVES may represent up to 20% of the
Portfolio's total assets. These investments may be in bond futures
contracts, options, credit swaps, interest rate swaps, and other types of
derivatives.
- ASSET-BACKED SECURITIES are bonds that represent partial ownership in pools
of consumer or commercial loans--most often credit card, automobile, or
trade receivables. Asset-backed securities are issued by entities formed
solely for that purpose, but their value ultimately depends on repayments
by underlying borrowers. A primary risk of asset-backed securities is that
their maturity is difficult to predict and driven by borrowers'
prepayments.
- INTERNATIONAL DOLLAR-DENOMINATED BONDS are bonds denominated in U.S.
dollars issued by foreign governments and companies.
- PREFERRED STOCKS distribute set dividends from the issuer. The preferred
stockholder's claim on the issuer's income and assets ranks before that of
common stockholders, but after that of bondholders.
- CONVERTIBLE SECURITIES are bonds or preferred stocks that are convertible
into, or exchangeable for, common stocks.
- COLLATERALIZED MORTGAGE OBLIGATIONS (CMOS) are special bonds that are
collateralized by mortgages or mortgage pass-through securities. Cash flow
rights on underlying mortgages--the rights to receive principal and
interest payments--are divided up and prioritized to create short-,
intermediate-, and long-term bonds. CMOs rely on assumptions about the
timing of cash flows on the underlying mortgages, including expected
prepayment rates. The primary risk of a CMO is that these assumptions are
wrong, which would either shorten or lengthen the bond's maturity.
- ILLIQUID SECURITIES are securities that the Portfolio may not be able to
sell in the ordinary course of business. The Portfolio may INVEST UP TO 15%
OF ITS ASSETS IN THESE SECURITIES. RESTRICTED SECURITIES are a special type
of illiquid security; these securities have not been publicly issued and
legally can be resold only to qualified institutional buyers. From time to
time, the board of TRUSTEES MAY DETERMINE THAT PARTICULAR RESTRICTED
SECURITIES ARE NOT illiquid, and those securities may then be purchased by
the Portfolio without limit.
HIGH-GRADE BOND PORTFOLIO
The High-Grade Bond Portfolio invests in a statistically selected sample of
fixed-income and mortgage-backed securities in an attempt to parallel the
performance of the Lehman Brothers Aggregate Bond Index. This Index is a widely
recognized benchmark for the U.S. bond market, and consists of close to 7,000
government, corporate, and mortgage-backed securities. The statistical sampling
technique is used because it would be impractical and too costly to actually own
all of the securities that make up the Index.
The Lehman Brothers Aggregate Bond Index comprises four major types of
taxable bonds in the United States: U.S. Treasury and agency securities;
corporate bonds; foreign bonds denominated in U.S. dollars; and mortgage-backed
securities. As of September 30, 2000, these four types of bonds represented the
following proportions of the Portfolio's market value:
--------------------------------------------------------------------------------
PORTION OF PORTFOLIO'S
TYPE OF BOND MARKET VALUE
-------------------------------------------------------------------------------
Mortgage-backed securities 35%
Corporate bonds 33
U.S. Treasury and agency securities 24
Foreign U.S.-dollar obligations 8
-------------------------------------------------------------------------------
Since 1991, the effective dollar-weighted average maturity of the Portfolio
has ranged from a high of 13.0 years to a low of 7.4 years; it was 8.9 years on
September 30, 2000. The Portfolio attempts to remain fully invested in bonds at
all times.
In attempting to parallel the Index's performance, the adviser selects
securities that, as a group, have characteristics similar to those of the Index.
These characteristics include market-sector weightings, average coupon interest
rates, maturity, effective duration, and credit quality.
To enhance the Portfolio's return, the adviser uses a "corporate
substitution" strategy. This means that the Portfolio invests up to 15% more of
its net assets in short-term, high-quality corporate bonds (1- to 4-year
maturities) than does the Index, while holding up to 15% less of its net assets
in short-term Treasury securities.
The corporate substitution policy increases the Portfolio's overall credit
risk, but the adviser attempts to mitigate the additional risk by widely
diversifying the corporate bond holdings. Overall, the Portfolio's credit risk
is expected to be low.
<PAGE>
18
MORTGAGE-BACKED SECURITIES AND PREPAYMENT RISK
The Portfolio invests a substantial portion of its assets in mortgage-backed
securities, which represent partial ownership in pools of mortgage loans. Unlike
ordinary bonds, which usually repay principal upon maturity, mortgage-backed
securities pay some principal along with interest as part of their periodic
payments. Because it holds mortgage-backed securities, the Portfolio is subject
to prepayment risk--the chance that, when interest rates are falling, homeowners
and other mortgage borrowers will repay their loans earlier than scheduled by
refinancing at lower rates. Because of prepayment risk, mortgage-backed
securities generally do not enjoy as large a gain in market value as do other
bonds during periods of falling interest rates. Also, when prepayments occur,
the Portfolio will have to reinvest the proceeds at generally lower rates,
thereby reducing its income. Conversely, when interest rates rise, borrowers are
less likely to prepay mortgage loans, so the market value of mortgage-backed
securities may decline more than the market values of ordinary bonds. To
compensate investors for these risks, mortgage-backed securities generally offer
higher yields than bonds of comparable credit quality and maturity. The credit
quality of mortgage-backed securities is high. The Portfolio may purchase
mortgage-backed securities issued by the Government National Mortgage
Association (GNMA), the Federal Home Loan Mortgage Corporation (FHLMC), the
Federal National Mortgage Association (FNMA), and the Federal Housing Authority
(FHA). The U.S. government guarantees the timely payment of interest and
principal on GNMA securities. Securities from other government-sponsored
entities are generally not secured by an explicit pledge of the U.S. government.
Guarantees by the U.S. government or its agencies are limited to the timely
payment of interest and principal; the market values of such securities are not
guaranteed and can fluctuate widely. The Portfolio also may invest in
conventional mortgage securities to the extent that these securities are
represented in the Index. Conventional mortgage securities are packaged by
private corporations and not guaranteed by the U.S. government.
HIGH YIELD BOND PORTFOLIO
The High Yield Bond Portfolio invests in a diversified group of high-yielding
corporate bonds, commonly known as "junk bonds." The Portfolio normally will
invest at least 80% of its assets in corporate bonds with credit-quality ratings
of at least B by Moody's or Standard & Poor's, or, if unrated, of comparable
quality as determined by the Portfolio's adviser. These bonds are considered to
be "below investment grade," meaning that they carry a high degree of risk and
are considered speculative. No more than 20% of the Portfolio's assets may be
invested in debt securities rated less than B or unrated, convertible
securities, or preferred stocks. The Portfolio will not invest in securities
that are rated less than Caa ("substantial risk, in poor standing") by Moody's
or CCC by Standard & Poor's or, if unrated, of comparable quality as determined
by the Portfolio's adviser. If the credit rating of a security held by the
Portfolio is later downgraded below Caa or CCC, the Portfolio may continue to
hold it, and it will be sold only if the adviser believes it would be
advantageous to do so.
[FLAG] BECAUSE IT INVESTS IN HIGH-YIELD BONDS--WHOSE PRICES AND CREDIT QUALITY
CAN CHANGE SUDDENLY AND UNEXPECTEDLY--THE PORTFOLIO IS SUBJECT TO A HIGH
DEGREE OF CREDIT RISK, WHICH IS THE CHANCE THAT A BOND ISSUER WILL FAIL TO
PAY INTEREST AND PRINCIPAL IN A TIMELY MANNER. PRICES OF HIGH-YIELD
SECURITIES ARE LIKELY TO FLUCTUATE MORE SEVERELY THAN PRICES OF
INVESTMENT-GRADE BONDS, AND MAY FLUCTUATE INDEPENDENTLY FROM THE BROADER
BOND MARKET.
The Portfolio's adviser selects securities on an individual basis after
researching--among other things--the nature of a company's business, its
strategy, and the quality of its management. The adviser looks for bonds with
attractive yields issued by companies whose financial prospects are stable or
improving.
The share price of the High Yield Bond Portfolio is influenced not only by
changing interest rates and by market perceptions of credit quality, but also by
the outlook for economic growth. When the economy appears to be weakening or
shrinking, investors may fear that defaults on high-yield bonds will increase,
and that the market value of high-yield bonds may decline even if other bond
prices are rising due to a decline in prevailing interest rates.
--------------------------------------------------------------------------------
PLAIN TALK ABOUT
HIGH-YIELD BONDS
High-yield bonds, or "junk bonds," are bonds issued by companies or other
entities whose ability to pay interest and principal on their debts in a timely
manner is considered questionable. Such bonds are rated "below investment grade"
by independent rating agencies. Because they are riskier than investment-grade
bonds, high-yield bonds must pay more interest to attract investors. Some
high-yield bonds are issued by smaller, less-seasoned companies, while others
are issued as part of a corporate restructuring, such as an acquisition, merger,
or leveraged buyout. Some high-yield bonds were once rated as investment grade
but have been downgraded to junk-bond status because of financial difficulties
experienced by their issuers. Conversely, an issuer's improving financial
condition may result in an upgrading of its junk bonds to investment-grade
status.
--------------------------------------------------------------------------------
<PAGE>
19
During such periods, trading activity in the market for high-yield bonds
may slow, and it may become more difficult to find buyers for the bonds. In such
conditions, prices of high-yield bonds could decline suddenly and substantially,
and the Portfolio could be forced to sell securities at a significant loss to
meet shareholder redemptions. Also, there may be significant disparities in the
prices quoted for high-yield securities by bond dealers, making it difficult for
the Portfolio to value its securities accurately.
The Portfolio's adviser seeks to mitigate credit risk by diversifying
holdings across many issuers and a wide variety of industries. It also seeks to
mitigate risk by making its own independent and ongoing assessment of the credit
quality of the Portfolio's holdings rather than relying solely on the
credit-quality analyses of rating agencies.
The Portfolio may invest in asset-backed securities--that is, bonds that
represent partial ownership in pools of consumer or commercial loans, such as
mortgage loans, automobile loans, or credit-card balances. The value of
asset-backed securities ultimately depends on repayments by the underlying
borrowers. A primary risk of asset-backed securities is that it is difficult to
predict how prepayments by borrowers will affect the maturity of such
investments.
The Portfolio may invest in restricted, privately placed securities that,
under SEC rules, may only be sold to qualified institutional buyers. Because
these securities can only be resold to qualified institutional buyers, they may
be considered illiquid securities--meaning that they could be difficult for the
Portfolio to convert to cash if needed.
The Portfolio will not invest more than 15% of its net assets in illiquid
securities. If a substantial market develops for a restricted security held by
the Portfolio, it will be treated as a liquid security, in accordance with
procedures and guidelines approved by the Fund's board of trustees. While the
Portfolio's investment adviser determines the liquidity of restricted securities
on a daily basis, the Board oversees and retains ultimate responsibility for the
adviser's decisions. The factors the Board considers in monitoring these
decisions include the valuation of a security, the availability of qualified
institutional buyers, and the availability of information on the security's
issuer.
OVERVIEW OF THE BALANCED PORTFOLIO
The Balanced Portfolio invests in both stocks and bonds. It invests 60% to 70%
of its assets in common stocks, with an emphasis on dividend-paying stocks of
well-established large or medium-size companies. The Portfolio invests 30% to
40% of its assets in high-quality, long-term bonds. The combination of stocks
and bonds is intended to conserve capital, provide a reasonable level of current
income, and offer the potential for long-term growth of capital and income.
--------------------------------------------------------------------------------
PLAIN TALK ABOUT
BALANCED FUNDS
Balanced funds are generally "middle-of-the-road" investments that seek to
provide some combination of growth, income, and conservation of capital by
investing in a mix of stocks, bonds, and/or money market instruments. Because
the prices of stocks and bonds often move in different directions, balanced
funds are able to use rewards from one type of investment to help offset the
risks from another.
--------------------------------------------------------------------------------
In building the Portfolio's stock holdings, the adviser seeks to purchase
companies whose prospects are improving but whose share prices do not reflect
their value. By purchasing a diversified group of such "value" stocks, the
adviser hopes to assemble a portfolio that will produce increased income and
capital appreciation over time, with moderate risk in comparison with the stock
market as a whole.
In selecting the Portfolio's bond holdings, the adviser emphasizes
corporate bonds issued by high-quality companies. The Portfolio also invests in
bonds issued by the U.S. government and government agencies and mortgage-backed
securities. To generate a relatively stable stream of interest income, the
adviser does not generally make large adjustments in the average maturity of the
Portfolio's bond holdings in anticipation of changes in interest rates.
Although the Portfolio may hold any mix of stocks, bonds, and cash
investments it deems desirable, the adviser generally adjusts the allocation
only gradually and only within the target ranges of 60% to 70% for stocks and
30% to 40% for bonds. Such allocation changes can occur for any of three
reasons:
- To improve the Portfolio's income stream.
- Because one type of asset has significantly outperformed the other.
- Because the adviser sees greater value in one type of asset than another.
The Portfolio may invest up to 20% of its total assets in foreign
securities. To the extent that it holds foreign securities, the Portfolio is
subject to (1) country risk, which is the chance that political events (such as
a war), financial problems (such as a government default), or natural disasters
(such as an earthquake) will weaken a country's economy and cause investments in
that country to lose money; and (2) currency risk, which is the chance that
Americans investing abroad could lose money because of a rise in the value of
the U.S. dollar versus foreign currencies.
<PAGE>
20
OVERVIEW OF THE STOCK PORTFOLIOS
The EQUITY INCOME, DIVERSIFIED VALUE, EQUITY INDEX, MID-CAP INDEX, GROWTH, SMALL
COMPANY GROWTH, INTERNATIONAL, and REIT INDEX PORTFOLIOS invest primarily in
common stocks, although each has its own strategies and types of holdings.
Common stocks represent partial ownership in companies, and entitle
stockholders to share proportionately in the companies' profits (or losses) and
in any dividends they distribute.
[FLAG] EACH PORTFOLIO IS SUBJECT TO STOCK MARKET RISK, WHICH IS THE CHANCE THAT
STOCK PRICES OVERALL WILL DECLINE OVER SHORT OR EVEN LONG PERIODS. STOCK
MARKETS TEND TO MOVE IN CYCLES, WITH PERIODS OF RISING PRICES AND PERIODS
OF FALLING PRICES.
Except for the International Portfolio, which invests primarily in stocks
of companies outside of the United States, the Portfolios invest primarily in
stocks of U.S. companies. To illustrate the volatility of stock prices, the
following table shows the best, worst, and average total returns for the U.S.
stock market over various periods as measured by the S&P 500 Index, a widely
used barometer of market activity. (Total returns consist of dividend income
plus change in market price.) Although this example is based on the U.S. stock
market, international stock prices and total returns fluctuate very widely, too.
Note that the returns shown in the table do not include the costs of buying and
selling stocks or other expenses that a real-world investment portfolio would
incur. Note, also, that the gap between best and worst tends to narrow over the
long term. (You will find a chart illustrating the volatility of the
international stock market on page 24.)
--------------------------------------------------------------------------------
U.S. STOCK MARKET RETURNS (1926-1999)
--------------------------------------------------------------------------------
1 YEAR 5 YEARS 10 YEARS 20 YEARS
--------------------------------------------------------------------------------
Best 54.2% 28.6% 19.9% 17.9%
Worst -43.1 -12.4 -0.9 3.1
Average 13.2 11.0 11.1 11.1
--------------------------------------------------------------------------------
The table covers all of the 1-, 5-, 10-, and 20-year periods from 1926
through 1999. You can see, for example, that while the average return on stocks
for all of the 5-year periods was 11.0%, returns for individual 5-year periods
ranged from a -12.4% average (from 1928 through 1932) to 28.6% (from 1995
through 1999). These average returns reflect past performance on common stocks;
you should not regard them as an indication of future returns from either the
stock market as a whole or any of these Portfolios in particular.
--------------------------------------------------------------------------------
PLAIN TALK ABOUT
VALUE FUNDS AND GROWTH FUNDS
Value investing and growth investing are two styles employed by stock fund
managers. Value funds generally emphasize stocks of companies from which the
market does not expect strong growth. The prices of value stocks typically are
below-average in comparison to such factors as earnings and book value, and
these stocks typically have above-average dividend yields. Growth funds
generally focus on companies believed to have above-average potential for growth
in revenue and earnings. Reflecting the market's high expectations for superior
growth, such stocks typically have low dividend yields and above-average prices
in relation to such measures as revenue, earnings, and book values. Value and
growth stocks have, in the past, produced similar long-term returns, though each
category has periods when it outperforms the other. In general, value funds are
appropriate for investors who want some dividend income and the potential for
capital gains, but are less tolerant of share-price fluctuations. Growth funds,
by contrast, appeal to investors who will accept more volatility in hopes of a
greater increase in share price. Growth funds also may appeal to investors with
taxable accounts who want a higher proportion of returns to come as capital
gains (which may be taxed at lower rates than dividend income).
--------------------------------------------------------------------------------
INVESTMENT STYLES
Mutual funds that invest in U.S. stocks can be classified according to the
average market capitalization (shares outstanding x market price) of their
holdings. The usual categories are small-cap, mid-cap, and large-cap. Stock
funds can also be categorized according to whether the stocks they hold are
value or growth stocks or a blend of those.
<PAGE>
21
The following illustration shows how each of the seven Portfolios that
invest in U.S. stocks generally fits into these categories. (The International
Portfolio invests primarily in large-capitalization growth stocks of companies
outside the United States.)
GRID APPEARS HERE
--------------------------------------------------
FUND STYLE MARKET CAP
Equity Income VALUE LARGE
Diversified Value VALUE LARGE
Equity Index BLEND LARGE
Growth GROWTH LARGE
Mid-Cap Index BLEND MEDIUM
REIT Index VALUE SMALL
Small Company Growth GROWTH SMALL
--------------------------------------------------
[FLAG] EACH PORTFOLIO IS SUBJECT TO INVESTMENT STYLE RISK, WHICH IS THE CHANCE
THAT RETURNS FROM THE MARKET SECTOR IN WHICH IT INVESTS WILL TRAIL RETURNS
FROM OTHER MARKET SECTORS. AS A GROUP, SPECIFIC TYPES OF STOCKS (FOR
INSTANCE, SMALL-CAP STOCKS, VALUE STOCKS OR HEALTH CARE STOCKS) TEND TO GO
THROUGH CYCLES OF DOING BETTER--OR WORSE--THAN COMMON STOCKS IN GENERAL.
THESE PERIODS HAVE, IN THE PAST, LASTED FOR AS LONG AS SEVERAL YEARS.
LIKEWISE, INTERNATIONAL STOCKS GO THROUGH CYCLES OF DOING BETTER--OR
WORSE--THAN U.S. STOCKS.
FOREIGN SECURITIES
The INTERNATIONAL PORTFOLIO invests primarily in foreign securities. None of the
other stock Portfolios typically makes significant investments in securities of
companies based outside the United States. For the EQUITY INDEX, MID-CAP INDEX,
and REIT INDEX PORTFOLIOS, foreign securities will be held only to the extent
that they are represented in the target benchmark indexes. The EQUITY INCOME,
DIVERSIFIED VALUE, GROWTH, and SMALL COMPANY GROWTH PORTFOLIOS may each invest
up to 20% of their total assets in foreign securities.
To the extent that a Portfolio holds foreign securities, it is subject to
(1) country risk, which is the chance that political events (such as a war),
financial problems (such as a government default), or natural disasters (such as
an earthquake) will weaken a country's economy and cause investments in that
country to lose money; and (2) currency risk, which is the chance that returns
on a foreign security will be reduced for American investors because of a rise
in the value of the U.S. dollar versus foreign currencies.
EQUITY INCOME PORTFOLIO
The Equity Income Portfolio invests primarily in dividend-paying stocks of
large, well-established U.S. companies. The Portfolio's adviser selects a
diversified group of stocks after evaluating companies that have dividend yields
(annualized dividends divided by stock price) at least 25% higher than the
average dividend yield of the Standard & Poor's Industrial Index; a corporate
commitment and the financial ability to pay dividends consistently; a market
capitalization of at least $3 billion; and the potential for long-term capital
appreciation.
The Portfolio's investment philosophy reflects a belief that dividend
income is an important component of long-term total returns and that dividend
income is a more stable source of returns than capital change, which can be
positive or negative. Because dividend income historically has tended to be
relatively stable in the short-term, while stock prices fluctuate widely, the
total returns of stocks that pay relatively high dividend yields have usually
been less volatile than the returns of stocks with low dividend yields.
Although the Portfolio generally invests primarily in common stocks or
securities that are convertible to common stocks, it may invest up to 20% of its
total assets in cash investments and investment-grade bonds (those that have
received one of the top four credit-quality ratings by Standard & Poor's
Corporation or Moody's Investor Service).
DIVERSIFIED VALUE PORTFOLIO
The Diversified Value Portfolio seeks to provide long-term growth of capital and
a moderate level of dividend income by investing primarily in common stocks of
mid- and large-capitalization companies. The adviser's method is to research
stocks on a company-by-company basis and to develop earnings forecasts for them.
From those companies that appear to have strong finances and good prospects for
growth in earnings and dividends, the adviser will select those whose stock
prices
<PAGE>
22
appear to be undervalued by the overall market. Such stocks (often called value
stocks) will typically have above-average current dividend yields and sell at
below-average prices in comparison to such fundamentals as their book value and
earnings.
To keep the Portfolio well-diversified, the adviser generally will invest
no more than 15% of the Portfolio's assets in a single industry group. The
Portfolio's overall makeup is expected to differ from the broad stock market in
terms of industry weightings and market capitalization. Therefore, the
Portfolio's performance is likely to differ from the performance of the overall
market or broad indexes such as the S&P 500 Index.
EQUITY INDEX PORTFOLIO
The Portfolio is a stock index fund that seeks long-term growth of capital and
income by attempting to match the performance of the S&P 500 Index, which is
made up primarily of stocks of large U.S. companies. These stocks represent
approximately 76% of the market value of all U.S. common stocks. In seeking to
fully replicate the Index performance, the Portfolio intends to hold all of the
approximately 500 stocks in the Index in roughly the same proportions as they
are represented in the Index. For example, if 3% of the S&P 500 Index were made
up of the stock of a specific company, the Portfolio will invest about 3% of its
assets in that company.
The actual stocks that constitute the Index are chosen by Standard & Poor's
Corporation. The Index is weighted according to the market capitalization of the
stocks it holds, so that the stocks with the highest market values represent the
largest portion of the Index and have the heaviest influence on its performance.
The 50 largest stocks in the Index account for approximately 58% of its market
capitalization. As of September 30, 2000, the five largest companies in the
Index were:
-------------------------------------------------------------------------------
COMPANY PERCENTAGE OF INDEX
-------------------------------------------------------------------------------
General Electric Co. 4.53%
Cisco Systems, Inc. 3.11
Microsoft Corp. 2.51
Exxon Mobil Corp. 2.46
Pfizer, Inc. 2.25
-------------------------------------------------------------------------------
MID-CAP INDEX PORTFOLIO
The Mid-Cap Index Portfolio is a stock index fund that seeks long-term growth of
capital by attempting to match the performance of the S&P MidCap 400 Index,
which is made up of stocks of medium-size U.S. companies. In seeking to
replicate the Index performance, the Portfolio intends to hold all of the
approximately 400 stocks in the Index in roughly the same proportions as they
are represented in the Index. For example, if 3% of the S&P MidCap 400 Index
were made up of the stock of a specific company, the Portfolio will invest about
3% of its assets in that company.
The actual stocks that constitute the Index are chosen by Standard & Poor's
Corporation. The Index is weighted according to the market capitalization of the
stocks it holds, so that the stocks with the highest market values represent the
largest portion of the Index and have the heaviest influence on its performance.
The 50 largest stocks in the Index account for approximately 39% of its market
capitalization. As of September 30, 2000, the five largest companies in the
Index were:
-------------------------------------------------------------------------------
COMPANY PERCENTAGE OF INDEX
-------------------------------------------------------------------------------
Dynegy, Inc. 1.82%
Vitesse Semiconductor Corp. 1.65
Calpine Corp. 1.49
Millennium Pharmaceutical Inc. 1.41
Rational Software Corp. 1.34
-------------------------------------------------------------------------------
Fluctuations in the total returns of mid-capitalization stocks historically
have been somewhat greater than those for large-cap stocks and somewhat lower
than those for small-cap stocks. There is no certainty, however, that this
pattern will continue in the future.
GROWTH PORTFOLIO
The Portfolio seeks long-term growth of capital by investing in
large-capitalization stocks of high-quality, seasoned U.S. companies with
records of superior growth. The Portfolio's adviser researches more than 200
large companies with superior records and good prospects for growth. Stocks
purchased for the Portfolio typically have strong positions in their markets,
reasonable financial strength, and relatively low sensitivity to changing
economic conditions, and they usually sell at attractive prices in relation to
their growth potential. The Portfolio will take relatively large positions in
the stocks whose prospects seem most favorable, and its ten largest holdings may
account for 35% to 40% of total assets. In addition, the
<PAGE>
23
Portfolio's overall makeup may differ substantially from that of the broad stock
market in terms of industry weightings and market capitalization.
[FLAG] BECAUSE THE PORTFOLIO INVESTS A HIGHER PERCENTAGE OF ITS ASSETS IN THE
SECURITIES OF FEWER ISSUERS AS COMPARED WITH OTHER MUTUAL FUNDS, THE
PORTFOLIO IS SUBJECT TO THE RISK THAT ITS PERFORMANCE MAY BE HURT
DISPROPORTIONATELY BY THE POOR PERFORMANCE OF RELATIVELY FEW SECURITIES.
SMALL COMPANY GROWTH PORTFOLIO
The Portfolio seeks long-term growth of capital by investing primarily in
small-capitalization stocks of companies that appear to offer favorable
prospects for growth and price appreciation. The Portfolio's stocks are expected
to provide only minimal dividend income.
The median market capitalization of the stocks held in the Portfolio is
expected to be below $1 billion. By way of comparison, the median market cap of
stocks in the S&P 500 Index, which is dominated by large stocks, exceeds $80
billion.
The Portfolio employs two investment advisers, each of whom independently
chooses and maintains a portfolio of common stocks for the Portfolio. The two
advisers use active management methods, which means they buy and sell securities
based on their judgments about companies and their financial prospects, the
prices of securities, and the stock market and the economy in general. Each
adviser uses different processes to select securities for its portion of the
Portfolio's assets; however, each is committed to buying stocks of small
companies that, in the adviser's opinion, have strong growth potential.
GRANAHAN INVESTMENT MANAGEMENT, INC. (GRANAHAN) categorizes stocks in its
portion of the Portfolio's assets into three categories: (1) "Core" growth
stocks, representing 50% to 80% of assets, are of companies with demonstrated
records of growth and a strong market position based on a proprietary product or
service; (2) "Pioneers," 10% to 25% of assets, are of companies that generally
have unique technology or other innovations that may lead to new products or
expansion into new markets; and (3) "Special values," 10% to 25% of assets, are
of companies whose stock prices are undervalued given the adviser's view of
their prospects for improvement over the next several years.
GRANTHAM, MAYO, VAN OTTERLOO & CO. LLC (GMO) began managing Portfolio
assets on October 1, 2000. GMO uses computerized models to select the most
attractive small-capitalization growth stocks according to several criteria,
including changes in projected earnings, earnings growth, and recent price
trends. This quantitative investment method is expected to result in a portfolio
that is broadly diversified among small-cap stocks. GMO seeks to maintain
reasonable liquidity by limiting positions in individual issues.
The Portfolio's board of trustees decides the proportion of net assets to
be managed by each adviser and may change the proportions as circumstances
warrant. Currently, Granahan manages the portion of Portfolio assets (other than
new cash invested) existing on October 1, 2000, while GMO manages new cash
invested on and after that date.
Besides common stocks, the Portfolio may invest in securities that are
convertible to common stocks.
The Portfolio's holdings may include securities issued by small or
unseasoned companies with speculative risk characteristics. Small company stocks
historically have been subject to wider fluctuations in share prices and total
returns than mid- or large-cap stocks. Among the reasons for this high degree of
price volatility: Markets for small-capitalization stocks are less liquid than
markets for larger stocks, meaning that during periods of market turbulence it
may be difficult to sell small-company stocks; small companies generally may be
less able than larger ones to ride out economic downturns; and small-company
stocks often pay no dividends.
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PLAIN TALK ABOUT
FUND DIVERSIFICATION
In general, the more diversified a fund's stock or bond holdings, the less
likely that a specific security's poor performance will hurt the fund. One
measure of a fund's diversification is the percentage of its assets represented
by its ten largest holdings. The average U.S. equity mutual fund has about 30%
of its assets invested in its ten largest holdings, while some less-diversified
mutual funds have more than 50% of assets invested in their top ten.
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INTERNATIONAL PORTFOLIO
The Portfolio seeks long-term growth of capital by investing in a broadly
diversified group of stocks of seasoned companies located outside of the United
States. In selecting stocks, the Portfolio's adviser evaluates foreign markets
around the world. Depending on its assessment of the business and investment
climates in the various markets, the adviser determines the proportion of the
Portfolio's assets to allocate to individual countries. Within the chosen
markets, the adviser selects companies believed to have above-average growth
potential and whose stocks sell at reasonable prices. The adviser's assessments
are based on extensive research by a team of analysts at 12 regional offices
around the world.
The core of the Portfolio--normally constituting 60% to 70% of its total
assets--consists of stocks of companies that possess what the adviser believes
are sustainable competitive advantages and strong prospects for growth. These
core
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24
holdings may include small- and mid-cap stocks along with large-cap stocks. The
remainder of the Portfolio's assets consist of "noncore" stocks selected to
increase the Portfolio's presence in markets where the near-term outlook is
particularly favorable. These noncore holdings typically are large-cap stocks
that have historically moved in accordance with their local markets.
The adviser's investment approach results in a Portfolio whose overall
characteristics will often differ substantially from those of broad
international stock indexes, such as the Morgan Stanley Capital International
Europe, Australasia, Far East (MSCI EAFE) Index. As a result of its different
makeup, the Portfolio's performance is apt to differ substantially from time to
time from the performance of broad international stock indexes.
Because it invests mainly in international stocks, the Portfolio is subject
to:
[FLAG] CURRENCY RISK, WHICH IS THE CHANCE THAT RETURNS WILL BE HURT BY A RISE IN
THE VALUE OF THE U.S. DOLLAR VERSUS FOREIGN CURRENCIES.
Conversely, when the U.S. dollar falls in value versus other currencies,
returns from international stocks are enhanced because a given sum in foreign
currency translates into more U.S. dollars.
[FLAG] COUNTRY RISK, WHICH IS THE CHANCE THAT POLITICAL EVENTS (SUCH AS A WAR),
FINANCIAL PROBLEMS (SUCH AS A GOVERNMENT DEFAULT), OR NATURAL DISASTERS
(SUCH AS AN EARTHQUAKE) WILL WEAKEN A COUNTRY'S ECONOMY AND CAUSE
INVESTMENTS IN THAT COUNTRY TO LOSE MONEY.
International investing involves other risks and considerations, including:
differences in accounting, auditing, and financial reporting standards;
generally higher costs for trading securities; foreign withholding taxes payable
on the Portfolio's securities, which can reduce dividend income available to
distribute to shareholders; and adverse changes in regulatory or legal climates.
Returns on international stocks can be as volatile as--or more volatile
than--returns on U.S. stocks. To illustrate the volatility of international
stock market returns for the U.S. dollar-based investor, the following table
shows the best, worst, and average total returns for international stocks over
various periods as measured by the MSCI EAFE Index, a widely used barometer of
international stock market activity. (Total returns consist of dividend income
plus change in market price.) Note that the returns shown in the table do not
include the costs of buying and selling stocks or other expenses that a
real-world investment portfolio would incur. Note, also, that the gap between
best and worst tends to narrow over the long term. Also, keep in mind that past
returns are not indicative of future returns and that volatility in the future
could be greater or less than past volatility.
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INTERNATIONAL STOCK MARKET RETURNS (1969-1999)
-------------------------------------------------------------------------------
1 YEAR 5 YEARS 10 YEARS 20 YEARS
-------------------------------------------------------------------------------
Best 69.9% 36.5% 22.8% 16.3%
Worst -23.2 1.5 5.9 12.0
Average 15.2 13.6 14.5 14.7
-------------------------------------------------------------------------------
The table covers all of the 1-, 5-, 10-, and 20-year periods from 1969
through 1999. Keep in mind that this was a particularly favorable period for all
stock markets. These average returns reflect past performance on international
stocks; you should not regard them as an indication of future returns from
either foreign markets as a whole or this Portfolio in particular.
The Portfolio may enter into forward foreign currency contracts, which can
help protect its holdings against unfavorable short-term changes in exchange
rates. A forward foreign currency contract is an agreement to buy or sell a
country's currency at a specific price on a specific date, usually 30, 60, or 90
days in the future. In other words, the contract guarantees an exchange rate on
a given date. Managers of international stock funds use these contracts to guard
against sudden, unfavorable changes in U.S. dollar/foreign currency exchange
rates. The contracts will not prevent the fund's securities from falling in
value during foreign market downswings. The adviser will use these contracts to
eliminate some of the uncertainty of foreign exchange rates.
REIT INDEX PORTFOLIO
The Portfolio uses an index approach in seeking to provide a high level of
income and moderate long-term growth of capital, by attempting to track the
performance of the Morgan Stanley REIT Index, a benchmark of U.S. real estate
investment trusts (REITs).
The Portfolio invests in stocks of REITs, which own office buildings,
hotels, shopping centers, and other properties. The Portfolio uses a "passively"
managed--or index--approach to create a mix of securities that will track, as
closely as possible, the performance of the REIT Index. Holdings of the Index,
and thus of the Portfolio, are weighted according to each stock's
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25
market-capitalization. The Portfolio will hold each stock found in the Index in
approximately the same proportion as represented in the Index itself. For
example, if a specific stock represented 2% of the Morgan Stanley REIT Index,
the Portfolio would invest 2% of its assets in that stock.
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PLAIN TALK ABOUT
REITS
Rather than owning properties directly--which can be costly and difficult to
convert into cash when needed--some investors buy shares in a company that owns
and manages real estate. Such a company is known as a real estate investment
trust, or REIT. Unlike corporations, REITs do not have to pay income taxes if
they meet certain Internal Revenue Code requirements. To qualify, a REIT must
distribute at least 95% of its taxable income to its shareholders and receive at
least 75% of that income from rents, mortgages, and sales of property. REITs
offer investors greater liquidity and diversification than direct ownership of a
handful of properties, as well as greater income potential than an investment in
common stocks. As with any investment in real estate, however, a REIT's
performance depends on several factors, such as its ability to find tenants for
its properties, to renew leases, and to finance property purchases and
renovations. That said, returns from REITs may not correspond to returns from
direct property ownership.
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[FLAG] BECAUSE IT INVESTS IN STOCKS OF REITS, THE PORTFOLIO IS SUBJECT TO
SEVERAL RISKS IN ADDITION TO THE RISK OF A GENERAL DECLINE IN THE STOCK
MARKET. THESE RISKS INCLUDE:
REAL ESTATE INDUSTRY RISK, WHICH IS THE CHANCE THAT A GENERAL DECLINE IN
PROPERTY VALUES COULD CAUSE THE PRICES OF REIT STOCKS TO FALL.
INTEREST RATE RISK, WHICH IS THE CHANCE THAT HIGHER INTEREST RATES COULD
HURT REIT PERFORMANCE. HIGHER INTEREST RATES COULD MAKE YIELDS ON COMPETING
INVESTMENTS, INCLUDING BONDS, MORE ATTRACTIVE THAN OWNING REIT SHARES.
ALSO, HIGHER RATES MAKE IT MORE DIFFICULT AND COSTLY FOR REITS TO BORROW TO
FINANCE PROPERTY PURCHASES AND IMPROVEMENTS.
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PLAIN TALK ABOUT
TYPES OF REITS
An equity REIT, which owns properties, generates income (from rental and lease
payments), and offers the potential for growth (from property appreciation) as
well as occasional capital gains from the sale of property. A mortgage REIT
makes loans to commercial real estate developers. Mortgage REITs earn interest
income and are subject to credit risk (that is, the chance that a developer will
fail to repay a loan). A hybrid REIT holds properties and mortgages.
--------------------------------------------------------------------------------
The Portfolio's returns will be strongly linked to the ups and downs of the
commercial real estate market. Real estate goes through up and down market
cycles that can be extreme and long-lasting. In general, many factors affect
real estate values, including: the supply of, and demand for, properties; the
economic health of the nation or of specific geographic regions; and the
strength of specific industries renting properties. Ultimately, an individual
REIT's performance depends on the types and locations of the properties it owns
and on how well the REIT manages its properties. For instance, rental income
could decline because of extensive vacancies, increased competition from nearby
properties, tenants' failure to pay rent, or incompetent management. Property
values could decrease because of overbuilding, environmental liabilities,
uninsured damages caused by natural disasters, loss of IRS status as a qualified
REIT, increases in property taxes, or changes in zoning laws.
The Morgan Stanley REIT Index comprises stocks of publicly traded equity
REITs (other than health care REITs) that meet certain criteria. For example, to
be included in the Index, a REIT must have a total market capitalization of at
least $100 million and have enough shares and trading volume to be considered
liquid. The REIT Index Portfolio invests in equity REITs only.
As of September 30, 2000, the Index included 122 REITs. The Index is
rebalanced every calendar quarter and whenever a REIT is removed from the Index.
A REIT can be removed from the Index because its market capitalization falls
below $75 million, or because of corporate activity such as a merger,
acquisition, bankruptcy, IRS removal of REIT status, a fundamental change in the
REIT's business, or a change in shares outstanding. REITs in the Morgan Stanley
REIT Index tend to be mid- and small-capitalization stocks, with market
capitalizations generally below $4 billion. Like small-capitalization stocks in
general, REIT stocks can be more volatile than the overall stock market.
<PAGE>
26
Stocks in the Morgan Stanley REIT Index represent a broadly diversified
range of property types and geographical regions. The Index's makeup, as of
September 30, 2000, follows.
-------------------------------------------------------------------------------
TYPE OF REIT PERCENTAGE OF INDEX
-------------------------------------------------------------------------------
Apartments 23%
Office 22
Retail 19
Diversified 15
Industrial 15
Hotels 6
-------------------------------------------------------------------------------
The Index's ten largest stocks make up more than 33% of its market value.
The Index's largest stocks, as of September 30, 2000, are listed below.
1. Equity Office Properties Trust REIT 6. Archstone Communities Trust REIT
2. Equity Residential Properties Trust REIT 7. Vornado Realty Trust REIT
3. Simon Property Group, Inc. REIT 8. Public Storage, Inc. REIT
4. ProLogis Trust REIT 9. Avalon Bay Communities, Inc. REIT
5. Spieker Properties, Inc. REIT 10. Apartment Investment &
Management Co., Inc. Class A REIT
The Portfolio intends to remain at least 98% invested in the stocks of
REITs; the remaining assets will be invested in cash reserves to maintain
liquidity.
INVESTING IN REPURCHASE AGREEMENTS
The Portfolios may invest in repurchase agreements, which carry several risks.
For instance, if the seller is unable to repurchase the securities as promised,
a Portfolio may experience a loss when trying to sell the securities to another
party. Or, if the seller becomes insolvent, a bankruptcy court may determine
that the securities do not belong to the Portfolio and order that they be sold
to pay off the seller's debts. The Portfolios' advisers attempt to control these
risks through careful counterparty selection and monitoring.
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PLAIN TALK ABOUT
REPURCHASE AGREEMENTS
A means of investing money for a short period, repurchase agreements are
contracts in which a U.S. commercial bank or securities dealer sells government
securities and agrees to repurchase the securities on a specific date (normally
the next business day) and at a specific price.
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TEMPORARY DEFENSIVE MEASURES
Each Portfolio (except the Money Market Portfolio) may temporarily depart from
its normal investment policies--for instance, by investing substantially in cash
reserves--in response to extraordinary market, economic, political, or other
conditions. In doing so, a Portfolio may succeed in avoiding losses but
otherwise fail to achieve its investment objective.
TURNOVER RATE
A mutual fund's turnover rate is a measure of its trading activity. (A turnover
rate of 100% would occur, for example, if a Portfolio sold and replaced
securities valued at 100% of its net assets within a one-year period.) The
Portfolios may sell securities regardless of how long they have been held. The
turnover rates for the Portfolios can be found in the Financial Highlights
section of this prospectus, except for the Money Market Portfolio, whose
turnover rate is not meaningful because of the very short-term nature of its
holdings.
<PAGE>
27
THE PORTFOLIOS AND VANGUARD
Vanguard Variable Insurance Fund is a member of The Vanguard Group, a family of
more than 35 investment companies with more than 100 distinct investment
portfolios holding assets worth more than $570 billion. All of the Vanguard
funds share in the expenses associated with business operations, such as
personnel, office space, equipment, and advertising.
Vanguard also provides marketing services to the funds. Although
shareholders do not pay sales commissions or 12b-1 distribution fees, each fund
pays its allocated share of The Vanguard Group's marketing costs.
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PLAIN TALK ABOUT
VANGUARD'S UNIQUE CORPORATE STRUCTURE
The Vanguard Group is truly a MUTUAL mutual fund company. It is owned jointly by
the funds it oversees and thus indirectly by the shareholders in those funds.
Most other mutual funds are operated by for-profit management companies that may
be owned by one person, by a group of individuals, or by investors who own the
management company's stock. By contrast, Vanguard provides its services on an
"at-cost" basis, and the funds' expense ratios reflect only these costs. No
separate management company reaps profits or absorbs losses from operating the
funds.
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INVESTMENT ADVISERS
THE VANGUARD GROUP
The Vanguard Group (Vanguard), P.O. Box 2600, Valley Forge, PA 19482, provides
investment advisory services on an at-cost basis to six of the Portfolios of
Vanguard Variable Insurance Fund.
Vanguard's Fixed Income Group provides advisory services for the MONEY
MARKET, SHORT-TERM CORPORATE, and HIGH-GRADE BOND PORTFOLIOS. Vanguard's Fixed
Income Group provides investment advisory services to many Vanguard funds; as of
September 30, 2000, the Fixed Income Group managed more than $158 billion in
total assets. The individuals responsible for overseeing the Portfolios'
investments are:
- IAN A. MACKINNON, Managing Director of Vanguard and head of Vanguard's
Fixed Income Group. He has worked in investment management since 1974; and
has had primary responsibility for Vanguard's internal fixed-income policy
and strategy since joining the company in 1981. Education: B.A., Lafayette
College; M.B.A., Pennsylvania State University.
- DAVID R. GLOCKE, Principal of Vanguard. He has worked in investment
management since 1991; and has managed portfolio investments and the Money
Market Portfolio since 1997. Education: B.S.; University of Wisconsin.
- ROBERT F. AUWAERTER, Principal of Vanguard. He has worked in investment
management since 1978; has managed portfolio investments since 1979; has
been with Vanguard since 1981; and has managed the Short-Term Corporate
Portfolio since its inception. Education: B.S., University of Pennsylvania;
M.B.A., Northwestern University.
- KENNETH E. VOLPERT, CFA, Principal of Vanguard, and head of Vanguard's Bond
Index Group. He has worked in investment management since 1981, has managed
portfolio investments since 1982; has been with Vanguard and has managed
the High-Grade Bond Portfolio since 1992. Education: B.S., University of
Illinois; M.B.A., University of Chicago.
Mr. Glocke, Mr. Auwaerter, and Mr. Volpert manage the portfolios on a day-to-day
basis. Mr. MacKinnon is responsible for setting the Portfolios' broad investment
policies and for overseeing the Portfolio managers.
For the fiscal year ended September 30, 2000, the Money Market Portfolio's
advisory expenses represented an effective annual rate of 0.01% of the
Portfolio's average net assets.
For the fiscal year ended September 30, 2000, the Short-Term Corporate
Portfolio's advisory expenses represented an effective annual rate of
approximately 0.01% of the Portfolio's average net assets.
For the fiscal year ended September 30, 2000, the High-Grade Bond
Portfolio's advisory expenses represented an effective annual rate of 0.01% of
the Portfolio's average net assets.
Vanguard's Quantitative Equity Group provides advisory services for the
EQUITY INDEX, MID-CAP INDEX, and REIT INDEX PORTFOLIOS. Vanguard's Quantitative
Equity Group provides investment advisory services to many Vanguard funds; as of
September 30, 2000, the Quantitative Equity Group managed more than $238 billion
in total assets. The individual responsible for overseeing each Portfolio's
investments is:
- GEORGE U. SAUTER, Managing Director of Vanguard and head of Vanguard's
Quantitative Equity Group. He has worked in investment management since
1985 and has had primary responsibility for Vanguard's stock indexing
investments and strategy since joining the company in 1987. Education:
A.B., Dartmouth College; M.B.A., University of Chicago.
For the fiscal year ended September 30, 2000, the Equity Index Portfolio's
advisory expenses represented an effective annual rate of 0.01% of the
Portfolio's average net assets.
<PAGE>
28
For the fiscal year ended September 30, 2000, the Mid-Cap Index Portfolio's
advisory expenses represented an effective annual rate of 0.02% of the
Portfolio's average net assets.
For the fiscal year ended September 30, 2000, the REIT Index Portfolio's
advisory expenses represented an effective annual rate of 0.05% of the
Portfolio's average net assets.
Vanguard employs seven independent investment advisers to manage the
remaining seven Portfolios.
WELLINGTON MANAGEMENT COMPANY, LLP
Wellington Management Company, LLP (Wellington Management), 75 State Street,
Boston, MA 02109, provides advisory services for the HIGH YIELD BOND and
BALANCED PORTFOLIOS. Wellington Management, an investment advisory firm founded
in 1928, managed more than $266 billion in stock and bond portfolios as of
September 30, 2000.
The individual responsible for overseeing the HIGH YIELD BOND PORTFOLIO'S
investments is:
- EARL E. MCEVOY, Senior Vice President and Partner of Wellington Management
Company, LLP. He has worked in investment management since 1972; has
managed portfolio investments for Wellington Management since 1978; and has
managed the Portfolio since its inception. Education: B.A., Dartmouth
College; M.B.A., Columbia Business School.
The individuals responsible for overseeing the BALANCED PORTFOLIO'S
investments are:
- ERNST H. VON METZSCH, CFA, Senior Vice President and Partner of Wellington
Management Company, LLP. He has worked in investment management since 1971;
has been with Wellington Management since 1973; has managed portfolio
investments since 1984; and has managed the Portfolio since 1995.
Education: M.Sc., University of Leiden, Holland; Ph.D., Harvard University.
- PAUL D. KAPLAN, Senior Vice President and Partner of Wellington Management
Company, LLP. He has worked in investment management since 1974; has been
with Wellington Management since 1978; and has assisted in the management
of the Portfolio since 1994. Education: B.S., Dickinson College; M.S., The
Sloan School of Management, Massachusetts Institute of Technology.
Wellington Management's advisory fee with respect to the Balanced Portfolio
is paid quarterly, and is based on certain annual percentage rates applied to
the Portfolio's average month-end assets for each quarter. In addition,
Wellington Management's advisory fee may be incrased or decreased, based on the
cumulative total return of the Portfolio over a trailing 36-month period as
compared with the cumulative total return of a Composite Index over the same
period. The index is a composite benchmark, 65% of which is made up of the
Standard & Poor's Composite Stock Price Index and 35% of which is made up of the
Lehman Brothers Corporate A or Better Bond Index. Please consult the Fund's
STATEMENT OF ADDITIONAL INFORMATION for a complete explanation of how advisory
fees are calculated.
For the fiscal year ended September 30, 2000, the advisory fee paid to
Wellington Management with respect to the Balanced Portfolio represented an
effective annual rate of 0.10% of the Portfolio's average net assets, before a
decrease of 0.02% based on performance.
For the fiscal year ended September 30, 2000, the advisory fee paid to
Wellington Management with respect to the High Yield Bond Portfolio represented
an effective annual rate of 0.06% of the Portfolio's average net assets.
NEWELL ASSOCIATES
Newell Associates (Newell), 525 University Avenue, Palo Alto, CA 94301, provides
advisory services for the EQUITY INCOME PORTFOLIO. Newell, an investment
advisory firm founded in 1986, managed about $1.7 billion in assets as of
September 30, 2000.
The individual responsible for overseeing the Equity Income Portfolio's
investments is:
- ROGER D. NEWELL, Chairman and Chief Investment Officer of Newell
Associates. He has worked in investment management since 1958; has managed
equity funds since 1959; has been with Newell since 1986; and has managed
the Portfolio since its inception. Education: B.A., University of
Minnesota; J.D., Harvard Law School; M.A., University of Minnesota.
For the fiscal year ended September 30, 2000, the advisory fee paid to
Newell represented an effective annual rate of 0.10% of the Portfolio's average
net assets.
BARROW, HANLEY, MEWHINNEY & STRAUSS, INC.
Barrow, Hanley, Mewhinney & Strauss, Inc. (Barrow, Hanley), One McKinney Plaza,
3232 McKinney Avenue, 15th Floor, Dallas, TX 75204, provides advisory services
for the DIVERSIFIED VALUE PORTFOLIO. Barrow, Hanley is owned by United Asset
Management, 1 International Place, Boston, MA 02109. Barrow, Hanley managed
approximately $26 billion in stock and bond portfolios as of September 30, 2000.
The individual responsible for overseeing the Diversified Value Portfolio's
investments is:
- JAMES P. BARROW, Partner and Vice President of Barrow, Hanley, Mewhinney &
Strauss, Inc. He has worked in investment management since 1965; has been
with Barrow, Hanley since 1979; and has managed the Portfolio since its
inception. Education: B.S., University of South Carolina.
Barrow, Hanley's advisory fee is paid quarterly, and is based on certain
annual percentage rates applied to the Diversified Value Portfolio's average
month-end assets for each quarter. In addition, Barrow, Hanley's advisory fee
may be increased or decreased, based on the cumulative total return of the
Portfolio over a trailing 36-month period as compared with the cumulative total
return of the Standard & Poor's/BARRA Value Index over the same period. Note
that this performance fee structure will not be in full operation until March
31, 2002; before then, advisory fees will be calculated using certain transition
rules that are explained in the Fund's STATEMENT OF ADDITIONAL INFORMATION.
Please consult the Fund's STATEMENT OF ADDITIONAL INFORMATION for a complete
explanation of how advisory fees are calculated.
For the fiscal year ended September 30, 2000, the advisory fee paid to
Barrow, Hanley represented an effective annual rate of 0.12% of the Portfolio's
average net assets, before a decrease of 0.02% based on performance.
<PAGE>
29
LINCOLN CAPITAL MANAGEMENT COMPANY
Lincoln Capital Management Company (Lincoln), 200 South Wacker Drive, Chicago,
IL 60606, provides advisory services for the GROWTH PORTFOLIO. Lincoln is an
investment advisory firm founded in 1967. As of September 30, 2000, Lincoln
managed approximately $73 billion in assets. It provides investment counseling
services to a limited number of clients, most of which are institutional clients
such as pension funds.
The individuals responsible for overseeing the Growth Portfolio's
investments are:
- J. PARKER HALL III, Chief Executive Officer and Managing Director of
Lincoln Capital Management Company. He has worked in investment management
since 1957; has been with Lincoln since 1971; and has managed the Portfolio
since its inception. Education: B.A., Swarthmore College; M.B.A., Harvard
Business School.
- DAVID M. FOWLER, Executive Vice President and Managing Director of Lincoln
Capital Management Company. He has worked in investment management since
1972; has been with Lincoln since 1984; and has managed the Portfolio since
its inception. Education: B.S., Loyola University; M.B.A., Northwestern
University.
- JOHN S. COLE, Principal of Lincoln Capital Management Company. He worked in
investment management as Executive Vice President and Chief Equity Officer
at Boatman's Trust Company from 1992 until he joined Lincoln in 1997; and
has managed the Portfolio since 1997. Education: B.S., Bentley College;
M.B.A., Notre Dame University.
Lincoln's advisory fee is paid quarterly, and is based on certain annual
percentage rates applied to the Growth Portfolio's average month-end assets for
each quarter. In addition, Lincoln's advisory fee may be increased or decreased,
based on the cumulative total return of the Portfolio over a trailing 36-month
period as compared with the cumulative total return of the Russell 1000 Growth
Index over the same period. Note that this performance fee structure will not be
in full operation until September 30, 2003; before then, advisory fees will be
calculated using certain transition rules that are explained in the Fund's
STATEMENT OF ADDITIONAL INFORMATION. Please consult the Fund's STATEMENT OF
ADDITIONAL INFORMATION for a complete explanation of how advisory fees are
calculated.
For the fiscal year ended September 30, 2000, the advisory fee paid to
Lincoln represented an effective annual rate of 0.15% of the Portfolio's average
net assets.
GRANAHAN INVESTMENT MANAGEMENT, INC., and GRANTHAM, MAYO, VAN OTTERLOO & CO. LLC
Granahan Investment Management, Inc. (Granahan), 275 Wyman Street, Waltham, MA
02154, and Grantham, Mayo, Van Otterloo & Co. LLC (GMO), 40 Rowes Wharf, Boston
MA 02110, each provide investment advisory services for the SMALL COMPANY GROWTH
PORTFOLIO.
Granahan is an investment advisory firm specializing in small-company stock
invesments. Founded in 1985, Granahan managed approximately $2 billion in assets
as of September 30, 2000.
GMO is an investment advisory firm founded in 1977. As of September 30,
2000, GMO managed about $22 billion in assets. GMO provides investment
counseling services to employee benefit plans, endowment funds, other
institutions, and individuals.
Granahan and GMO each independently manage a percentage of the Portfolio's
assets subject to the control of the trustees and officers of Vanguard Variable
Insurance Fund.
The individuals responsible for overseeing the Small Company Growth
Portfolio's investments are:
- JOHN J. GRANAHAN, CFA, Founder and President of Granahan Investment
Management, Inc. He has worked in investment management since 1963; has
been with Granahan since 1985; and has managed the Portfolio since its
inception. Education: B.A., St. Joseph's University; Graduate Fellow of
Catholic University of America.
- GARY C. HATTON, CFA, Executive Vice President of Granahan. He has worked in
investment management since 1982; has been with Granahan since 1985; and
has managed the Portfolio since its inception. Education: B.S., University
of Rhode Island; M.S., University of Wisconsin.
- JANE M. WHITE, Executive Vice President of Granahan. She has worked in
investment management since 1980; has been with Granahan since its
inception; and has managed the Portfolio since 1996. Education: B.A.,
Boston University.
- CHRISTOPHER M. DARNELL, Chief Investment Officer of Quantitative Investment
Products and Chairman of the U.S. Equity Investment Policy Group at
Grantham, Mayo, Van Otterloo & LLC. He has managed investments for GMO
since 1979; and began managing assets of the Portfolio in 2000. Education:
B.A., Yale University; M.B.A., Harvard University.
- ROBERT M. SOUCY, Managing Director of U.S. Quantitative Equity at GMO. He
has managed investments for GMO since 1979; and began managing assets of
the Portfolio in 2000. Education: B.S., University of Massachusetts.
The Portfolio pays each adviser on a quarterly basis. For each adviser, the
quarterly fee is based on certain annual percentage rates applied to average
month-end net assets managed by the adviser over the quarterly period. In
addition, the quarterly fees paid to each adviser are increased or decreased
based upon the adviser's performance in comparison to a benchmark index. For
these purposes, the cumulative investment performance of each adviser's portion
of the Portfolio over a trailing 36-month period is compared to the cumulative
total return of the Russell 2000 Growth Index over the same period. Note that
this performance fee structure will not be in full operation for GMO until
December 31, 2003; before then, GMO's advisory fees will be calculated using
certain transition rules that are explained in the Fund's STATEMENT OF
ADDITIONAL INFORMATION. Please consult the Fund's STATEMENT OF ADDITIONAL
INFORMATION for a complete explanation of how advisory fees are calculated.
For the fiscal year ended September 30, 2000, the advisory fee paid to
Granahan represented an effective annual rate of 0.15% of the Portfolio's
average net assets, before an increase 0.04% based on performance. GMO began
serving as an investment adviser on October 1, 2000.
<PAGE>
30
SCHRODER INVESTMENT MANAGEMENT NORTH AMERICA INC.
Schroder Investment Management North America Inc. (Schroder), 31 Gresham Street,
London EC2V 7QA, England, provides investment advisory services for the
INTERNATIONAL PORTFOLIO. Schroder, an investment advisory firm founded in 1979,
is part of a worldwide group of banks and financial services companies known as
The Schroder Group. As of September 30, 2000, The Schroder Group managed more
than $210 billion in assets.
The individual responsible for overseeing the International Portfolio's
investments is:
- RICHARD FOULKES, Executive Vice President and Deputy Chairman of Schroder
Investment Management North America Inc. He has been with Schroder since
1968 and has managed the Portfolio since its inception. Education: the
Sorbonne, France; B.A. and M.A., Cambridge University, England.
Schroder's advisory fee is paid quarterly, and is based on certain annual
percentage rates applied to the International Portfolio's average month-end
assets for each quarter. In addition, Schroder's advisory fee may be increased
or decreased, based on the cumulative total return of the Portfolio over a
trailing 36-month period as compared with the cumulative total return of the
Morgan Stanley Capital International Europe, Australasia, Far East Index. Please
consult the Fund's STATEMENT OF ADDITIONAL INFORMATION for a complete
explanation of how advisory fees are calculated.
For the fiscal year ended September 30, 2000, the advisory fee paid to
Schroder represented an effective annual rate of 0.125% of the Portfolio's
average net assets, with no performance adjustment required.
The advisers are authorized to choose broker-dealers to handle the purchase
and sale of the Portfolios' securities, and to seek out the best available price
and most favorable execution for all transactions. Also, the Fund may direct an
adviser to use a particular broker for certain transactions in exchange for
commission rebates or research services provided to the Fund.
TAXES
The tax consequences of your investment in a Portfolio depend on the provisions
of the variable annuity or variable life insurance plan through which you
invest. For more information on taxes, please refer to the accompanying
prospectus of the insurance company separate account that offers your annuity or
life insurance contract.
SHARE PRICE
Each Portfolio's share price, called its net asset value, or NAV, is calculated
each business day after the close of regular trading on the New York Stock
Exchange (the NAV is not calculated on holidays or other days when the Exchange
is closed). Purchase and redemption orders for each Portfolio are based on the
Portfolio's net asset value next computed after Vanguard receives a request in
good order. Net asset value per share is computed by dividing the net assets of
the Portfolio by the number of Portfolio shares outstanding.
A NOTE ON PRICING: Each Portfolio's investments (with the exception of the
Money Market Portfolio, which uses the amortized cost method of valuation) will
be priced at their market value when market quotations are readily available.
When these quotations are not readily available, investments will be priced at
their fair value, calculated according to procedures adopted by the Fund's board
of trustees.
Each Portfolio's NAV is used to determine the unit value for the separate
account that invests in that Portfolio. For more information on unit values,
please refer to the accompanying prospectus of the insurance company separate
account that offers your annuity or life insurance contract.
FINANCIAL HIGHLIGHTS
The following financial highlights tables are intended to help you understand
each Portfolio's financial performance for the past five years or since its
inception, and certain information reflects financial results for a single
Portfolio share in each case. The total returns in each table represent the rate
that an investor would have earned or lost each period on an investment in the
Portfolio (assuming reinvestment of all dividend and capital gains
distributions). This information has been derived from the financial statements
audited by PricewaterhouseCoopers LLP, independent accountants, whose
report--along with each Portfolio's financial statements--is included in the
Fund's most recent annual report to shareholders. You may have the annual report
sent to you without charge by contacting Vanguard.
<PAGE>
31
--------------------------------------------------------------------------------
PLAIN TALK ABOUT
HOW TO READ THE FINANCIAL HIGHLIGHTS TABLES
This explanation uses the Money Market Portfolio as an example. The Portfolio
began fiscal 2000 with a net asset value (price) of $1.00 per share. During the
year, the Portfolio earned $.061 per share from investment income (interest and
dividends).
Shareholders received $.061 per share in the form of dividend distributions. The
earnings ($.061 per share) minus the distributions ($.061 per share) resulted in
a share price of $1.00 at the end of the year. For a shareholder who reinvested
the distributions in the purchase of more shares, the total return from the
Portfolio was 6.21% for the year.
As of September 30, 2000, the Portfolio had $861 million in net assets. For the
year, its expense ratio was 0.17% ($1.70 per $1,000 of net assets); and its net
investment income amounted to 6.06% of its average net assets.
--------------------------------------------------------------------------------
-------------------------------------------------------------------------------
MONEY MARKET PORTFOLIO
YEAR ENDED SEPTEMBER 30,
---------------------------------------
2000 1999 1998 1997 1996
-------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF YEAR $1.00 $1.00 $1.00 $1.00 $1.00
-------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .061 .050 .055 .054 .054
Net Realized and Unrealized Gain
(Loss) on Investments -- -- -- -- --
---------------------------------------
Total from Investment Operations .061 .050 .055 .054 .054
---------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.061) (.050) (.055) (.054) (.054)
Distributions from Realized Capital
Gains -- -- -- -- --
---------------------------------------
Total Distributions (.061) (.050) (.055) (.054) (.054)
-------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $1.00 $1.00 $1.00 $1.00 $1.00
===============================================================================
TOTAL RETURN 6.21% 5.09% 5.60% 5.48% 5.49%
===============================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $861 $723 $590 $393 $285
Ratio of Total Expenses to Average
Net Assets 0.17% 0.20% 0.20% 0.21% 0.19%
Ratio of Net Investment Income to
Average Net Assets 6.06% 4.98% 5.46% 5.36% 5.36%
===============================================================================
-------------------------------------------------------------------------------
SHORT-TERM CORPORATE PORTFOLIO
YEAR ENDED FEB. 8* TO
SEPTEMBER 30, 2000 SEP. 30, 1999
-------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD $9.75 $10.00
-------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .646 .355
Net Realized and Unrealized Gain (Loss)
on Investments (.030) (.250)
------------------------------------
Total from Investment Operations .616 .105
------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.646) (.355)
Distributions from Realized Capital Gains -- --
------------------------------------
Total Distributions (.646) (.355)
-------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $9.72 $ 9.75
===============================================================================
TOTAL RETURN 6.54% 1.08%
===============================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $63 $29
Ratio of Total Expenses to Average Net Assets 0.20% 0.27%**
Ratio of Net Investment Income to Average
Net Assets 6.74% 5.74%**
Portfolio Turnover Rate 44% 39%
===============================================================================
*Inception.
**Annualized.
<PAGE>
32
FINANCIAL HIGHLIGHTS (continued)
-------------------------------------------------------------------------------
HIGH-GRADE BOND PORTFOLIO
YEAR ENDED SEPTEMBER 30,
--------------------------------------
2000 1999 1998 1997 1996
-------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF YEAR $10.34 $11.07 $10.57 $10.29 $10.47
-------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .680 .646 .663 .678 .670
Net Realized and Unrealized Gain
(Loss) on Investments .020 (.700) .500 .280 (.180)
---------------------------------------
Total from Investment Operations .700 (.054) 1.163 .958 .490
---------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.680) (.646) (.663) (.678) (.670)
Distributions from Realized Capital
Gains -- (.030) -- -- --
---------------------------------------
Total Distributions (.680) (.676) (.663) (.678) (.670)
-------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $10.36 $10.34 $11.07 $10.57 $10.29
===============================================================================
TOTAL RETURN 7.05% -0.49% 11.36% 9.60% 4.80%
===============================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $337 $337 $322 $188 $139
Ratio of Total Expenses to Average Net
Assets 0.20% 0.23% 0.28% 0.29% 0.25%
Ratio of Net Investment Income to
Average Net Assets 6.63% 6.06% 6.16% 6.51% 6.43%
Portfolio Turnover Rate 61% 69% 65% 40% 56%
===============================================================================
-------------------------------------------------------------------------------
HIGH YIELD BOND PORTFOLIO
YEAR ENDED SEPTEMBER 30,
------------------------------- JUN. 3* TO
2000 1999 1998 1997 SEP. 30, 1996
-------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF
PERIOD $9.50 $10.09 $10.59 $10.15 $10.00
-------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .849 .847 .895 .922 .299
Net Realized and Unrealized
Gain (Loss) on Investments (.480) (.573) (.485) .450 .150
----------------------------------------------
Total from Investment
Operations .369 .274 .410 1.372 .449
----------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment
Income (.849) (.847) (.895) (.922) (.299)
Distributions from Realized
Capital Gains -- (.017) (.015) (.010) --
----------------------------------------------
Total Distributions (.849) (.864) (.910) (.932) (.299)
-------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $9.02 $ 9.50 $10.09 $10.59 $10.15
===============================================================================
TOTAL RETURN 4.03% 2.68% 3.85% 14.12% 4.56%
===============================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year
(Millions) $142 $146 $131 $85 $22
Ratio of Total Expenses to
Average Net Assets 0.26% 0.29% 0.31% 0.31% 0.32%**
Ratio of Net Investment Income
to Average Net Assets 9.12% 8.51% 8.45% 8.88% 9.29%**
Portfolio Turnover Rate 23% 31% 38% 30% 8%
===============================================================================
*Inception.
**Annualized.
<PAGE>
33
-------------------------------------------------------------------------------
BALANCED PORTFOLIO
YEAR ENDED SEPTEMBER 30,
--------------------------------------
2000 1999 1998 1997 1996
-------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF YEAR $17.41 $17.73 $17.97 $14.81 $13.33
-------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .71 .63 .63 .60 .565
Net Realized and Unrealized Gain
(Loss) on Investments .26 .95 .56 3.31 1.420
----------------------------------------
Total from Investment Operations .97 1.58 1.19 3.91 1.985
----------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.64) (.62) (.60) (.19) (.505)
Distributions from Realized Capital
Gains (.81) (1.28) (.83) (.56) --
----------------------------------------
Total Distributions (1.45) (1.90) (1.43) (.75) (.505)
-------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $16.93 $17.41 $17.73 $17.97 $14.81
===============================================================================
TOTAL RETURN 5.91% 9.44% 7.26% 27.60% 15.26%
===============================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $512 $599 $553 $468 $330
Ratio of Total Expenses to Average Net
Assets 0.25% 0.29% 0.31% 0.32% 0.31%
Ratio of Net Investment Income to
Average Net Assets 3.98% 3.58% 3.72% 3.96% 4.04%
Portfolio Turnover Rate 28% 24% 31% 25% 36%
===============================================================================
--------------------------------------------------------------------------------
EQUITY INCOME PORTFOLIO
YEAR ENDED SEPTEMBER 30,
--------------------------------------
2000 1999 1998 1997 1996
-------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF YEAR $21.10 $19.69 $18.50 $13.71 $12.00
-------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .58 .51 .490 .42 .48
Net Realized and Unrealized Gain
(Loss) on Investments .08 1.50 1.475 4.69 1.75
--------------------------------------
Total from Investment Operations .66 2.01 1.965 5.11 2.23
--------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.52) (.49) (.400) (.15) (.46)
Distributions from Realized Capital
Gains (.15) (.11) (.375) (.17) (.06)
--------------------------------------
Total Distributions (.67) (.60) (.775) (.32) (.52)
-------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $21.09 $21.10 $19.69 $18.50 $13.71
===============================================================================
TOTAL RETURN 3.06% 10.36% 11.19% 38.05% 19.07%
===============================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $322 $429 $375 $271 $142
Ratio of Total Expenses to Average Net
Assets 0.31% 0.33% 0.36% 0.37% 0.35%
Ratio of Net Investment Income to
Average Net Assets 2.44% 2.44% 2.69% 3.11% 3.69%
Portfolio Turnover Rate 8% 6% 6% 8% 8%
================================================================================
<PAGE>
34
-------------------------------------------------------------------------------
DIVERSIFIED VALUE PORTFOLIO
YEAR ENDED FEB. 8* TO
SEPTEMBER 30, 2000 SEP. 30, 1999
-------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD $9.31 $10.00
-------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .21 .11
Net Realized and Unrealized Gain (Loss)
on Investments .45 (.80)
------------------------------------
Total from Investment Operations .66 (.69)
------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.21) --
Distributions from Realized Capital Gains -- --
------------------------------------
Total Distributions (.21) --
-------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $9.85 $ 9.31
===============================================================================
TOTAL RETURN 7.18% -6.90%
===============================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $47 $42
Ratio of Total Expenses to Average Net
Assets 0.45% 0.37%**
Ratio of Net Investment Income to Average
Net Assets 2.67% 2.38%**
Portfolio Turnover Rate 42% 18%
===============================================================================
*Inception.
**Annualized.
-------------------------------------------------------------------------------
EQUITY INDEX PORTFOLIO
YEAR ENDED SEPTEMBER 30,
--------------------------------------
2000 1999 1998 1997 1996
-------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF YEAR $33.85 $26.94 $25.32 $18.32 $15.69
-------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .38 .37 .37 .34 .34
Net Realized and Unrealized Gain
(Loss) on Investments 4.12 7.04 1.83 6.94 2.75
----------------------------------------
Total from Investment Operations 4.50 7.41 2.20 7.28 3.09
----------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.38) (.37) (.34) (.19) (.33)
Distributions from Realized Capital
Gains (.33) (.13) (.24) (.09) (.13)
----------------------------------------
Total Distributions (.71) (.50) (.58) (.28) (.46)
-------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $37.64 $33.85 $26.94 $25.32 $18.32
===============================================================================
TOTAL RETURN 13.43% 27.84% 8.97% 40.31% 20.19%
===============================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $1,507 $1,365 $920 $718 $406
Ratio of Total Expenses to Average Net
Assets 0.16% 0.18% 0.20% 0.23% 0.22%
Ratio of Net Investment Income to
Average Net Assets 1.01% 1.21% 1.48% 1.78% 2.13%
Portfolio Turnover Rate 11% 4% 1% 1% 2%
===============================================================================
<PAGE>
35
-------------------------------------------------------------------------------
MID-CAP INDEX PORTFOLIO
YEAR ENDED FEB. 8* TO
SEPTEMBER 30, 2000 SEP. 30, 1999
-------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD $10.65 $10.00
-------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .08 .04
Net Realized and Unrealized Gain (Loss)
on Investments 4.49 .61
------------------------------------
Total from Investment Operations 4.57 .65
------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.05) --
Distributions from Realized Capital Gains (.20) --
------------------------------------
Total Distributions (.25) --
-------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $14.97 $10.65
===============================================================================
TOTAL RETURN 43.77% 6.50%
===============================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $192 $54
Ratio of Total Expenses to Average Net
Assets 0.28% 0.24%**
Ratio of Net Investment Income to Average
Net Assets 0.90% 1.03%**
Portfolio Turnover Rate 43% 24%
===============================================================================
*Initial share purchase date. All assets were held in money market instruments
until February 9, 1999, when performance measurement began.
**Annualized.
-------------------------------------------------------------------------------
GROWTH PORTFOLIO
YEAR ENDED SEPTEMBER 30,
--------------------------------------
2000 1999 1998 1997 1996
-------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF YEAR $28.96 $24.33 $21.51 $17.58 $14.10
-------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .080 .16 .16 .190 .18
Net Realized and Unrealized Gain
(Loss) on Investments 7.795 6.16 3.43 4.615 3.65
----------------------------------------
Total from Investment Operations 7.875 6.32 3.59 4.805 3.83
----------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.160) (.16) (.20) (.180) (.16)
Distributions from Realized Capital
Gains (1.535) (1.53) (.57) (.695) (.19)
----------------------------------------
Total Distributions (1.695) (1.69) (.77) (.875) (.35)
-------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $35.14 $28.96 $24.33 $21.51 $17.58
===============================================================================
TOTAL RETURN 28.25% 27.27% 17.37% 28.76% 27.79%
===============================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $1,302 $953 $631 $460 $276
Ratio of Total Expenses to Average Net
Assets 0.31% 0.35% 0.39% 0.38% 0.39%
Ratio of Net Investment Income to
Average Net Assets 0.24% 0.59% 0.74% 1.12% 1.29%
Portfolio Turnover Rate 81% 50% 48% 38% 42%
===============================================================================
<PAGE>
36
-------------------------------------------------------------------------------
SMALL COMPANY GROWTH PORTFOLIO
YEAR ENDED SEPTEMBER 30,
--------------------------------- JUN. 3* TO
2000 1999 1998 1997 SEP. 30, 1996
-------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING
OF PERIOD $12.87 $ 9.53 $11.97 $ 9.84 $10.00
-------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .17 .06 .06 .04 .04
Net Realized and Unrealized
Gain (Loss) on Investments 9.69 3.35 (2.46) 2.13 (.20)
--------------------------------------------------
Total from Investment
Operations 9.86 3.41 (2.40) 2.17 (.16)
--------------------------------------------------
DISTRIBUTIONS
Dividends from Net
Investment Income (.07) (.06) (.04) (.04) --
Distributions from
Realized Capital Gains -- (.01) -- -- --
--------------------------------------------------
Total Distributions (.07) (.07) (.04) (.04) --
-------------------------------------------------------------------------------
NET ASSET VALUE, END OF
PERIOD $22.66 $12.87 $ 9.53 $11.97 $ 9.84
===============================================================================
TOTAL RETURN 76.97% 35.98% -20.10% 22.16% -1.60%
===============================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year
(Millions) $480 $168 $111 $133 $44
Ratio of Total Expenses to
Average Net Assets 0.46% 0.49% 0.42% 0.39% 0.45%**
Ratio of Net Investment
Income to Average Net
Assets 0.98% 0.58% 0.54% 0.67% 1.42%**
Portfolio Turnover Rate 125% 85% 106% 72% 18%
===============================================================================
*Inception.
**Annualized.
-------------------------------------------------------------------------------
INTERNATIONAL PORTFOLIO
YEAR ENDED SEPTEMBER 30,
--------------------------------------
2000 1999 1998 1997 1996
-------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF YEAR $15.58 $12.96 $14.55 $12.74 $11.40
-------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .25 .23 .21 .17 .14
Net Realized and Unrealized Gain
(Loss) on Investments 1.80 2.59 (1.48) 2.10 1.36
----------------------------------------
Total from Investment Operations 2.05 2.82 (1.27) 2.27 1.50
----------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.21) (.20) (.18) (.14) (.16)
Distributions from Realized Capital
Gains (.46) -- (.14) (.32) --
----------------------------------------
Total Distributions (.67) (.20) (.32) (.46) (.16)
-------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $16.96 $15.58 $12.96 $14.55 $12.74
===============================================================================
TOTAL RETURN 13.62% 21.97% -8.74% 18.55% 13.36%
===============================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $365 $272 $217 $246 $162
Ratio of Total Expenses to Average Net
Assets 0.38% 0.46% 0.48% 0.46% 0.49%
Ratio of Net Investment Income to
Average Net Assets 1.48% 1.51% 1.48% 1.43% 1.42%
Portfolio Turnover Rate 41% 39% 38% 22% 19%
===============================================================================
<PAGE>
37
-------------------------------------------------------------------------------
REIT INDEX PORTFOLIO
YEAR ENDED FEB. 8* TO
SEPTEMBER 30, 2000 SEP. 30, 1999
-------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD $9.85 $10.00
-------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .43 .28
Net Realized and Unrealized Gain (Loss)
on Investments 1.57 (.43)
------------------------------------
Total from Investment Operations 2.00 (.15)
------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.23) --
Distributions from Realized Capital Gains (.01) --
------------------------------------
Total Distributions (.24) --
-------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $11.61 $ 9.85
===============================================================================
TOTAL RETURN 20.79% -1.50%
===============================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $47 $21
Ratio of Total Expenses to Average Net
Assets 0.47% 0.27%**
Ratio of Net Investment Income to Average
Net Assets 6.30% 6.26%**
Portfolio Turnover Rate 6% 4%
===============================================================================
*Initial share purchase date. All assets were held in money market
instruments until February 9, 1999, when performance measurement began.
**Annualized.
Yields and total returns presented for the Portfolios are net of the
Portfolios' operating expenses, but do not take into account charges and
expenses attributable to the variable annuity or variable insurance plan through
which you invest. The expenses of the annuity or insurance plan reduce the
returns and yields you ultimately receive, so you should bear those expenses in
mind when evaluating the performance of the Portfolios and when comparing the
yields and returns of the Portfolios with those of other mutual funds.
The REIT Index Portfolio is not sponsored, sold, promoted, or endorsed by Morgan
Stanley. The Morgan Stanley REIT Index is the exclusive property of Morgan
Stanley and is a service mark of Morgan Stanley Group Inc. "Standard &
Poor's(R)," "S&P(R)," "S&P 500(R)," "Standard & Poor's 500," "500," and "S&P
MidCap 400," are trademarks of The McGraw-Hill Companies, Inc., and have been
licensed for use by Vanguard Variable Insurance Fund and The Vanguard Group.
These mutual funds are not sponsored, endorsed, sold, or promoted by Standard &
Poor's, and Standard & Poor's makes no representation regarding the advisability
of investing in the Funds.
<PAGE>
38
GENERAL INFORMATION
If the board of trustees determines that continued offering of shares would be
detrimental to the best interests of a Portfolio's shareholders, the Portfolio
may suspend the offering of shares for a period of time. If the board of
trustees determines that a specific purchase acceptance would be detrimental to
the best interest of the Portfolio's shareholders, the Fund may reject such a
purchase request.
If you wish to redeem monies from a Portfolio, please refer to the
instructions provided in the prospectus for the insurance company's separate
account. Shares of the 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 administrator 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 receive a
check from the administrator for the redemption amount.
A Portfolio may suspend the redemption right or postpone payment 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 detrimental to the
best interests of a Portfolio's remaining shareholders to make payment in cash,
the Portfolio may pay redemption proceeds in whole or in part by a distribution
in kind of readily marketable securities.
<PAGE>
39
GLOSSARY OF INVESTMENT TERMS
BOND
A debt security (IOU) issued by a corporation, government, or government agency
in exchange for the money you lend it. In most instances, the issuer agrees to
pay back the loan by a specific date and to make regular interest payments until
that date.
CAPITAL GAINS DISTRIBUTION
Payment to mutual fund shareholders of gains realized on securities that a fund
has sold at a profit, minus any realized losses.
CASH RESERVES
Cash deposits, short-term bank deposits, and money market instruments which
include U.S. Treasury bills, bank certificates of deposit (CDs), repurchase
agreements, commercial paper, and banker's acceptances.
COMMON STOCK
A security representing ownership rights in a corporation. A stockholder is
entitled to share in the company's profits, some of which may be paid out as
dividends.
COUNTRY RISK
The chance that events such as political or financial troubles or natural
disasters will weaken a country's economy.
CREDIT QUALITY
A measure of a bond issuer's ability to pay interest and principal in a timely
manner.
CURRENCY RISK
The chance that returns on a foreign investment will be reduced because of
unfavorable changes in currency exchange rates.
DIVIDEND INCOME
Payment to shareholders of income from interest or dividends generated by a
portfolio's investments.
EXPENSE RATIO
The percentage of a portfolio's average net assets used to pay its expenses. The
expense ratio includes management fees, administrative fees, and any 12b-1
distribution fees.
FIXED INCOME SECURITIES
Investments, such as bonds, that have a fixed payment schedule. While the level
of income offered by these securities is predetermined, their prices may
fluctuate.
FUND DIVERSIFICATION
Holding a variety of securities so that a portfolio's return is not hurt badly
by the poor performance of a single security, industry, or country.
INVESTMENT GRADE
A bond whose credit quality is considered by independent bond-rating agencies to
be sufficient to ensure timely payment of principal and interest under current
economic circumstances.
MATURITY
The date when a bond issuer agrees to repay the bond's principal, or face value,
to the bond's buyer.
PRICE/EARNINGS (P/E) RATIO
The current share price of a stock, divided by its per-share earnings (profits).
A stock selling for $20, with earnings of $2 per share, has a price/earnings
ratio of 10.
PRINCIPAL
The amount of money you put into an investment.
TOTAL RETURN
A percentage change, over a specified time period, in a mutual fund's net asset
value, assuming the reinvestment of all distributions of dividends and capital
gains.
VOLATILITY
The fluctuations in value of a mutual fund or other security. The greater a
fund's volatility, the wider the fluctuations between its high and low prices.
YIELD
Income (interest or dividends) earned by an investment, expressed as a
percentage of the investment's price.
<PAGE>
[SHIP LOGO]
[THE VANGUARD GROUP(R) LOGO]
Post Office Box 2600
Valley Forge, PA 19482-2600
FOR MORE INFORMATION
If you'd like more information about
Vanguard Variable Insurance Fund, the
following documents are available free
upon request:
ANNUAL/SEMIANNUAL REPORTS
TO SHAREHOLDERS
Additional information about the Fund's
investments is available in the Fund's
annual and semiannual reports to
shareholders.
STATEMENT OF ADDITIONAL
INFORMATION (SAI)
The SAI provides more detailed
information about the Fund.
The current annual and semiannual
reports and the SAI are incorporated by
reference into (and are thus legally a part
of) this prospectus.
All market indexes referenced in this
prospectus are the exclusive property of
their respective owners.
To receive a free copy of the latest annual
or semiannual report or the SAI, or to
request additional information about the
Fund or other Vanguard funds, please
contact us as follows:
VANGUARD VARIABLE
INSURANCE FUND
P.O. BOX 2600
VALLEY FORGE, PA 19482-2600
TELEPHONE:
1-800-522-5555
WORLD WIDE WEB:
WWW.VANGUARD.COM
INFORMATION PROVIDED BY THE
SECURITIES AND EXCHANGE
COMMISSION (SEC)
You can review and copy information
about the Fund (including the SAI) at the
SEC's Public Reference Room in
Washington, DC. To find out more about
this public service, call the SEC at 1-202-
942-8090. Reports and other information
about the Fund are also available on the
SEC's Internet site at http://www.sec.gov, or
you can receive copies of this information, for a
fee, by electronic request at the following
e-mail address: [email protected], or by
writing the Public Reference Section,
Securities and Exchange Commission,
Washington, DC 20549-0102.
Fund's Investment Company Act
file number: 811-5962
(C)2000 The Vanguard Group, Inc.
All rights reserved.
Vanguard Marketing Corporation,
Distributor.
<PAGE>
P064N 122000
<PAGE>
P064NY 122000
<PAGE>
PART B
VANGUARD(R) VARIABLE INSURANCE FUND (THE FUND)
STATEMENT OF ADDITIONAL INFORMATION DECEMBER 29, 2000
This Statement is not a prospectus, but should be read in conjunction with the
Fund's current Prospectus (dated December 29, 2000). To obtain the Prospectus or
the most recent Annual Report to Shareholders, containing the Fund's financial
statements, which are hereby incorporated by reference, please write to the Fund
or contact the insurance company sponsoring the accompanying variable life
insurance or variable annuity contract.
TABLE OF CONTENTS
PAGE
----
DESCRIPTION OF THE FUND..........................................B-1
INVESTMENT POLICIES..............................................B-3
FUNDAMENTAL INVESTMENT LIMITATIONS...............................B-8
SHARE PRICE......................................................B-9
PURCHASE OF SHARES...............................................B-11
REDEMPTION OF SHARES.............................................B-11
YIELD (MONEY MARKET PORTFOLIO)...................................B-11
YIELD AND TOTAL RETURN...........................................B-12
MANAGEMENT OF THE FUND...........................................B-14
INVESTMENT ADVISORY SERVICES.....................................B-17
PORTFOLIO TRANSACTIONS...........................................B-28
COMPARATIVE INDEXES..............................................B-29
FINANCIAL STATEMENTS.............................................B-31
APPENDIX--DESCRIPTION OF SECURITIES AND RATINGS..................B-32
DESCRIPTION OF THE FUND
ORGANIZATION
The Fund was organized as a Maryland corporation in 1989 before becoming a
Pennsylvania business trust later in 1989, and was reorganized as a Delaware
business trust on June 30, 1998. Prior to its reorganization as a Delaware
business trust, the Fund was known by the same name as is currently used. The
Fund is registered with the United States Securities and Exchange Commission
(the Commission) under the Investment Company Act of 1940 (the 1940 Act) as an
open-end diversified management investment company. It currently offers the
following portfolios (all Investor Share Class):
Balanced Portfolio High-Grade Bond Portfolio
Diversified Value Portfolio International Portfolio
Equity Income Portfolio Mid-Cap Index Portfolio
Equity Index Portfolio Money Market Portfolio
Growth Portfolio REIT Index Portfolio
High Yield Bond Portfolio Short-Term Corporate Portfolio
Small Company Growth Portfolio
(individually, a Portfolio; collectively, the Portfolios)
The Fund has the ability to offer additional portfolios or classes of
shares. There is no limit on the number of full and fractional shares that the
Fund may issue for a single portfolio or class of shares.
B-1
<PAGE>
SERVICE PROVIDERS
CUSTODIAN. Brown Brothers Harriman & Co., 40 Water Street, Boston, MA 02109
(for International Portfolio); First Union National Bank, PA4943, 530 Walnut
Street, Philadelphia, PA 19106, (for High-Grade Bond, Equity Index, Balanced,
High Yield Bond, Small Company Growth, Diversified Value, Mid-Cap Index, REIT
Index, and Short-Term Corporate Portfolios); State Street Bank and Trust
Company, 225 Franklin Street, Boston, MA 02110 (for Equity Income and Growth
Portfolios); and The Bank of New York, One Wall Street, New York, NY 10286 (for
Money Market Portfolio) serve as the Fund's custodians. The custodians are
responsible for maintaining the Fund's assets and keeping all necessary accounts
and records.
INDEPENDENT ACCOUNTANTS. PricewaterhouseCoopers LLP, Two Commerce Square,
Suite 1700, 2001 Market Street, Philadelphia, PA 19103-7042, serves as the
Fund's independent accountants. The accountants audit the Fund's financial
statements and provide other related services.
TRANSFER AND DIVIDEND-PAYING AGENT. The Fund's transfer agent and
dividend-paying agent is The Vanguard Group, Inc., 100 Vanguard Boulevard,
Malvern, PA 19355.
CHARACTERISTICS OF THE FUND'S SHARES
RESTRICTIONS ON HOLDING OR DISPOSING OF SHARES. There are no restrictions
on the right of shareholders to retain or dispose of the Fund's shares, other
than the possible future termination of the Fund or any of its Portfolios. The
Fund or any of its Portfolios may be terminated by reorganization into another
mutual fund or by liquidation and distribution of the assets of the affected
Portfolio. Unless terminated by reorganization or liquidation, the Fund and its
Portfolios will continue indefinitely.
SHAREHOLDER LIABILITY. The Fund is organized under Delaware law, which
provides that shareholders of a business trust are entitled to the same
limitations of personal liability as shareholders of a corporation organized
under Delaware law. Effectively, this means that a shareholder of the Fund will
not be personally liable for payment of the Fund's debts except by reason of his
or her own conduct or acts. In addition, a shareholder could incur a financial
loss on account of a Fund obligation only if the Fund itself had no remaining
assets with which to meet such obligation. We believe that the possibility of
such a situation arising is extremely remote.
DIVIDEND RIGHTS. The shareholders of a Portfolio are entitled to receive
any dividends or other distributions declared for such Portfolios. No shares
have priority or preference over any other shares of the same Portfolio with
respect to distributions. Distributions will be made from the assets of a
Portfolio, and will be paid ratably to all shareholders of the Portfolio (or
class) according to the number of shares of such Portfolio (or class) held by
shareholders on the record date. The amount of income dividends per share may
vary between separate share classes of the same Portfolio based upon differences
in the way that expenses are allocated between share classes pursuant to a
multiple class plan.
VOTING RIGHTS. Shareholders are entitled to vote on a matter if: (i) a
shareholder vote is required under the 1940 Act; (ii) the matter concerns an
amendment to the Declaration of Trust that would adversely affect to a material
degree the rights and preferences of the shares of any class or Portfolio; or
(iii) the trustees determine that it is necessary or desirable to obtain a
shareholder vote. The 1940 Act requires a shareholder vote under various
circumstances, including to elect or remove trustees upon the written request of
shareholders representing 10% or more of the Fund's net assets, and to change
any fundamental policy of the Fund. Unless otherwise required by applicable law,
shareholders of the Fund receive one vote for each dollar of net asset value
owned on the record date, and a fractional vote for each fractional dollar of
net asset value owned on the record date. However, only the shares of the
Portfolio affected by a particular matter are entitled to vote on that matter.
Voting rights are non-cumulative and cannot be modified without a majority vote
of shareholders.
LIQUIDATION RIGHTS. In the event of liquidation, shareholders will be
entitled to receive a pro rata share of the net assets of the applicable
Portfolio of the Fund.
PREEMPTIVE RIGHTS. There are no preemptive rights associated with shares of
the Fund.
CONVERSION RIGHTS. There are no conversion rights associated with shares of
the Fund.
REDEMPTION PROVISIONS. The Fund's redemption provisions are described in
the current Plan prospectus and elsewhere in this Statement of Additional
Information.
B-2
<PAGE>
SINKING FUNDS PROVISION. The Fund has no sinking fund provisions.
CALLS OR ASSESSMENT. The Fund's shares, when issued, are fully paid and
non-assessable.
TAX STATUS OF THE FUND
Each Portfolio of the Fund intends to qualify as a "regulated investment
company" under Subchapter M of the Internal Revenue Code. This special tax
status means that a Portfolio will not be liable for federal tax on income and
capital gains distributed to shareholders. In order to preserve its tax status,
each Portfolio of the Fund must comply with certain requirements. If a Portfolio
fails to meet these requirements in any taxable year, it will be subject to tax
on its taxable income at corporate rates, and all distributions from earnings
and profits, including any distributions of net tax-exempt income and net
long-term capital gains, will be taxable to shareholders as ordinary income. In
addition, the Portfolio could be required to recognize unrealized gains, pay
substantial taxes and interest, and make substantial distributions before
regaining its tax status as a regulated investment company.
INVESTMENT POLICIES
REPURCHASE AGREEMENTS. Each Portfolio of the Fund, along with other members
of the Vanguard Group, may invest in repurchase agreements with commercial
banks, brokers, or dealers either for defensive purposes due to market
conditions or to generate income from its excess cash balances. The 13
Portfolios of the Fund, along with other Vanguard Funds, may deposit their daily
cash reserves into a joint account which invests such reserves in repurchase
agreements and other short-term instruments. The Bank of New York is the
custodian for the joint account. A repurchase agreement is an agreement under
which a Portfolio acquires a money market instrument (generally a security
issued by the U.S. Government or an agency thereof, a banker's acceptance or a
certificate of deposit) from a Federal Reserve member bank or a registered
securities dealer, subject to resale to the seller at an agreed upon price and
date (normally, the next business day). A repurchase agreement may be considered
a loan collateralized by securities. The resale price reflects an agreed upon
interest rate effective for the period the instrument is held by a Portfolio and
is unrelated to the interest rate on the underlying instrument. In these
transactions, the securities acquired by a Portfolio (including accrued interest
earned thereon) must have a total value in excess of the value of the repurchase
agreement and are held by the custodian bank for the joint account until
repurchased. In addition, the Fund's board of trustees will monitor each
Portfolio's repurchase agreement transactions generally and will establish
guidelines and standards for review of the creditworthiness of any bank, broker
or dealer party to a repurchase agreement with a Portfolio of the Fund.
The use of repurchase agreements involves certain risks. For example, if
the other party to the agreement defaults on its obligation to repurchase the
underlying security at a time when the value of the security has declined, a
Portfolio may incur a loss upon disposition of the security. If the other party
to the agreement becomes insolvent and subject to liquidation or reorganization
under the Bankruptcy Code or other laws, a court may determine that the
underlying security is collateral for a loan by the Portfolio not within the
control of the Portfolio and therefore the Portfolio may not be able to
substantiate its interest in the underlying security and may be deemed an
unsecured creditor of the other party to the agreement. While the Fund's
management acknowledges these risks, it is expected that they can be controlled
through careful monitoring procedures.
LENDING OF SECURITIES. Each Portfolio of the Fund (except for the Money
Market Portfolio) may lend its securities to qualified institutional investors
(typically brokers, dealers, banks or other financial institutions) who need to
borrow securities in order to complete certain transactions, such as covering
short sales, avoiding failures to deliver securities or completing arbitrage
operations. By lending its portfolio securities, a Portfolio attempts to
increase its net investment income through the receipt of interest on the loan.
Any gain or loss in the market price of the securities loaned that might occur
during the term of the loan would be for the account of the Portfolio. The terms
and the structure and the aggregate amount of such loans must be consistent with
the 1940 Act, and the Rules and Regulations or interpretations of the Commission
thereunder. These provisions limit the amount of securities a Portfolio may lend
to 33 1/3% of the Portfolio's total assets, and require that: (a) the borrower
pledge and maintain with the Portfolio collateral consisting of cash, a letter
of credit issued by a domestic U.S. bank, or securities issued or guaranteed by
the United States Government having at all times not less than 100% of the value
of the securities loaned, (b) the borrower add to such collateral whenever the
price
B-3
<PAGE>
of the securities loaned rises (i.e., the borrower "marks to the market" on a
daily basis), (c) the loan be made subject to termination by the Portfolio at
any time, and (d) the Portfolio receive reasonable interest on the loan, which
may include the Portfolio's investing any cash collateral in interest bearing
short-term investments, any distribution on the loaned securities and any
increase in their market value. Loan arrangements made by a Portfolio will
comply with all other applicable regulatory requirements, including the rules of
the New York Stock Exchange, which presently require the borrower, after notice,
to redeliver the securities within the normal settlement time of three business
days. All relevant facts and circumstances, including the creditworthiness of
the broker, dealer or institution, will be considered in making decisions with
respect to the lending of securities, subject to review by the Fund's board of
trustees.
At the present time, the Staff of the Commission does not object if an
investment company pays reasonable negotiated fees in connection with loaned
securities, so long as such fees are set forth in a written contract and
approved by the investment company's trustees. In addition, voting rights pass
with loaned securities; but if a material event will occur affecting an
investment on loan, the loan must be called and the securities voted.
VANGUARD INTERFUND LENDING PROGRAM. The Commission has issued an exemptive
order permitting the Fund to participate in Vanguard's interfund lending
program. This program allows the Vanguard funds to borrow money from and loan
money to each other for temporary or emergency purposes. The program is subject
to a number of conditions, including the requirement that no fund may borrow or
lend money through the program unless it receives a more favorable interest rate
than is available from a typical bank for a comparable transaction. In addition,
a fund may participate in the program only if and to the extent that such
participation is consistent with the fund's investment objective and other
investment policies. The Boards of trustees of the Vanguard funds are
responsible for ensuring that the interfund lending program operates in
compliance with all conditions of the Commission's exemptive order.
ILLIQUID SECURITIES. Each Portfolio of the Fund may invest up to 15% of its
net assets (10% with respect to the Money Market Portfolio) in illiquid
securities. Illiquid securities are securities that may not be sold or disposed
of in the ordinary course of business within seven business days at
approximately the value at which they are being carried on a Portfolio's books.
The Fund may invest in restricted, privately placed securities that, under
the Commission's rules, may be sold only to qualified institutional buyers.
Because these securities can only be resold to qualified institutional buyers,
they may be considered illiquid securities--meaning that they could be difficult
for these Portfolios to convert to cash if needed.
If a substantial market develops for a restricted security held by the
Fund, it will be treated as a liquid security, in accordance with procedures and
guidelines approved by the Fund's board of trustees. This generally includes
securities that are unregistered that can be sold to qualified institutional
buyers in accordance with Rule 144A under the Securities Act of 1933 (the 1933
Act). While the Portfolios' investment advisers determine the liquidity of
restricted securities on a daily basis, the Board oversees and retains ultimate
responsibility for the advisers' decisions. The factors the Board considers in
monitoring these decisions include the valuation of a security, the availability
of qualified institutional buyers, and the availability of information on the
security's issuer.
FOREIGN INVESTMENTS. As indicated in the Prospectus, the International,
Equity Index, Growth, Equity Income, Small Company Growth, Balanced, Short-Term
Corporate, High Grade Bond, and Money Market Portfolios may include foreign
securities to a certain extent. Investors should recognize that investing in
foreign companies involves certain special considerations which are not
typically associated with investing in U.S. companies.
Country Risk. As foreign companies are not generally subject to uniform
accounting, auditing and financial reporting standards and practices comparable
to those applicable to domestic companies, there may be less publicly available
information about certain foreign companies than about domestic companies.
Securities of some foreign companies are generally less liquid and more volatile
than securities of comparable domestic companies. There is generally less
government supervision and regulation of stock exchanges, brokers and listed
companies than in the U.S. In addition, with respect to certain foreign
countries, there is the
B-4
<PAGE>
possibility of expropriation or confiscatory taxation, political or social
instability, or diplomatic developments which could affect U.S. investments in
those countries.
Although each Portfolio will endeavor to achieve most favorable execution
costs in its portfolio transactions, commissions on many foreign stock exchanges
are generally higher than commissions on U.S. exchanges. In addition, it is
expected that the expenses for custodial arrangements of the Portfolios' foreign
securities will be somewhat greater than the expenses for the custodial
arrangements for handling U.S. securities of equal value.
Certain foreign governments levy withholding taxes against dividend and
interest income. Although in some countries a portion of these taxes is
recoverable, the non-recovered portion of foreign withholding taxes will reduce
the income a Portfolio receives from its foreign investments.
Currency Risk. Since the stocks of foreign companies are frequently
denominated in foreign currencies, and since the Portfolios may temporarily hold
uninvested reserves in bank deposits in foreign currencies, the Portfolios will
be affected favorably or unfavorably by changes in currency rates and in
exchange control regulations, and may incur costs in connection with conversions
between various currencies. The investment policies of the Portfolios permit
them to enter into forward foreign currency exchange contracts in order to hedge
holdings and commitments against changes in the level of future currency rates.
Such contracts involve an obligation to purchase or sell a specific currency at
a future date at a price set at the time of the contract.
Federal Tax Treatment of Non-U.S. Transactions. Special rules govern the
Federal income tax treatment of certain transactions denominated in terms of a
currency other than the U.S. dollar or determined by reference to the value of
one or more currencies other than the U.S. dollar. The types of transactions
covered by the special rules include the following: (i) the acquisition of, or
becoming the obligor under, a bond or other debt instrument (including, to the
extent provided in Treasury regulations, preferred stock); (ii) the accruing of
certain trade receivables and payables; and (iii) the entering into or
acquisition of any forward contract, futures contract, option, or similar
financial instrument if such instrument is not marked to market. The disposition
of a currency other than the U.S. dollar by a U.S. taxpayer is also treated as a
transaction subject to the special currency rules. However, foreign
currency-related regulated futures contracts and nonequity options are generally
not subject to the special currency rules if they are or would be treated as
sold for their fair market value at year-end under the marking-to-market rules
applicable to other futures contracts unless an election is made to have such
currency rules apply. With respect to transactions covered by the special rules,
foreign currency gain or loss is calculated separately from any gain or loss on
the underlying transaction and is normally taxable as ordinary gain or loss. A
taxpayer may elect to treat as capital gain or loss foreign currency gain or
loss arising from certain identified forward contracts, futures contracts and
options that are capital assets in the hands of the taxpayer and which are not
part of a straddle. The Treasury Department issued regulations under which
certain transactions subject to the special currency rules that are part of a
"section 988 hedging transaction" (as defined in the Internal Revenue Code of
1986, as amended, and the Treasury regulations) will be integrated and treated
as a single transaction or otherwise treated consistently for purposes of the
Code. Any gain or loss attributable to the foreign currency component of a
transaction engaged in by a Fund which is not subject to the special currency
rules (such as foreign equity investments other than certain preferred stocks)
will be treated as capital gain or loss and will not be segregated from the gain
or loss on the underlying transaction. It is anticipated that some of the
non-U.S. dollar-denominated investments and foreign currency contracts the
Portfolios may make or enter into will be subject to the special currency rules
described above.
COLLATERALIZED MORTGAGE OBLIGATIONS. The High-Grade Bond Portfolio may
invest in a relatively conservative class of collateralized mortgage obligations
(CMOs) which feature a high degree of cash flow predictability and less
vulnerability to mortgage prepayment risk. To reduce credit risk, the Portfolio
purchases these less risky classes of CMOs issued only by agencies of the U.S.
Government or privately-issued CMOs that carry high-quality investment-grade
ratings.
The Short-Term Corporate Portfolio may invest in CMOs that are
collateralized by whole loan mortgages or mortgage pass-through securities. The
Short-Term Corporate Portfolio may also purchase privately-issued CMOs carrying
investment grade ratings. The bonds issued under a CMO structure are divided
into groups with varying maturities, and the cash flows generated by the
mortgages or mortgage pass-through securities in the collateral pool are used to
first pay interest and then pay principal to the CMO bondholders. Under the CMO
structure, the repayment of principal among the different groups is prioritized
in accordance with the terms of the particular CMO issuance. The "fastest-pay"
group of bonds, as specified in the prospectus for the issuance,
B-5
<PAGE>
would initially receive all principal payments. When that group of bonds is
retired, the next group or groups, in the sequence, as specified in the
prospectus, receive all of the principal payments until all of the groups are
retired. Aside from market risk, the primary risk involved in any mortgage
security, such as a CMO issuance, is its exposure to prepayment risk. To the
extent a particular group of bonds is exposed to this risk, the bondholder is
generally compensated in the form of higher yield. In order to provide security,
in addition to the underlying collateral, many CMO issues also include minimum
reinvestment rate and minimum sinking-fund guarantees. Typically, the Portfolio
will invest in those CMOs that most appropriately reflect its average maturity
and market risks profile. Consequently, the Short-Term Corporate Portfolio
invests only in CMOs with highly predictable short-term average maturities.
The maturity of some classes of CMOs may be very difficult to predict
because any such predictions are highly dependent upon assumptions regarding the
prepayments which CMOs may experience. Deviations in the actual prepayments
experienced may significantly affect the ultimate maturity of CMOs, and in such
an event, the maturity and risk characteristics of CMOs purchased by the
Portfolios may be significantly greater or less than intended. The possibility
that rising interest rates may cause prepayments to occur at a slower than
expected rate is known as extension risk. This particular risk may effectively
change a CMO which was considered short- or intermediate-term at the time of
purchase into a long-term security. Alternatively, there are certain classes of
CMOs that are by design constructed to have highly predictable average
maturities. Such CMOs will retain their relative predictability over a broad
range of prepayment experience. The Portfolios expect to control extension risk
by purchasing these specific classes of CMOs which, in the advisers' opinions,
are reasonably predictable.
FUTURES CONTRACTS AND OPTIONS THEREON. Each Portfolio of the Fund (except
the Money Market Portfolio) may enter into futures contracts, options, and
options on futures contracts to maintain cash reserves while remaining fully
invested, to facilitate trading or to reduce transaction costs. Futures
contracts provide for the future sale by one party and purchase by another party
of a specified amount of a specific security at a specified future time and at a
specified price. Futures contracts which are standardized as to maturity date
and underlying financial instrument are traded on national futures exchanges.
Futures exchanges and trading are regulated under the Commodity Exchange Act by
the Commodity Futures Trading Commission (CFTC), a U.S. Government agency.
Assets committed to futures contracts will be segregated to the extent required
by law.
Although futures contracts by their terms call for actual delivery or
acceptance of the underlying securities, in most cases the contracts are closed
out before the settlement date without the making or taking of delivery. Closing
out an open futures position is done by taking an opposite position ("buying" a
contract which has previously been "sold," or "selling" a contract previously
"purchased") in an identical contract to terminate the position. Brokerage
commissions are incurred when a futures contract is bought or sold.
Futures traders are required to make a good faith margin deposit in cash or
government securities with a broker or custodian to initiate and maintain open
positions in futures contracts. A margin deposit is intended to assure
completion of the contract (delivery or acceptance of the underlying security)
if it is not terminated prior to the specified delivery date. Minimal initial
margin requirements are established by the futures exchange and may be changed.
Brokers may establish deposit requirements which are higher than the exchange
minimums. Futures contracts are customarily purchased and sold on margin which
may range upward from less than 5% of the value of the contract being traded.
After a futures contract position is opened, the value of the contract is
marked to market daily. If the futures contract price changes to the extent that
the margin on deposit does not satisfy margin requirements, payment of
additional "variation" margin will be required. Conversely, change in the
contract value may reduce the required margin, resulting in a repayment of
excess margin to the contract holder. Variation margin payments are made to and
from the futures broker for as long as the contract remains open. The Portfolios
of the Fund may earn interest income on their margin deposits.
Traders in futures contracts may be broadly classified as either "hedgers"
or "speculators." Hedgers use the futures markets primarily to offset
unfavorable changes in the value of securities otherwise held for investment
purposes or expected to be acquired by them. Speculators are less inclined to
own the securities underlying the futures contracts which they trade, and use
futures contracts with the expectation of realizing profits from fluctuations in
the prices of underlying securities. The Portfolios of the Fund intend to use
futures contracts only for bona fide hedging purposes.
B-6
<PAGE>
Regulations of the CFTC applicable to the Portfolios of the Fund require
that all of its futures transactions constitute bona fide hedging transactions
except to the extent that the aggregate initial margins and premiums required to
establish any non-hedging positions do not exceed five percent of the value of
the Fund's portfolio. The Portfolios of the Fund will only sell futures
contracts to protect securities they own against price declines or purchase
contracts to protect against an increase in the price of securities they intend
to purchase. As evidence of this hedging interest, the Portfolios of the Fund
expect that approximately 75% of their futures contract purchases will be
"completed," that is, equivalent amounts of related securities will have been
purchased or are being purchased by the Portfolios upon sale of open futures
contracts.
Although techniques other than the sale and purchase of futures contracts
could be used to control a Portfolio's exposure to market fluctuations, the use
of futures contracts may be a more effective means of hedging this exposure.
While a Portfolio will incur commission expenses in both opening and closing out
futures positions, these costs are lower than transaction costs incurred in the
purchase and sale of the underlying securities.
Restrictions on the Use of Future Contracts. A Portfolio of the Fund will
not enter into futures contracts transactions to the extent that, immediately
thereafter, the sum of its initial margin deposits on open contracts exceeds 5%
of the Portfolio's total assets. In addition, each Portfolio will not enter into
futures contracts to the extent that its outstanding obligations to purchase
securities under these contracts would exceed 20% of the Portfolio's total
assets.
Risk Factors in Futures Transactions. Positions in futures contracts may be
closed out only on an exchange which provides a secondary market for such
futures. However, there can be no assurance that a liquid secondary market will
exist for any particular futures contract at any specific time. Thus, it may not
be possible to close a futures position. In the event of adverse price
movements, a Portfolio would continue to be required to make daily cash payments
to maintain its required margin. In such situations, if a Portfolio has
insufficient cash it may have to sell portfolio securities to meet daily margin
requirements at a time when it may be disadvantageous to do so. In addition, a
Portfolio may be required to make delivery of the instruments underlying future
contracts it holds. The inability to close options and futures positions also
could have an adverse impact on the ability to hedge effectively.
The Portfolios will minimize the risk that they will be unable to close out
a futures contract by only entering into futures contracts which are traded on
national futures exchanges and for which there appears to be a 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 (as well as gain) to the investor. For example, if at the time
of purchase, 10% of the value of the futures contract is deposited as margin, a
subsequent 10% decrease in the value of the futures contract would result in a
total loss of the margin deposit, before any deduction for the transaction
costs, if the account were then closed out. A 15% decrease would result in a
loss equal to 150% of the original margin deposit if the contract were closed
out. Thus, a purchase or sale of a futures contract may result in losses in
excess of the amount invested in the contract. However, because the futures
strategies of the Portfolios are engaged in only for hedging purposes, the
advisers do not believe that the Portfolios are subject to the risks of loss
frequently associated with futures transactions. A Portfolio would presumably
have sustained comparable losses if, instead of the futures contract, it had
invested in the underlying financial instrument and sold it after the decline.
Utilization of futures transactions by a Portfolio does involve the risk of
imperfect or no correlation where the securities underlying futures contracts
have different maturities than the portfolio securities being hedged. It is also
possible that a Portfolio could both lose money on futures contracts and also
experience a decline in value of its portfolio securities. There is also the
risk of loss by a Portfolio of margin deposits in the event of bankruptcy of a
broker with whom the Portfolio has an open position in a futures contract or
related option.
Most futures exchanges limit the amount of fluctuation permitted in futures
contract prices during a single trading day. The daily limit establishes the
maximum amount that the price of a futures contract may vary either up or down
from the previous day's settlement price at the end of a trading session. Once
the daily limit has been reached in a particular type of contract, no trades may
be made on that day at a price beyond that limit.
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<PAGE>
The daily limit governs only price movement during a particular trading day and
therefore does not limit potential losses, because the limit may prevent the
liquidation of unfavorable positions. Futures contract prices have occasionally
moved to the daily limit for several consecutive trading days with little or no
trading, thereby preventing prompt liquidation of futures positions and
subjecting some futures traders to substantial losses.
Federal Tax Treatment of Futures Contracts. A Portfolio is required for
Federal income tax purposes to recognize as income for each taxable year its net
unrealized gains and losses on certain futures contracts as of the end of the
year as well as those actually realized during the year. In most cases, any gain
or loss recognized with respect to a futures contract is considered to be 60%
long-term capital gain or loss and 40% short-term capital gain or loss, without
regard to the holding period of the contract. Furthermore, sales of futures
contracts which are intended to hedge against a change in the value of
securities held by a Portfolio may affect the holding period of such securities
and, consequently, the nature of the gain or loss on such securities upon
disposition. A Portfolio may be required to defer the recognition of losses on
futures contracts to the extent of any unrecognized gains on related positions
held by the Portfolio.
In order for a Portfolio to continue to qualify for Federal income tax
treatment as a regulated investment company, at least 90% of its gross income
for a taxable year must be derived from qualifying income; i.e., dividends,
interest, income derived from loans of securities, gains from the sale of
securities or foreign currencies, or other income derived with respect to its
business of investing in such securities or currencies. It is anticipated that
any net gain realized from the closing out of futures contracts will be
considered qualifying income for purposes of the 90% requirement.
Each Portfolio of the Fund will distribute to shareholders annually any net
capital gains which have been recognized for Federal income tax purposes
including unrealized gains at the end of a Portfolio's fiscal year on futures
transactions. Such distributions will be combined with distributions of capital
gains realized on a Portfolio's other investments and shareholders will be
advised on the nature of the payments.
FUNDAMENTAL INVESTMENT LIMITATIONS
Each Portfolio of the Fund is subject to the following fundamental investment
limitations, which cannot be changed in any material way without the approval of
the holders of a majority of the affected Portfolios' shares. For these
purposes, a "majority" of shares means the lesser of: (i) 67% or more of the
shares voted, so long as more than 50% of a Portfolio's outstanding shares are
present or represented by proxy; or (ii) more than 50% of the Portfolio's
outstanding shares.
BORROWING. Each Portfolio may not borrow money, except for temporary or
emergency purposes in an amount not exceeding 15% of the Portfolio's net assets.
Each Portfolio may borrow money through banks, or Vanguard's interfund lending
program only, and must comply with all applicable regulatory conditions. Each
Portfolio may not make any additional investments whenever its outstanding
borrowings exceed 5% of total assets.
COMMODITIES, FUTURES, AND OPTIONS THEREON. Each Portfolio may not invest in
commodities, except that the Portfolios (except for the Money Market Portfolio)
may invest in futures contracts and options transactions. No more than 5% of a
Portfolio's total assets may be used as initial margin deposit for futures
contracts, and no more than 20% of the Portfolio's total assets may be invested
in futures contracts or options at any time.
DIVERSIFICATION. With respect to 75% of its total assets, each Portfolio
may not: (i) purchase more than 10% of the outstanding voting securities of any
one issuer, or (ii) purchase securities of any issuer if, as a result, more than
5% of the Portfolio's total assets would be invested in that issuer's
securities. This limitation does not apply to obligations of the United States
Government, its agencies, or instrumentalities.
ILLIQUID SECURITIES.* Each Portfolio may not acquire any security if, as a
result, more than 15% (10% with respect to the Money Market Portfolio) of its
net assets would be invested in securities that are illiquid.
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INDUSTRY CONCENTRATION. Each Portfolio may not invest more than 25% of its
total assets in any one industry. (Except that for the Money Market Portfolio,
this limitation does not apply to certificates of deposit and bankers
acceptances, and for all Portfolios, this limitation does not apply to
securities issued by the U.S. Government, its agencies and instrumentalities.)
INVESTING FOR CONTROL.* Each Portfolio may not invest in a company for the
purpose of controlling its management.
INVESTMENT COMPANIES.* Each Portfolio may not invest in any other
investment company, except through a merger, consolidation or acquisition of
assets, or to the extent permitted by Section 12 of the 1940 Act. Investment
companies whose shares the Portfolio acquires pursuant to Section 12 must have
investment objectives and investment policies consistent with those of the
Portfolio.
LOANS. Each Portfolio may not lend money to any person except by purchasing
fixed income securities or by entering into repurchase agreements, by lending
its portfolio securities, or through Vanguard's interfund lending program.
MARGIN.* Each Portfolio may not purchase securities on margin or sell
securities short, except as permitted by the Portfolio's investment policies
relating to commodities.
OIL, GAS, MINERALS.* Each Portfolio may not invest in interests in oil, gas
or other mineral exploration or development programs.
PLEDGING ASSETS.* Each Portfolio may not pledge, mortgage, or hypothecate
more than 15% of its net assets.
PUT OPTIONS, CALL OPTIONS, STRADDLES, AND SPREADS.* Each Portfolio may not
invest in put or call options, or employ straddles or spreads, except as
permitted by the Portfolio's fundamental investment limitations relating to
commodities, futures, and options thereon.
REAL ESTATE. Each Portfolio may not invest directly in real estate,
although it may invest in securities of companies that deal in real estate and
bonds secured by real estate.
SENIOR SECURITIES. Each Portfolio may not issue senior securities, except
in compliance with the 1940 Act.
UNDERWRITING. Each Portfolio may not engage in the business of underwriting
securities issued by other persons. The Portfolio will not be considered an
underwriter when disposing of its investment securities.
The investment limitations set forth above are considered at the time
investment securities are purchased. If a percentage restriction is adhered to
at the time the investment is made, a later increase in percentage resulting
from a change in the market value of assets will not constitute a violation of
such restriction.
None of these limitations prevents the Portfolios from participating in The
Vanguard Group (Vanguard). As a member of the Group, each Portfolio may own
securities issued by Vanguard, make loans to Vanguard, and contribute to
Vanguard's costs or other financial requirements. See "Management of the Fund"
for more information.
*The above asterisked items are operational, rather than fundamental,
policies for the Diversified Value, Mid-Cap Index, REIT Index, and Short-Term
Corporate Portfolios of Vanguard Variable Insurance Fund. Accordingly,
shareholder approval is not required in order to change these stated policies
for the Diversified Value, Mid-Cap Index, REIT Index, and Short-Term Corporate
Portfolios.
SHARE PRICE
Each Portfolio's share price, or "net asset value" per share, is calculated by
dividing the total assets of the Portfolio, less all liabilities, by the total
number of shares outstanding. The net asset value is determined as of the
regular close of the New York Stock Exchange (the Exchange), generally 4:00 p.m.
Eastern time, on each day that the Exchange is open for trading.
It is the policy of the Money Market Portfolio to attempt to maintain a net
asset value of $1.00 per share for sales and redemptions. The instruments held
by the Portfolio are valued on the basis of amortized cost, which does not take
into account unrealized capital gains or losses. This involves valuing an
instrument at its cost and thereafter assuming a constant amortization to
maturity of any discount or premium, regardless of the impact of
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<PAGE>
fluctuating interest rates on the market value of the instrument. While this
method provides certainty in valuation, it may result in periods during which
value, as determined by amortized cost, is higher or lower than the price which
the Portfolio would receive if it sold the instrument. Such procedures will
include a review of the Portfolio's holdings by the trustees, at such intervals
as they may deem appropriate, to determine whether the Portfolio's net asset
value calculated by using available market quotations deviates from $1.00 per
share based on amortized cost. The extent of any deviation will be examined by
the trustees. If such deviation exceeds 1/2 of 1%, the trustees will promptly
consider what action, if any, will be initiated. In the event the trustees
determine that a deviation exists which may result in material dilution or other
unfair results to investors or existing shareholders, they have agreed to take
such corrective action as they regard as necessary and appropriate, including
the sale of portfolio instruments prior to maturity to realize capital gains or
losses or to shorten average portfolio maturity; withholding dividends; making a
special capital distribution; redemptions of shares in kind; or establishing a
net asset value per share by using available market quotations.
The use of amortized cost and the maintenance of the Money Market
Portfolio's net asset value at $1.00 is based on its election to operate under
Rule 2a-7 under the 1940 Act. As a condition of operating under the rule, the
Portfolio must maintain a dollar-weighted average portfolio maturity of 90 days
or less, purchase only instruments having remaining maturities of 397 days or
less, and invest only in securities that are determined by methods approved by
the trustees to present minimal credit risks and that are of high quality as
determined by the requisite rating services, or in the case of an instrument not
so rated, determined by methods approved by the trustees to be of comparable
quality.
For the other Portfolios of the Fund, portfolio securities for which market
quotations are readily available (includes those securities listed on national
securities exchanges, as well as those quoted on the NASDAQ Stock Market) will
be valued at the last quoted sales price or the official closing price on the
day the valuation is made. Such securities which are not traded on the valuation
date are valued at the mean of the bid and ask prices. Price information on
exchange-listed securities is taken from the exchange where the security is
primarily traded. Securities may be valued on the basis of prices provided by a
pricing service when such prices are believed to reflect the fair market value
of such securities.
Short term instruments (those with remaining maturities of 60 days or less)
may be valued at cost, plus or minus any amortized discount or premium, which
approximates market value.
Bonds and other fixed income securities may be valued on the basis of
prices provided by a pricing service when such prices are believed to reflect
the fair market value of such securities. The prices provided 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 specific securities.
Foreign securities are valued at the last quoted sales price, or the most
recently determined closing price calculated according to local market
convention, available at the time the Portfolio is valued. Prices are obtained
from the broadest and most representative market on which the securities trade.
If events which materially affect the value of a Portfolio's investments occur
after the close of the securities markets on which such securities are primarily
traded, those investments may be valued by such methods as the board of trustees
deems in good faith to reflect fair value.
In determining a Portfolio's net asset value per share, all assets and
liabilities initially expressed in foreign currencies will be converted into
U.S. dollars using the officially quoted daily exchange rates used by Morgan
Stanley Capital International in calculating various benchmarking indexes. This
officially quoted exchange rate may be determined prior to or after the close of
a particular securities market. If such quotations are not available or do not
reflect market conditions at the time the Portfolio is valued, the rate of
exchange will be determined in accordance with policies established in good
faith by the board of trustees.
Other assets and securities for which no quotations are readily available
or which are restricted as to sale (or resale) are valued by such methods as the
board of trustees deems in good faith to reflect fair value.
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<PAGE>
PURCHASE OF SHARES
Each Portfolio reserves the right in its sole discretion (i) to suspend the
offerings of its shares, (ii) to reject purchase orders when in the judgment of
management such rejection is in the best interest of the Portfolio, and (iii) to
reduce or waive the minimum investment for or any other restrictions on initial
and subsequent investments for certain fiduciary accounts or under circumstances
where certain economies can be achieved in sales of the Portfolio's shares.
REDEMPTION OF SHARES
Each Portfolio may suspend redemption privileges or postpone the date of payment
(i) during any period that the New York Stock Exchange is closed, or trading on
the Exchange is restricted as determined by the Commission, (ii) during any
period when an emergency exists as defined by the rules of the Commission as a
result of which it is not reasonably practicable for a Portfolio to dispose of
securities owned by it, or fairly to determine the value of its assets, and
(iii) for such other periods as the Commission may permit.
Each Portfolio has made an election with the Commission to pay in cash all
redemptions requested by any shareholder of record limited in amount during any
90-day period to the lesser of $250,000 or 1% of the net assets of the Portfolio
at the beginning of such period.
YIELD (MONEY MARKET PORTFOLIO)
The current yield of the Fund's Money Market Portfolio is calculated daily on a
base period return of a hypothetical account having a beginning balance of one
share for a particular period of time (generally 7 days). The return is
determined by dividing the net change (exclusive of any capital changes) in such
account by its average net asset value for the period, and then multiplying it
by 365/7 to get the annualized current yield. The calculation of net change
reflects the value of additional shares purchased with the dividends by the
Portfolio, including dividends on both the original share and on such additional
shares. An effective yield, which reflects the effects of compounding and
represents an annualization of the current yield with all dividends reinvested,
may also be calculated for the Portfolio by adding 1 to the net change, raising
the sum to the 365/7 power, and subtracting 1 from the result.
Set forth below is an example, for purposes of illustration only, of the
current and effective yield calculations for the Money Market Portfolio for the
7-day base period ended September 30, 2000.
MONEY MARKET PORTFOLIO
9/30/2000
---------
Value of account at beginning of period. $1.00000
Value of same account at end of period*. $1.00125
--------
Net change in account value. . . . . . . $0.00125
Annualized current net yield
(Net change X 365/7) / average net
asset value . . . . . . . . . . . . . . 6.51%
=====
Effective Yield
[(Net change) + 1]365/7 - 1 . . . . . . 6.72%
=====
Average weighted maturity of investments 55 days
=======
---------
* Exclusive of any capital changes.
The net asset value of a share of the Money Market Portfolio is $1.00 and
it is not expected to fluctuate. However, the yield of the Portfolio will
fluctuate. The Fund has obtained private insurance that partially protects the
Money Market Portfolio against default of principal or interest payments on the
instruments it holds and against bankruptcy by issuers and credit enhancers of
these instruments. Treasury and other U.S. Government securities held by the
Portfolio are excluded from this coverage. The annualization of a week's
dividend is not a representation by the Portfolio as to what an investment in
the Portfolio will actually yield in the future. Actual yields will depend on
such variables as investment quality, average maturity, the type of instruments
the Portfolio invests in, changes in interest rates on instruments, changes in
the expenses of the Portfolio and other
B-11
<PAGE>
factors. Yields are one basis investors may use to analyze the Portfolio and
other investment vehicles; however, yields of other investment vehicles may not
be comparable because of the factors set forth in the preceding sentence,
differences in the time periods compared, and differences in the methods used in
valuing portfolio instruments, computing net asset value and calculating yield.
YIELD AND TOTAL RETURN
The yield of each Portfolio of the Fund (except the Money Market Portfolio) for
the 30-day period ended September 30, 2000, is set forth below. Premiums and
discounts on asset-backed securities are not amortized.
Balanced Portfolio. . . . . . . . . 3.89%
Diversified Value. . . . . . . . . 3.04%
Equity Income Portfolio. . . . . . 2.35%
Equity Index Portfolio. . . . . . . 0.96%
Growth Portfolio. . . . . . . . . . 0.09%
High Yield Bond Portfolio. . . . . 10.28%
High-Grade Bond Portfolio. . . . . 6.99%
International Portfolio. . . . . . N/A
Mid-Cap Index Portfolio. . . . . . 0.97%
REIT Index. . . . . . . . . . . . . N/A
Short-Term Corporate Portfolio. . . 7.44%
Small Company Growth Portfolio. . . 1.02%
The average annual total return of each Portfolio of the Fund (except the
Money Market Portfolio) for the one-, five-, and ten-year periods, or the period
since inception, is set forth below:
ONE YEAR ENDED FIVE YEARS ENDED TEN YEARS ENDED
9/30/2000 9/30/2000 9/30/2000
--------- --------- ---------
Balanced Portfolio 5.91% 12.83% 12.43%*
Diversified Value
Portfolio 7.18% -0.13%* N/A
Equity Income
Portfolio 3.06% 15.76% 14.80%*
Equity Index Portfolio 13.43% 21.66% 17.74%*
Growth Portfolio 28.25% 25.81% 22.90%*
High Yield Bond
Portfolio 4.03% 6.70%* N/A
High-Grade Bond
Portfolio 7.05% 6.38% 7.25%*
International
Portfolio 13.62% 11.19% 11.12%*
Mid-Cap Index
Portfolio 43.77% 29.68%* N/A
REIT Index Portfolio 20.79% 11.19%* N/A
Short-Term Corporate
Portfolio 6.54% 4.62%* N/A
Small Company Growth
Portfolio 76.97% 21.37%* N/A
---------
* Since Inception:
Balanced Portfolio--May 23, 1991
Diversified Value Portfolio and Short-Term Corporate Portfolio--
February 8, 1999
Equity Income Portfolio and Growth Portfolio--June 7, 1993
Equity Index Portfolio and High-Grade Bond Portfolio--April 29, 1991
High Yield Bond Portfolio and Small Company Growth Portfolio--
June 3, 1996
International Portfolio--June 3, 1994
Mid-Cap Index Portfolio and REIT Index Portfolio--February 9, 1999
B-12
<PAGE>
SEC YIELDS
Yield is the net annualized yield based on a specified 30-day (or one month)
period assuming semiannual compounding of income. Yield is calculated by
dividing the net investment income per share earned during the period by the
maximum offering price per share on the last day of the period, according to the
following formula:
YIELD = 2[((A-B)/CD+1)6 - 1]
Where:
a =dividends and interest earned during the period
b =expenses accrued for the period (net of reimbursements)
c =the average daily number of shares outstanding during
the period that were entitled to receive dividends
d =the maximum offering price per share on the last day of
the period
AVERAGE ANNUAL TOTAL RETURN
Average annual total return is the average annual compounded rate of return for
the periods of one year, five years, ten years, or the life of each Portfolio,
all ended on the last day of a recent month. Average annual total return
quotations will reflect changes in the price of the Portfolios' shares and
assume that all dividends and capital gains distributions during the respective
periods were reinvested in Portfolio shares. Average annual total return is
calculated by finding the average annual compounded rates of return of a
hypothetical investment over such periods according to the following formula
(average annual total return is then expressed as a percentage):
T = (ERV/P)1/N - 1
Where:
T =average annual total return
P =a hypothetical initial investment of $1,000
n =number of years
ERV =ending redeemable value: ERV is the value, at the end
of the applicable period, of a hypothetical $1,000
investment made at the beginning of the applicable
period
CUMULATIVE TOTAL RETURN
Cumulative total return is the cumulative rate of return on a hypothetical
initial investment of $1,000 for a specified period. Cumulative total return
quotations reflect changes in the price of each Portfolios' shares and assume
that all dividends and capital gains distributions during the period were
reinvested in Portfolio shares. Cumulative total return is calculated by finding
the cumulative rates of a return of a hypothetical investment over such periods,
according to the following formula (cumulative total return is then expressed as
a percentage):
C = (ERV/P) - 1
Where:
C =cumulative total return
P =a hypothetical initial investment of $1,000
ERV =ending redeemable value: ERV is the value, at the end
of the applicable period, of a hypothetical $1,000
investment made at the beginning of the applicable
period
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<PAGE>
MANAGEMENT OF THE FUND
TRUSTEES AND OFFICERS
The officers of the Fund manage its day-to-day operations and are responsible to
the Fund's board of trustees. The trustees set broad policies for the Fund and
choose its officers. The following is a list of rrustees and officers of the
Fund and a statement of their present positions and principal occupations during
the past five years. As a group, the Fund's trustees and officers own less than
1% of the outstanding shares of each Portfolio of the Fund. Each trustee also
serves as a Director of The Vanguard Group, Inc., and as a trustee of each of
the 109 investment companies administered by Vanguard (107 in the case of Mr.
Malkiel and 99 in the case of Mr. MacLaury). The mailing address of the trustees
and officers of the Fund is Post Office Box 876, Valley Forge, PA 19482.
JOHN J. BRENNAN, (DOB: 7/29/1954) Chairman, Chief Executive Officer, and
Trustee*
Chairman, Chief Executive Officer and Director of The Vanguard Group, Inc., and
Trustee of each of the investment companies in The Vanguard Group.
JOANN HEFFERNAN HEISEN, (DOB: 1/25/1950) Trustee
Vice President, Chief Information Officer, and member of the Executive Committee
of Johnson and Johnson (Pharmaceuticals/Consumer Products), Director of Johnson
& Johnson*MERCK Consumer Pharmaceuticals Co., The Medical Center at Princeton,
and Women's Research and Education Institute.
BRUCE K. MACLAURY, (DOB: 5/7/1931) Trustee
President Emeritus of The Brookings Institution (Independent Non-Partisan
Research Organization); Director of American Express Bank, Ltd., The St. Paul
Companies, Inc. (Insurance and Financial Services), and National Steel Corp.
BURTON G. MALKIEL, (DOB: 8/28/1932) Trustee
Chemical Bank Chairman's Professor of Economics, Princeton University; Director
of Prudential Insurance Co. of America, Banco Bilbao Argentaria, Gestion, BKF
Capital (Investment Management), The Jeffrey Co. (Holding Company), NeuVis, Inc.
(Software Co.), and Select Sector SPDR Trust (Exchange-Traded Mutual Fund).
ALFRED M. RANKIN, JR., (DOB: 10/8/1941) Trustee
Chairman, President, Chief Executive Officer, and Director of NACCO Industries,
Inc. (Machinery/Coal/ Appliances); and Director of The BFGoodrich Co. (Aircraft
Systems/Manufacturing/Chemicals), and The Standard Products Co. (Rubber Products
Company).
JAMES O. WELCH, JR., (DOB: 5/13/1931) Trustee
Retired Chairman of Nabisco Brands, Inc. (Food Products); retired Vice Chairman
and Director of RJR Nabisco (Food and Tobacco Products); Director of TECO
Energy, Inc., and Kmart Corp.
J. LAWRENCE WILSON, (DOB: 3/2/1936) Trustee
Retired Chairman and CEO of Rohm & Haas Co. (Chemicals); Director of Cummins
Engine Co. (Diesel Engines), The Mead Corp. (Paper Products), and AmeriSource
Health Corp. (Pharmaceutical Distribution); and Trustee of Vanderbilt
University.
RAYMOND J. KLAPINSKY, (DOB: 12/7/1938) Secretary*
Managing Director of The Vanguard Group, Inc.; Secretary of The Vanguard Group,
Inc. and of each of the investment companies in The Vanguard Group.
THOMAS J. HIGGINS, (DOB: 5/21/1957) Treasurer*
Principal of The Vanguard Group, Inc.; Treasurer of each of the investment
companies in The Vanguard Group.
---------
*Officers of the Fund are "interested persons" as defined in the 1940 Act.
B-14
<PAGE>
THE VANGUARD GROUP
Vanguard Variable Insurance Fund is a member of The Vanguard Group of Investment
Companies, which consists of more than 100 individual portfolios (funds).
Through their jointly-owned subsidiary, The Vanguard Group, Inc. (Vanguard), the
Fund and the other funds in The Vanguard Group obtain at cost virtually all of
their corporate management, administrative, and distribution services. Vanguard
also provides investment advisory services on an at-cost basis to certain
Vanguard funds.
Vanguard employs a supporting staff of management and administrative
personnel needed to provide the requisite services to the funds and also
furnishes the funds with necessary office space, furnishings, and equipment.
Each fund pays its share of Vanguard's total expenses which are allocated among
the funds under methods approved by the board of trustees of each fund. In
addition, each fund bears its own direct expenses such as legal, auditing, and
custodian fees.
The fund's officers are also officers and employees of Vanguard. No officer
or employee owns, or is permitted to own, any securities of any external adviser
for the funds.
Vanguard adheres to a Code of Ethics established pursuant to Rule 17j-1
under the 1940 Act. The Code is designed to prevent unlawful practices in
connection with the purchase or sale of securities by persons associated with
Vanguard. Under Vanguard's Code of Ethics certain officers and employees of
Vanguard who are considered access persons are permitted to engage in personal
securities transactions. However, such transactions are subject to procedures
and guidelines similar to, and in many cases more restrictive than, those
recommended by a blue ribbon panel of mutual fund industry executives.
Vanguard was established and operates under an Amended and Restated Funds'
Service Agreement which was approved by the shareholders of each of the funds.
The amounts which each of the funds has invested are adjusted from time to time
in order to maintain the proportionate relationship between each fund's relative
net assets and its contribution to Vanguard's capital. At September 30, 2000,
each Portfolio had contributed capital to Vanguard (included in other assets)
representing 0.02% of each Portfolio's net assets. The total amount contributed
by the Fund was $1,153,000, which represented 1.15% of Vanguard's
capitalization. The Amended and Restated Funds' Service Agreement provides as
follows: (a) each Vanguard fund may invest up to 0.40% of its current net assets
in Vanguard, and (b) there is no other limitation on the dollar amount that each
Vanguard fund may contribute to Vanguard's capitalization.
MANAGEMENT. Corporate management and administrative services include: (1)
executive staff; (2) accounting and financial; (3) legal and regulatory; (4)
shareholder account maintenance; (5) monitoring and control of custodian
relationships; (6) shareholder reporting; and (7) review and evaluation of
advisory and other services provided to the funds by third parties.
DISTRIBUTION. Vanguard Marketing Corporation, a wholly-owned subsidiary of
The Vanguard Group, Inc., provides all distribution and marketing activities for
the funds in the Group. The principal distribution expenses are for advertising,
promotional materials and marketing personnel. Distribution services may also
include organizing and offering to the public, from time to time, one or more
new investment companies which will become members of Vanguard. The trustees and
officers of Vanguard determine the amount to be spent annually on distribution
activities, the manner and amount to be spent on each fund, and whether to
organize new investment companies.
One half of the distribution expenses of a marketing and promotional nature
is allocated among the funds based upon relative net assets. The remaining one
half of those expenses is allocated among the funds based upon each fund's sales
for the preceding 24 months relative to the total sales of the funds as a Group;
provided, however, that no fund's aggregate quarterly rate of contribution for
distribution expenses of a marketing and promotional nature shall exceed 125% of
average distribution expense rate for The Vanguard Group, and that no fund shall
incur annual distribution expenses in excess of 20/100 of 1% of its average
month-end net assets.
B-15
<PAGE>
During the fiscal years ended September 30, 1998, 1999, and 2000, the
Portfolios incurred the following approximate amounts of Vanguard's management
(including transfer agency), distribution, and marketing expenses:
PORTFOLIO 1998 1999 2000
--------- ---- ---- ----
Balanced Portfolio $1,126,000 $1,240,000 $880,000
Diversified Value Portfolio N/A 42,000 113,000
Equity Income Portfolio 872,000 952,000 701,000
Equity Index Portfolio 1,653,000 2,111,000 2,331,000
Growth Portfolio 1,262,000 1,680,000 1,799,000
High Yield Bond Portfolio 288,000 314,000 265,000
High-Grade Bond Portfolio 555,000 663,000 527,000
International Portfolio 591,000 656,000 650,000
Mid-Cap Index Portfolio N/A 32,000 243,000
Money Market Portfolio 810,000 1,082,000 1,176,000
REIT Index Portfolio N/A 8,000 110,000
Short-Term Corporate
Portfolio N/A 21,000 72,000
Small Company Growth
Portfolio 372,000 445,000 931,000
INVESTMENT ADVISORY SERVICES. Vanguard also provides investment advisory
services to several Vanguard funds. These services are provided on an at-cost
basis from a money management staff employed directly by Vanguard. The
compensation and other expenses of this staff are paid by the funds utilizing
these services.
TRUSTEE COMPENSATION
The same individuals serve as trustees of all Vanguard funds (with two
exceptions, which are noted in the table appearing on page B-17), and each fund
pays a proportionate share of the trustees' compensation. The funds employ their
officers on a shared basis, as well. However, officers are compensated by The
Vanguard Group, Inc., not the funds.
INDEPENDENT TRUSTEES. The funds compensate their independent trustees--that
is, the ones who are not also officers of the funds--in three ways:
- The independent trustees receive an annual fee for their service to the
funds, which is subject to reduction based on absences from scheduled Board
meetings.
- The independent trustees are reimbursed for the travel and other expenses
that they incur in attending Board meetings.
- Upon retirement, the independent trustees receive an aggregate annual fee
of $1,000 for each year served on the Board, up to fifteen years of
service. This annual fee is paid for ten years following retirement, or
until each trustee's death.
"INTERESTED" TRUSTEES. Mr. Brennan serves as a trustee, but is not paid in
this capacity. He is, however, paid in his role as officer of The Vanguard
Group, Inc.
COMPENSATION TABLE. The following table provides compensation details for
each of the trustees. For the Fund, we list the amounts paid as compensation and
accrued as retirement benefits by the Fund for each trustee. In addition, the
table shows the total amount of benefits that we expect each trustee to receive
from all Vanguard funds upon retirement, and the total amount of compensation
paid to each trustee by all Vanguard funds.
B-16
<PAGE>
VANGUARD VARIABLE INSURANCE FUND
COMPENSATION TABLE
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
PENSION OR
AGGREGATE RETIREMENT BENEFITS TOTAL COMPENSATION
COMPENSATION ACCRUED AS PART OF ESTIMATED ANNUAL FROM ALL VANGUARD
FROM THIS FUND'S BENEFITS UPON FUNDS PAID TO
NAMES OF TRUSTEES THIS FUND(1) EXPENSES(1) RETIREMENT TRUSTEES(2)
---------------------------------------------------------------------------------------------------------------------
John C. Bogle(3) None None None None
John J. Brennan None None None None
JoAnn Heffernan Heisen $1,091 $48 $15,000 $100,000
Bruce K. MacLaury $1,129 $80 $12,000 $ 95,000
Burton G. Malkiel $1,097 $80 $15,000 $100,000
Alfred M. Rankin, Jr. $1,091 $58 $15,000 $100,000
James O. Welch, Jr. $1,091 $85 $15,000 $100,000
J. Lawrence Wilson $1,091 $62 $15,000 $100,000
</TABLE>
---------
(1) The amounts shown in this column are based on the Fund's fiscal year ended
September 30, 2000.
(2) The amounts reported in this column reflect the total compensation paid to
each trustee for his or her service as trustee of 109 Vanguard funds (107
in the case of Mr. Malkiel; 99 in the case of Mr. MacLaury) for the 1999
calendar year.
(3) Mr. Bogle retired from the Fund's Board on December 31, 1999.
INVESTMENT ADVISORY SERVICES
The investment policies of each of the Portfolios may lead to frequent changes
in investments, particularly in periods of rapidly fluctuating interest rates. A
change in securities held by a Portfolio is known as "portfolio turnover" and
may involve the payment by the Portfolio of dealer mark-ups, underwriting
commissions, and other transaction costs on the sales of securities as well as
on the reinvestment of the proceeds in other securities. The annual portfolio
turnover rate for the Portfolios is set forth under the heading "Financial
Highlights" in the Vanguard Variable Insurance Fund Prospectus. The portfolio
turnover rate is not a limiting factor when management deems it desirable to
sell or purchase securities. It is impossible to predict whether or not the
portfolio turnover rates in future years will vary significantly from the rates
in recent years.
THE BALANCED AND HIGH YIELD BOND PORTFOLIOS' INVESTMENT ADVISORY AGREEMENTS
BALANCED PORTFOLIO
The Fund employs Wellington Management Company, LLP (Wellington Management) to
manage the investment and reinvestment of the assets included in the Fund's
BALANCED PORTFOLIO and to continuously review, supervise, and administer the
Balanced Portfolio's investment program. Wellington Management discharges its
responsibilities subject to the control of the officers and trustees of the
Fund.
The Fund pays Wellington Management a basic fee at the end of each fiscal
quarter, calculated by applying a quarterly rate, based on the following annual
percentage rates, to the Balanced Portfolio's average month-end net assets for
the quarter:
NET ASSETS RATE
---------- ----
First $500 million. . . . . . . .100%
Next $500 million. . . . . . . . .050%
Over $1 billion. . . . . . . . . .040%
The basic fee will be increased or decreased by applying a performance fee
adjustment based on the investment performance of the Balanced Portfolio
relative to the investment performance of the composite benchmark (the
Benchmark), of which 65% will be comprised of the Standard and Poor's Composite
Stock Price Index (the Stock Index) and 35% of which will be comprised of the
Lehman Brothers Credit A or Better Bond Index (the Bond Index). The investment
performance of the Balanced Portfolio will be based on the cumulative
B-17
<PAGE>
return over a trailing 36-month period ending with the applicable quarter,
relative to the cumulative total return of the Benchmark for the same time
period. The adjustment applies as follows:
CUMULATIVE 36-MONTH PERFORMANCE FEE
PERFORMANCE VS. THE BENCHMARK ADJUSTMENT*
----------------------------- -----------
Trails by -6% or more. . . . . . . . . . -0.20 X Basic Fee
Trails by more than -6% up to -3%. . . . -0.10 X Basic Fee
Trails/exceeds from -3% through +3%. . . 0 X Basic Fee
Exceeds by more than +3% but less
than +6%. . . . . . . . . . . . . . . . +0.10 X Basic Fee
Exceeds by +6% or more . . . . . . . . . +0.20 X Basic Fee
---------
* For purposes of this calculation, the basic fee is calculated by applying
the quarterly rate against average assets over the same time period which
the performance is measured.
The Benchmark will not be fully operable as the sole performance index used
to determine the adjustment until the quarter ending March 31, 2003. Until that
date, the adjustment will be determined by linking the investment performance of
the Benchmark and that of the "Prior Benchmark," 65% of which will be comprised
of the Stock Index and 35% of which will be comprised of the Lehman Brothers
Long Credit A or Better Bond Index (the Prior Bond Index) as follows.
1. QUARTER ENDED JUNE 30, 2000. The adjustment was determined by linking
the investment performance of the Prior Benchmark for the eleven quarters ended
March 31, 2000, with that of the Benchmark for the quarter ended June 30, 2000.
2. QUARTER ENDED SEPTEMBER 30, 2000. The adjustment was determined by
linking the investment performance of the Prior Benchmark for the ten quarters
ended March 31, 2000, with that of the Benchmark for the two quarters ended
September 30, 2000.
3. QUARTER ENDING DECEMBER 31, 2000. The adjustment will be determined by
linking the investment performance of the Prior Benchmark for the nine quarters
ended March 31, 2000, with that of the Benchmark for the three quarters ending
December 31, 2000.
4. QUARTER ENDING MARCH 31, 2001. The adjustment will be determined by
linking the investment performance of the Prior Benchmark for eight quarters
ended March 31, 2000, with that of the Benchmark for the four quarters ending
March 31, 2001.
5. QUARTER ENDING JUNE 30, 2001. The adjustment will be determined by
linking the investment performance of the Prior Benchmark for the seven quarters
ended March 31, 2000, with that of the Benchmark for the five quarter ending
June 30, 2001.
6. QUARTER ENDING SEPTEMBER 30, 2001. The adjustment will be determined by
linking the investment performance of the Prior Benchmark for the six quarters
ended March 31, 2000, with that of the Benchmark for the six quarter ending
September 30, 2001.
7. QUARTER ENDING DECEMBER 31, 2001. The adjustment will be determined by
linking the investment performance of the Prior Benchmark for the five quarters
ended March 31, 2000, with that of the Benchmark for the seven quarters ending
December 31, 2001.
8. QUARTER ENDING MARCH 31, 2002. The adjustment will be determined by
linking the investment performance of the Prior Benchmark for four quarters
ended March 31, 2000, with that of the Benchmark for the eight quarters ending
March 31, 2002.
9. QUARTER ENDING JUNE 30, 2002. The adjustment will be determined by
linking the investment performance of the Prior Benchmark for the three quarters
ended March 31, 2000, with that of the Benchmark for the nine quarter ending
June 30, 2002.
10. QUARTER ENDING SEPTEMBER 30, 2002. The adjustment will be determined by
linking the investment performance of the Prior Benchmark for the two quarters
ended March 31, 2000, with that of the Benchmark for the ten quarter ending
September 30, 2002.
B-18
<PAGE>
11. QUARTER ENDING DECEMBER 31, 2002. The adjustment will be determined by
linking the investment performance of the Prior Benchmark for the one quarter
ended March 31, 2000, with that of the Benchmark for the eleven quarters ending
December 31, 2002.
12. QUARTER ENDING MARCH 31, 2003. The Benchmark will be fully operable.
The following special rules also apply to the adviser's compensation.
1. FUND PERFORMANCE. The investment performance of the Portfolio for the
period, expressed as a percentage of the Portfolio's net asset value per share
at the beginning of the period shall be the sum of: (i) the change in the
Portfolio's net asset value per share during such period; (ii) the value of the
Portfolio's cash distributions per share having an ex-dividend date occurring
within the period; and (iii) the per share amount of capital gains taxes paid or
accrued during such period by the Portfolio for undistributed realized long-term
capital gains.
2. BENCHMARK PERFORMANCE. Computations of the two components of the
Benchmark will be made at the beginning of each quarter, based on the allocation
set forth in the agreement.
3. INDEX PERFORMANCE. The investment record of the Stock Index for the
period, expressed as a percentage of the Stock Index level at the beginning of
the period, shall be the sum of (i) the change in the level of the Stock Index
during the period and (ii) the value, computed consistently with the Stock
Index, of cash distributions having an ex-dividend date occurring within the
period made by companies whose securities comprise the Stock Index. The
investment record of the Bond Index for the period, expressed as a percentage of
the Bond Index level at the beginning of such period shall be the sum of (i) the
change in the level of the Bond Index during the period, and (ii) the value of
the interest accrued or paid on the bonds included in the Bond Index, assuming
the reinvestment of such interest on a monthly basis.
During the fiscal years ended September 30, 1998, 1999, and 2000, the Fund
incurred investment advisory fees with respect to the Balanced Portfolio of
approximately $514,000 (before a decrease of $68,000 based on performance),
$556,000 (before a decrease of $93,000 based on performance), and $518,000
(before a decrease of $105,000 based on performance), respectively, to
Wellington Management.
HIGH YIELD BOND PORTFOLIO
The Fund also employs Wellington Management to manage the investment and
reinvestment of the assets of the Fund's HIGH YIELD BOND PORTFOLIO and to
continuously review, supervise, and administer the investment program for such
Portfolio. Wellington Management discharges its responsibilities subject to the
control of the officers and trustees of the Fund.
The Fund pays Wellington Management a basic advisory fee at the end of each
fiscal quarter calculated by applying a quarterly rate, based on an annual
percentage rate of 0.06% to the average month-end net assets of the High Yield
Bond Portfolio for the quarter.
During the fiscal years ended September 30, 1998, 1999, and 2000, the Fund
incurred investment advisory fees with respect to the High Yield Bond Portfolio
of approximately $74,000, $90,000, and $85,000, respectively, to Wellington
Management.
DESCRIPTION OF WELLINGTON MANAGEMENT
Wellington Management is a Massachusetts limited liability partnership of which
the following persons are managing partners: Laurie A. Gabriel, Duncan M.
McFarland, and John R. Ryan.
THE DIVERSIFIED VALUE PORTFOLIO INVESTMENT ADVISORY AGREEMENT
The Fund has entered into an investment advisory agreement with Barrow, Hanley,
Mewhinney & Strauss, Inc. (Barrow, Hanley) to manage the Diversified Value
Portfolio. Under this agreement, Barrow, Hanley manages the investment and
reinvestment of the Portfolio's assets and continuously reviews, supervises, and
administers the investment program of the Portfolio with respect to those
assets. Barrow, Hanley discharges its responsibilities subject to the control of
the officers and trustees of the Fund.
The Fund pays Barrow, Hanley an 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 Portfolio for the
quarter.
B-19
<PAGE>
The basic advisory fee may be increased or decreased by applying a
performance adjustment to the basic fee reflecting the investment performance of
the Portfolio relative to the investment record of the Standard & Poor's/BARRA
Value Index (the Index) over the same period as follows:
CUMULATIVE 36-MONTH PERFORMANCE FEE
PERFORMANCE VS. THE INDEX ADJUSTMENT*
------------------------- -----------
Trails by -9% or more. . . . . . . . . . . -0.25 X Basic Fee
Trails by more than -6% up to -9%. . . . . -0.15 X Basic Fee
Trails/exceeds from -6% through +6%. . . . 0.00 X Basic Fee
Exceeds by more than +6% but less than +9% +0.15 X Basic Fee
Exceeds by +9% or more . . . . . . . . . . +0.25 X Basic Fee
---------
* For purposes of this calculation, the basic fee is calculated by applying
the quarterly rate against average assets over the same time period for
which the performance is measured.
Until the quarter ending December 31, 2001, the performance adjustment for
Barrow, Hanley will be calculated according to the following transition rules:
1. FEBRUARY 8, 1999 THROUGH DECEMBER 31, 1999. The performance fee
adjustment was not operable, and Barrow, Hanley was paid the basic fee set forth
above.
2. QUARTER ENDING MARCH 31, 2000 THROUGH QUARTER ENDING MARCH 31, 2002. The
performance fee adjustment shall be calculated based on a comparison of the
Portfolio's investment performance and that of the Index over the number of
months that have elapsed between March 31, 1999 and the end of the quarter for
which the fee is computed. The number of percentage points by which the
Portfolio's investment performance must exceed or fall below that of the Index
shall increase proportionately from 3 percentage points and 2 percentage points,
respectively, for the twelve months ended March 31, 2000 to 9 percentage points
and 6 percentage points, respectively, for the thirty-six months ending March
31, 2002.
The BARRA Value Index includes stocks in the Standard and Poor's 500
Composite Stock Price Index with lower than average rates of market price to
book value. These types of stocks are often referred to as "value" stocks.
The Portfolio began operations on February 9, 1999. During the fiscal
period ended September 30, 1999, and the fiscal year ended September 30, 2000,
the Fund incurred investment advisory fees of approximately $28,000 and $46,000,
(before a decrease of $8,000 based on performance), respectively, to Barrow,
Hanley.
DESCRIPTION OF BARROW, HANLEY
Barrow, Hanley is a Nevada corporation controlled by the following officers of
Barrow, Hanley: James Purdy Barrow, President, Secretary, and Treasurer; Richard
Albert Englander, Principal; Joseph Ray Nixon, Jr., Principal; Robert David
Barkley, Principal; Robert James Chambers, Principal; Timothy James Culler,
Principal; Mary Jane Gilday, Principal; and Hiram Monroe Helm III, Principal.
THE EQUITY INCOME PORTFOLIO INVESTMENT ADVISORY AGREEMENT
The Fund employs Newell Associates (Newell), to manage the investment and
reinvestment of the assets of the Equity Income Portfolio and to continuously
review, supervise, and administer the Portfolio's investment program. Newell
discharges its responsibilities subject to the control of the officers and
trustees of the Fund.
The Fund pays Newell an advisory fee at the end of each fiscal quarter,
calculated by applying a quarterly rate, based on an annual percentage rate of
0.10%, to the average month-end net assets of the Portfolio for the quarter.
During the fiscal years ended September 30, 1998, 1999, and 2000, the Fund
incurred investment advisory fees of approximately $357,000, $436,000, and
$356,000, respectively, to Newell.
B-20
<PAGE>
DESCRIPTION OF NEWELL
Newell is a California corporation of which 90% of its outstanding shares are
owned by its directors and officers. The directors of the corporation and the
offices they currently hold are: Roger D. Newell, Chairman, Jennifer C. Newell,
President, Robert A. Huret, Vice Chairman, and Alan E. Rothenberg, Director.
THE GROWTH PORTFOLIO INVESTMENT ADVISORY AGREEMENT
The Fund entered into an investment advisory agreement with Lincoln Capital
Management Company (Lincoln) under which Lincoln manages the investment and
reinvestment of the assets included in the Fund's Growth Portfolio and
continuously reviews, supervises, and administers the Fund's Growth Portfolio.
Lincoln will invest or reinvest such assets predominantly in U.S. securities.
Lincoln discharges its responsibilities subject to the control of the officers
and trustees of the Fund. Under this agreement the Fund pays Lincoln a basic 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 Portfolio's average month-end
net assets for the quarter.
The basic fee will be increased or decreased by applying a performance fee
adjustment based on the investment performance of the Growth Portfolio relative
to the investment performance of the Russell 1000 Growth Index (the Index). The
investment performance of the Growth Portfolio will be based on its cumulative
return over a trailing 36-month period ending with the applicable quarter,
compared with the cumulative total return of the Index for the same period. The
adjustment applies as follows:
CUMULATIVE 36-MONTH
PERFORMANCE VS. THE INDEX PERFORMANCE FEE ADJUSTMENT*
------------------------- ---------------------------
Exceeds by more than +9%. . . . . +15% x Basic Fee
Exceeds by 0% to +9%. . . . . . . Linear increase between 0%
and +15% x Basic Fee
Trails by 0% to -9% . . . . . . . Linear decrease between 0%
and -15% x Basic Fee
Trails by more than -9% . . . . . -15% x Basic Fee
---------
* For purposes of the adjustment calculation, the basic fee is calculated by
applying the above rate schedule against the average net assets of the
Growth Portfolio over the same period for which the performance is
measured. Linear application of the adjustment provides for an infinite
number of results within the stated range. Example: Cumulative 36-month
performance of the Growth Portfolio versus the Index is +7.2%. Accordingly,
a performance fee adjustment of +12% [(7.2% divided by 9.0%) times 15%
maximum] of the basic fee, as calculated over the trailing 36-months, would
be due and payable.
The adjustment will not be fully operable until the close of the quarter
ending September 30, 2003. Until that date, the following transition rules will
apply:
1. OCTOBER 1, 2000 THROUGH JUNE 30, 2001. Compensation will be the basic
fee. No adjustment will apply during this period.
2. JULY 1, 2001 THROUGH SEPTEMBER 30, 2003. Beginning July 1, 2001, the
adjustment will take effect on a progressive basis with regards to the number of
months elapsed between October 1, 2000, and the quarter for which the fee is
computed. During this period, the +/-9% hurdle rate, as well as the adjustment
described above, will be multiplied by a fraction, which will equal the number
of months elapsed since October 1, 2000, divided by 36. Example: Cumulative
18-month performance of the Growth Portfolio versus the Index is +8.1%.
Accordingly, a performance fee adjustment of +7.5% [(8.1 divided by 4.5%(a))
times 7.5% maximum] of the basic fee, as calculated over the trailing 18-months,
would be due and payable.
(a) Note that the cumulative performance versus the Index exceeds the
maximum hurdle rate (adjusted in this case).
3. ON AND AFTER OCTOBER 1, 2003. The adjustment will be fully operable at
this time.
The following special rules will also apply to Lincoln's compensation:
1. GROWTH PORTFOLIO PERFORMANCE. The investment performance of the Growth
Portfolio for any period, expressed as a percentage of the "Growth Portfolio
unit value" at the beginning of the period, will be the sum of: (i) the change
in the Growth Portfolio unit value during such period; (ii) the unit value of
the Portfolio's cash distributions from the Growth Portfolio's net investment
income and realized net capital gains (whether short or long term) having an
ex-dividend date occurring within the period; and (iii) the unit value of
capital gains taxes
B-21
<PAGE>
per share paid or payable on undistributed realized long-term capital gains
accumulated to the end of such period; expressed as a percentage of its net
asset value per share at the beginning of such period. For this purpose, the
value of distributions per share of realized capital gains, of dividends per
share paid from investment income and of capital gains taxes per share paid or
payable on undistributed realized long-term capital gains shall be treated as
reinvested in shares of the investment company at the net asset value per share
in effect at the close of business on the record date for the payment of such
distributions and dividends and the date on which provision is made for such
taxes, after giving effect to such distributions, dividends, and taxes.
2. "GROWTH PORTFOLIO UNIT VALUE". The "Growth Portfolio unit value" will be
determined by dividing the total net assets of the Growth Portfolio by a given
number of units. Initially, the number of units in the Growth Portfolio will
equal the total Portfolio shares outstanding on October 1, 2000. Subsequently,
as assets are added to or withdrawn from the Growth Portfolio, the number of
units of the Growth Portfolio will be adjusted based on the unit value of the
Growth Portfolio on the day such changes are executed. Any cash buffer
maintained by the Portfolio outside of the Growth Portfolio shall neither be
included in the total net assets of the Growth Portfolio nor included in the
computation of the Growth Portfolio unit value.
3. INDEX PERFORMANCE. The investment record of the Index for any period,
expressed as a percentage of the Index level at the beginning of such period,
will be the sum of (i) the change in the level of the Index during such period,
and (ii) the value, computed consistently with the Index, of cash distributions
having an ex-dividend date occurring within such period made by companies whose
securities make up the Index. For this purpose, cash distributions on the
securities that make up the Index will be treated as reinvested in the Index, at
least as frequently as the end of each calendar quarter following the payment of
the dividend. The calculation will be gross of applicable costs and expenses.
4. PERFORMANCE COMPUTATIONS. The foregoing notwithstanding, any computation
of the investment performance of the Growth Portfolio and the investment record
of the Index shall be in accordance with any then applicable rules of the U.S.
Securities and Exchange Commission.
During the fiscal years ended September 30, 1998, 1999, and 2000, the Fund
incurred investment advisory fees of approximately $859,000, $1,362,000, and
$1,802,000, respectively, to Lincoln.
DESCRIPTION OF LINCOLN
Lincoln is an Illinois corporation in which a controlling interest is held by
the following persons: J. Parker Hall III, Chairman; Kenneth R. Meyer, Chief
Executive Officer; David M. Fowler, President; Richard W. Knee, Executive Vice
President; Alan M. Sebulsky, Executive Vice President; John S. Cole, Executive
Vice President; and Peter J. Knez, Executive Vice President.
THE INTERNATIONAL PORTFOLIO INVESTMENT ADVISORY AGREEMENT
The Fund has entered into an investment advisory agreement with Schroder
Investment Management North America Inc. (Schroder) under which Schroder
supervises and administers the International Portfolio's investment program. In
this regard, it is the responsibility of Schroder to make decisions relating to
the International Portfolio's investment in foreign securities and to place the
International Portfolio's purchase and sale orders for such securities. Schroder
will invest or reinvest the assets of the International Portfolio predominantly
in foreign (non-U.S.) securities. Schroder discharges its responsibilities
subject to the control of the officers and trustees of the Fund.
As compensation for the services rendered by Schroder under the agreement,
the Fund pays Schroder at the end of each of the Fund's fiscal quarters, a basic
fee calculated by applying an annual percentage rate of 0.125% to the average
value of the month-end net assets of the International Portfolio for the
quarter.
B-22
<PAGE>
The basic fee, as provided above, shall be increased or decreased by
applying an adjustment formula based on the investment performance of the
International Portfolio relative to that of the Morgan Stanley Capital
International Europe, Australasia, Far East Index (EAFE) as follows:
CUMULATIVE 36-MONTH PERFORMANCE VS. EAFE ANNUAL PERFORMANCE FEE RATE
-------------------------------------------- ---------------------------
+12% or above . . . . . . . . . . . . . . . +0.0500%
Between +6% and +12%. . . . . . . . . . . . +0.0250%
Between +6% and -6% . . . . . . . . . . . . -0-
Between -6% and -12%. . . . . . . . . . . . -0.0250%
-12% or below . . . . . . . . . . . . . . . -0.0500%
For the purpose of determining the fee adjustment for investment
performance, as described above, the net assets of the International Portfolio
are averaged over the same period as the investment performance of the
International Portfolio and the investment record of the EAFE Index are
computed.
The investment performance of the International Portfolio for such period,
expressed as a percentage of the net asset value per share of the International
Portfolio at the beginning of such period, shall be the sum of: (i) the change
in the net asset value per share of the International Portfolio during such
period; (ii) the value of the cash distributions per share of the International
Portfolio accumulated to the end of such period; and (iii) the value of capital
gains taxes per share paid or payable by the International Portfolio on
undistributed realized long-term capital gains accumulated to the end of such
period. For this purpose, the value of distributions per share of realized
capital gains, of dividends per share paid from investment income and of capital
gains taxes per share paid or payable on undistributed realized long-term
capital gains shall be treated as reinvested in shares of the International
Portfolio at the net asset value per share in effect at the close of business on
the record date for the payment of such distributions and dividends and the date
on which provision is made for such taxes, after giving effect to such
distributions, dividends and taxes. The investment record of the EAFE Index for
any period, expressed as a percentage of the EAFE Index level at the beginning
of such period, shall be the sum of (i) the change in the level of the EAFE
Index during such period and (ii) the value, computed consistently with the EAFE
Index, of cash distributions made by companies whose securities comprise the
EAFE Index accumulated to the end of such period. For this purpose cash
distributions on the securities which comprise the EAFE Index shall be treated
as reinvested in the EAFE Index at least as frequently as the end of each
calendar quarter following the payment of the dividend. The foregoing
notwithstanding, any computation of the investment performance of the
International Portfolio and the investment record of the EAFE Index shall be in
accordance with any then applicable rules of the Commission.
The trustees believe that the EAFE Index is an appropriate standard against
which the investment performance of the Fund's International Portfolio can be
measured. The EAFE Index is the only index available which covers the major
international markets outside North America. The weighting of securities in the
EAFE Index is based on each stock's relative total market value, that is, its
market price per share times the number of shares outstanding.
During the fiscal years ended September 30, 1998, 1999, and 2000, the Fund
incurred investment advisory fees of approximately $351,000 (including an
increase of $62,000 based on performance), $332,000 (including an increase of
$13,000 based on performance), and $462,000 (including no adjustment for
performance), respectively, to Schroder.
DESCRIPTION OF SCHRODER
Schroder is the London branch office of Schroder Investment Management North
America, Inc. (SIMNA). SIMNA is a wholly-owned subsidiary of Schroders
Incorporated, 787 7th Avenue, New York, New York. Schroders PLC is the holding
company parent of a large world-wide group of banks and financial service
companies (referred to as "The Schroder Group") with associated companies and
branch and representative offices located in seventeen countries. The Schroder
Group specializes in providing investment management services, with Group funds
under management currently in excess of $210 billion.
B-23
<PAGE>
THE SMALL COMPANY GROWTH PORTFOLIO INVESTMENT ADVISORY AGREEMENTS
GRANAHAN INVESTMENT MANAGEMENT, INC.
The Fund entered into an investment advisory agreement with GRANAHAN INVESTMENT
MANAGEMENT, INC. (GRANAHAN) under which Granahan manages the investment and
reinvestment of a portion of the Small Company Growth Portfolio's assets (the
Granahan Portfolio) and continuously reviews, supervises, and administers the
Portfolio's investment program with respect to those assets. Granahan discharges
its responsibilities subject to the control of the officers and trustees of the
Fund.
The Fund pays Granahan a basic 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 Granahan Portfolio for the
quarter.
The basic advisory fee may be increased or decreased by applying a
performance fee adjustment to the basic fee based on the investment performance
of the Granahan Portfolio relative to the investment record of the Russell 2000
Growth Index (the Index). The investment performance of the Granahan Portfolio
will be based on the cumulative return over a trailing 36-month period ending
with the applicable quarter, relative to the cumulative total return of the
Index for the same time period as follows:
CUMULATIVE 36-MONTH PERFORMANCE FEE
PERFORMANCE VS. THE INDEX ADJUSTMENT*
------------------------- -----------
Trails by -12% or more. . . . . . . . . . . -0.50 X Basic Fee
Trails by more than -6% up to -12%. . . . . -0.25 X Basic Fee
Trails/exceeds from -6% through +6% . . . . 0 X Basic Fee
Exceeds by more than +6% but less than +12% +0.25 X Basic Fee
Exceeds by +12% or more . . . . . . . . . . +0.50 X Basic Fee
---------
* For purposes of this calculation, the basic fee is calculated by
applying the quarterly rate against average assets over the same
time period for which the performance is measured.
The Index will not be fully operable as the sole index used to determine
the performance adjustment until the quarter ending June 30, 2003. Until that
date, the adjustment will be determined by linking the investment performance of
the Index and that of the Small Company Growth Fund Stock Index (the Prior
Index) as follows.
1. QUARTER ENDED SEPTEMBER 30, 2000. The adjustment was determined by
linking the investment performance of the Prior Index for the eleven quarters
ended June 30, 2000, with that of the Index for the quarter ended September 30,
2000.
2. QUARTER ENDING DECEMBER 31, 2000. The adjustment will be determined by
linking the investment performance of the Prior Index for the ten quarters ended
June 30, 2000, with that of the Index for the two quarters ending December 31,
2000.
3. QUARTER ENDING MARCH 31, 2001. The adjustment will be determined by
linking the investment performance of the Prior Index for the nine quarters
ended June 30, 2000, with that of the Index for the three quarters ending March
31, 2001.
4. QUARTER ENDING JUNE 30, 2001. The adjustment will be determined by
linking the investment performance of the Prior Index for eight quarters ended
June 30, 2000, with that of the Index for the four quarters ending June 30,
2001.
5. QUARTER ENDING SEPTEMBER 30, 2001. The adjustment will be determined by
linking the investment performance of the Prior Index for the seven quarters
ended June 30, 2000, with that of the Index for the five quarters ending
September 30, 2001.
6. QUARTER ENDING DECEMBER 31, 2001. The adjustment will be determined by
linking the investment performance of the Prior Index for the six quarters ended
June 30, 2000, with that of the Index for the six quarters ending December 31,
2001.
7. QUARTER ENDING MARCH 31, 2002. The adjustment will be determined by
linking the investment performance of the Prior Index for the five quarters
ended June 30, 2000, with that of the Index for the seven quarters ending March
31, 2002.
B-24
<PAGE>
8. QUARTER ENDING JUNE 30, 2002. The adjustment will be determined by
linking the investment performance of the Prior Index for four quarters ended
June 30, 2000, with that of the Index for the eight quarters ending June 30,
2002.
9. QUARTER ENDING SEPTEMBER 30, 2002. The adjustment will be determined by
linking the investment performance of the Prior Index for the three quarters
ended June 30, 2000, with that of the Index for the nine quarters ending
September 30, 2002.
10. QUARTER ENDING DECEMBER 31, 2002. The adjustment will be determined by
linking the investment performance of the Prior Index for the two quarters ended
June 30, 2000, with that of the Index for the ten quarters ending December 31,
2002.
11. QUARTER ENDING MARCH 31, 2003. The adjustment will be determined by
linking the investment performance of the Prior Index for the one quarter ended
June 30, 2000, with that of the Index for the eleven quarters ending March 31,
2003.
12. QUARTER ENDING JUNE 30, 2003. The Index will be fully operable.
During the fiscal years ended September 30, 1998, 1999, and 2000, the Fund
incurred investment advisory fees of approximately $196,000 (before a decrease
of $55,000 based on performance), $229,000 (after an increase of $9,000 based on
performance), and $710,000 (after an increase of $131,000 based on performance),
respectively, to Granahan.
DESCRIPTION OF GRANAHAN
Granahan is a professional investment advisory firm founded in 1985. As of
September 30, 2000, Granahan held discretionary management authority with
respect to approximately $2 billion in assets. John J. Granahan is portfolio
manager of the Granahan Portfolio of the Small Company Growth Portfolio, and
Gary C. Hatton and Jane M. White are assistant portfolio managers.
GRANTHAM, MAYO, VAN OTTERLOO & CO. LLC
The Fund also entered into an investment advisory agreement with GRANTHAM, MAYO,
VAN OTTERLOO & CO. LLC (GMO) under which GMO manages the investment and
reinvestment of a portion of the Small Company Growth Portfolio's assets (the
GMO Portfolio) and continuously reviews, supervises, and administers the
Portfolio's investment program with respect to those assets. GMO discharges its
responsibilities subject to the control of the officers and trustees of the
Fund.
The Fund pays GMO a basic fee at the end of each fiscal quarter, calculated
by applying a quarterly rate based on an annual percentage rate of 0.225% to the
average month-end net assets of the GMO Portfolio for the quarter.
Subject to the transition rule described below, the basic fee, as provided
above, will be increased or decreased by the amount of a performance fee
adjustment. The adjustment will be calculated as a percentage of the average net
assets managed by GMO for the 36-month period ending with the then-ended
quarter, and the adjustment will change proportionately with the investment
performance of the GMO Portfolio relative to the investment performance of the
Russell 2000 Growth Index (the Index) for the same period. The adjustment is
computed as follows:
B-25
<PAGE>
CUMULATIVE 36-MONTH PERFORMANCE FEE ADJUSTMENT AS A
PERFORMANCE VS. THE INDEX(A) PERCENTAGE OF AVERAGE ASSETS(B)
---------------------------- -------------------------------
Trails by any amount. . . . . . -0.15%
Equals-to-Exceeds by up to 3% . Linear decrease from 0% to -0.15%
Exceeds by 3% to 6% . . . . . . Linear increase from 0% to +0.15%
Exceeds by more than 6% . . . . +0.15%
---------
(a) During the second through thirty-sixth month under the
agreement, the adjustment will be calculated using cumulative
performance of the GMO Portfolio and the Index from October 31,
2000 until the end of the applicable quarter.
(b) For purposes of this calculation, the average net assets will be calculated
as average month-end net assets over the same time period for which
performance is measured. Linear application of the adjustment provides for
an infinite number of results within the stated range. Example: If the
cumulative 36-month performance of the GMO Portfolio versus the Index is
+3.6%, an adjustment of +0.03%* or [(0.6%/3%) 0.15%] would apply. This
would be calculated as [(a/b) 0.15%], where "a" equals the percentage
amount by which the performance of the GMO Portfolio has exceeded the
applicable baseline percentage for the linear adjustment, and "b" equals
the size of the range over which the linear adjustment applies.
*As rounded for purposes of this example. In practice, the calculation
will be extended to the eighth decimal point.
The adjustment will not be fully operable until the close of the quarter
ending December 31, 2003. Until that time, the following transition rules will
apply:
1. OCTOBER 1, 2000 THROUGH SEPTEMBER 30, 2001. The compensation will be the
basic fee. No adjustment will apply during this period.
2. OCTOBER 1, 2001 THROUGH OCTOBER 31, 2003. Beginning October 1, 2001, the
adjustment will take effect on a progressive basis with regards to the number of
months elapsed between October 31, 2000, and the end of the quarter for which
the fee is being computed, subject to the special rules described below. During
this period, the endpoints and size of the range over which a positive or
negative adjustment applies and the corresponding maximum fee adjustment amount
will be multiplied by a fractional time-elapsed adjustment. The fraction will
equal the number of months elapsed since October 31, 2000, divided by
thirty-six. Example: Assume that compensation is being calculated for the
quarter ended September 30, 2002 and that the cumulative performance of the GMO
Portfolio versus the Index for the applicable period is +2.5%. In this case, an
adjustment of +0.03%* would apply. This would be calculated as [(a/c)(+0.095%)],
where "a" equals the percentage amount by which the performance of the GMO
Portfolio has exceeded the baseline percentage for the linear adjustment and "c"
equals the size of the adjusted range over which the linear adjustment applies.
The adjusted range is determined as [(23/36) x 3%] to [(23/36) x 6%] = +1.91% to
+3.82%. The size of the adjustment range is 3.82% minus 1.91% = 1.91% = "c". The
value of "a" is 2.5% minus 1.91% = +0.59%. Similarly, +0.095% is determined as
[(23/36)(+0.15%)].
*As rounded for purposes of this example. In practice, the calculation will be
extended to the eighth decimal point.
3. ON AND AFTER NOVEMBER 1, 2003. Commencing November 1, 2003, the
adjustment will be fully operable.
The following special rules will also apply to GMO's compensation:
1. GMO PORTFOLIO UNIT VALUE. The "GMO Portfolio unit value" will be
determined by dividing the total net assets of the GMO Portfolio by a given
number of units. Initially, the number of units in the GMO Portfolio will equal
a nominal value as determined by dividing initial assets by a unit value of
$22.64 on October 1, 2000. Subsequently, as assets are added to or withdrawn
from the GMO Portfolio, the number of units of the GMO Portfolio will be
adjusted based on the unit value of the GMO Portfolio on the day such changes
are executed. Any cash buffer maintained by the Fund outside of the GMO
Portfolio will neither be included in the total net assets of the GMO Portfolio
nor included in the computation of the GMO Portfolio unit value.
2. GMO PORTFOLIO PERFORMANCE. The GMO Portfolio's investment performance
for any period, expressed as a percentage of the "GMO Portfolio unit value" at
the beginning of such period, shall be the sum of: (i) the change in the GMO
Portfolio unit value during such period; (ii) the unit value of the Fund's cash
distributions from the GMO Portfolio's net investment income and realized net
capital gains (whether short- or long-term) having an ex-dividend date occurring
within the period; and (iii) the unit value of capital gains taxes paid or
payable by the Fund on undistributed realized long-term capital gains
accumulated to the end of the period by the GMO Portfolio, expressed as a
percentage of the GMO Portfolio's unit value at the beginning of the period.
B-26
<PAGE>
For this purpose, the value of distributions of realized capital gains per unit
of the GMO Portfolio, of dividends per unit of the GMO Portfolio paid from
investment income, and of capital gains taxes per unit of the GMO Portfolio paid
or payable on undistributed realized long-term capital gains shall be treated as
reinvested in units of the GMO Portfolio at the unit value in effect at the
close of business on the record date for the payment of such distributions and
dividends and the date on which provision is made for such taxes, after giving
effect to such distributions, dividends, and taxes.
3. INDEX PERFORMANCE. The investment record of the Index for any period,
expressed as a percentage of the Index at the beginning of such period, shall be
the sum of: (i) the change in the level of the Index, during such period, and
(ii) the value, computed consistently with the Index of cash distributions
having an ex-dividend date occurring within such period made by companies whose
securities comprise the Index. For this purpose, cash distributions on the
securities which comprise the Index shall be treated as reinvested in the Index
at least as frequently as the end of each calendar quarter following the payment
of the dividend.
4. PERFORMANCE COMPUTATIONS. The foregoing notwithstanding, any computation
of the investment performance of the Fund and the investment record of the Index
shall be in accordance with any then applicable rules of the U.S. Securities and
Exchange Commission.
DESCRIPTION OF GMO
GMO is an investment advisory firm founded in 1977. GMO currently manages about
$22 billion in assets. It provides investment counseling services to employee
benefit plans, endowment funds, other institutions, and individuals. Christopher
M. Darnell and Robert M. Soucy are portfolio managers of the GMO Portfolio of
the Small Company Growth Portfolio.
THE VANGUARD GROUP
The Equity Index, High-Grade Bond, Mid-Cap Index, Money Market, REIT Index, and
Short-Term Corporate Portfolios of the Fund receive investment advisory services
on an "internalized," at-cost basis from an experienced investment management
staff employed directly by Vanguard. The investment management staff is
supervised by the senior officers of the Fund. Vanguard's Fixed Income Group
provides advisory services for the High-Grade Bond, Money Market, and Short-Term
Corporate Portfolios, and Vanguard's Quantitative Equity Group provides advisory
services to the Equity Index, Mid-Cap Index, and REIT Index Portfolios.
Vanguard's investment management staff is also responsible for the
allocation of principal business and portfolio brokerage and the negotiation of
commissions. For the Money Market Portfolio, the purchase and sale of investment
securities will ordinarily be principal transactions. Portfolio securities will
normally be purchased directly from the issuer or from an underwriter or market
maker for the securities. There will usually be no brokerage commissions paid by
the Money Market Portfolio for such purchases. Purchases from underwriters of
securities will include a commission or concession paid by the issuer to the
underwriter, and purchases from dealers serving as market makers will include a
dealer's mark-up.
In placing portfolio transactions, Vanguard's advisory staff uses its best
judgment to choose the broker most capable of providing the brokerage services
necessary to obtain the best available price and most favorable execution at the
lowest commission rate. The full range and quality of brokerage services
available are considered in making these determinations. In selecting
broker-dealers to execute securities transactions for the Portfolios,
consideration will be given to such factors as: the price of the security; the
rate of the commission; the size and difficulty of the order; the reliability,
integrity, financial condition, general execution, and operational capabilities
of competing broker-dealers; and the brokerage and research services provided to
the Fund.
<PAGE>
B-27
During the fiscal years ended September 30, 1998, 1999, and 2000, the
Portfolios managed by Vanguard incurred expenses for investment advisory
services in the following amounts:
PORTFOLIO 1998 1999 2000
--------- ---- ---- ----
Equity Index Portfolio $22,000 $93,000 $23,000
High-Grade Bond Portfolio 30,000 42,000 38,000
Mid-Cap Index Portfolio N/A 7,000 17,000
Money Market Portfolio 58,000 74,000 88,000
REIT Index Portfolio N/A 7,000 17,000
Short-Term Corporate Portfolio N/A 1,000 5,000
DURATION AND TERMINATION OF INVESTMENT ADVISORY AGREEMENTS
The Fund's current agreements with Wellington Management, Barrow, Hanley,
Newell, Lincoln, Schroder, Granahan, GMO, and Vanguard are renewable for
successive one-year periods, only if (1) each renewal is specifically approved
by a vote of the Portfolio's board of trustees, including the affirmative votes
of a majority of the trustees who are not parties to the agreement or
"interested persons" (as defined in the 1940 Act) of any such party, cast in
person at a meeting called for the purpose of considering such approval, or (2)
each renewal is specifically approved by a vote of a majority of the Portfolio's
outstanding voting securities. An agreement is automatically terminated if
assigned, and may be terminated without penalty at any time (1) by vote of the
board of trustees of the Portfolio on sixty (60) days' written notice to the
adviser, (2) by a vote of a majority of the Portfolio's outstanding voting
securities, or (3) by the adviser upon ninety (90) days' written notice to the
Portfolio.
PORTFOLIO TRANSACTIONS
The investment advisory agreements authorize Wellington Management, Lincoln,
Newell, Granahan, GMO, Schroder, Barrow, Hanley, Vanguard's Quantitative Equity
Group, and Vanguard's Fixed Income Group (the Advisers) (with the approval of
the Fund's board of trustees), to select the brokers or dealers that will
execute the purchases and sales of portfolio securities for the Portfolios of
the Fund and directs the Advisers to use their best efforts to obtain the best
available price and most favorable execution as to all transactions for the
Portfolios. The Advisers have undertaken to execute each investment transaction
at a price and commission which provides the most favorable total cost or
proceeds reasonably obtainable under the circumstances.
In placing portfolio transactions for their respective Portfolios, the
Advisers will use their best judgment to choose the broker most capable of
providing the brokerage services necessary to obtain best available price and
most favorable execution. The full range and quality of brokerage services
available will be considered in making these determinations. In those instances
where it is reasonably determined that more than one broker can offer the
brokerage services needed to obtain the best available price and most favorable
execution, consideration may be given to those brokers which supply investment
research and statistical information and provide other services in addition to
execution services to the Portfolios of the Fund and/or the Advisers. Research
services may include, but are not limited to, individual company and industry
analysis, and investment publications. The Advisers consider such information
useful in the performance of their obligations under the agreement but are
unable to determine the amount by which such services may reduce their expenses.
The investment advisory agreements also incorporate the concepts of Section
28(e) of the Securities Exchange Act of 1934 by providing that, subject to the
approval of the Fund's board of trustees, the Advisers may cause the Portfolios
of the Fund to pay a broker-dealer which furnishes brokerage services a higher
commission than that which might be charged by another broker-dealer for
effecting the same transaction; provided that such commission is deemed
reasonable in terms of either that particular transaction or the overall
responsibilities of the Advisers to their respective Portfolios and the other
Funds in the Group.
Currently, it is the Fund's policy that the Advisers may at times pay
higher commissions in recognition of brokerage services felt necessary for the
achievement of better execution of certain securities transactions that
otherwise might not be available. The Advisers will only pay such higher
B-27
<PAGE>
commissions if they believe this to be in the best interest of the Portfolios of
the Fund. Some brokers or dealers who may receive such higher commissions in
recognition of brokerage services related to execution of securities
transactions are also providers of research information to the Advisers and/or
the Portfolios of the Fund. However, the Advisers have informed the Fund that
they generally will not pay higher commission rates specifically for the purpose
of obtaining research services.
Some securities considered for investment by the Portfolios may also be
appropriate for other funds and/or clients served by the Advisers. If purchase
or sale of securities consistent with the investment policies of the Portfolios
and one or more of these other funds or clients served by the Advisers are
considered at or about the same time, transactions in such securities will be
allocated among the several funds and clients in a manner deemed equitable by
the Advisers. Although there may be no specified formula for allocating such
transactions, the allocation methods used, and the results of such allocations,
will be subject to periodic review by the Fund's board of trustees.
During the fiscal years ended September 30, 1998, 1999, and 2000, the
Portfolios paid brokerage commissions in the following amounts:
PORTFOLIO 1998 1999 2000
--------- ---- ---- ----
Balanced Portfolio $165,000 $155,000 $187,000
Diversified Value Portfolio N/A 54,000 56,000
Equity Income Portfolio 135,000 105,000 186,000
Equity Index Portfolio 42,000 65,000 60,000
Growth Portfolio 437,000 736,000 1,111,000
High Yield Bond Portfolio 0 0 0
High-Grade Bond Portfolio 0 0 0
International Portfolio 341,000 417,000 696,000
Mid-Cap Index Portfolio N/A 17,000 38,000
Money Market Portfolio 0 0 0
REIT Index Portfolio N/A 12,000 12,000
Short-Term Corporate Portfolio N/A 0 0
Small Company Growth Portfolio 215,000 219,000 619,000
COMPARATIVE INDEXES
Each of the investment company members of The Vanguard Group, including Vanguard
Variable Insurance Fund, may from time to time, use one or more of the following
unmanaged indexes for comparative performance purposes.
STANDARD & POOR'S 500 COMPOSITE STOCK PRICE INDEX--includes stocks selected by
Standard & Poor's Index Committee to include leading companies in leading
industries and to reflect the U.S. stock market.
STANDARD & POOR'S MIDCAP 400 INDEX--is composed of 400 medium sized domestic
stocks.
STANDARD & POOR'S SMALLCAP 600/BARRA VALUE INDEX--contains stocks of the S&P
SmallCap 600 Index which have a lower than average price-to-book ratio.
STANDARD & POOR'S SMALLCAP 600/BARRA GROWTH INDEX--contains stocks of the S&P
SmallCap 600 Index which have a higher than average price-to-book ratio.
STANDARD & POOR'S 500/BARRA VALUE INDEX--contains stocks of the S&P 500 Index
which have a lower than average price-to-book ratio.
STANDARD & POOR'S 500/BARRA GROWTH INDEX--contains stocks of the S&P 500 Index
which have a higher than average price-to-book ratio.
RUSSELL 1000 VALUE INDEX--consists of the stocks in the Russell 1000 Index
(comprising the 1,000 largest U.S.-based companies measured by total market
capitalization) with the lowest price-to-book ratios, comprising 50% of the
market capitalization of the Russell 1000 Index.
B-29
<PAGE>
RUSSELL 1000 GROWTH INDEX--consists of the stocks in the Russell 1000 Index
(comprising the 1,000 largest U.S.-based companies measured by total market
capitalization) with the highest price-to-book ratios, comprising 50% of the
market capitalization of the Russell 1000 Index.
WILSHIRE 5000 TOTAL MARKET INDEX--consists of more than 7,000 common equity
securities, covering all stocks in the U.S. for which daily pricing is
available.
WILSHIRE 4500 COMPLETION INDEX--consists of all stocks in the Wilshire 5000
Equity Index except for the 500 stocks in the Standard & Poor's 500 Index.
RUSSELL 3000 STOCK INDEX--consists of approximately the 3,000 largest stocks of
U.S.-domiciled companies commonly traded on the New York and American Stock
Exchanges or the NASDAQ over-the-counter market, accounting for over 90% of the
market value of publicly traded stocks in the U.S.
RUSSELL 2000 STOCK INDEX--composed of the 2,000 smallest stocks contained in the
Russell 3000 Stock Index; a widely-used benchmark for small capitalization
common stocks.
RUSSELL 2000 VALUE INDEX--contains stocks from the Russell 2000 Index with a
less-than-average growth orientation.
RUSSELL 2000 GROWTH INDEX--contains stocks from the Russell 2000 Index with a
better-than-average growth orientation.
MORGAN STANLEY CAPITAL INTERNATIONAL EAFE INDEX--is an arithmetic, market
value-weighted average of the performance of over 900 securities listed on the
stock exchanges of countries in Europe, Australia, Asia, and the Far East.
MORGAN STANLEY REIT INDEX--consist of approximately 122 stocks of equity Real
Estate Investment Trusts (REITs). REITs in the index meet size and liquidity
criteria specified by Morgan Stanley.
SMALL COMPANY GROWTH FUND STOCK INDEX--tracks the performance of stocks held by
the nation's largest small-capitalization mutual funds.
GOLDMAN SACHS 100 CONVERTIBLE BOND INDEX--currently includes 71 bonds and 29
preferreds. The original list of names was generated by screening for
convertible issues of 100 million or greater in market capitalization. The index
is priced monthly.
SALOMON BROTHERS GNMA INDEX--includes pools of mortgages originated by private
lenders and guaranteed by the mortgage pools of the Government National Mortgage
Association.
SALOMON BROTHERS HIGH GRADE CORPORATE BOND INDEX--consists of publicly issued,
non-convertible corporate bonds rated AA or AAA. It is a value-weighted, total
return index, including approximately 800 issues with maturities of 12 years or
greater.
SALOMON SMITH BARNEY 3-MONTH TREASURY INDEX--tracks the performance of
short-term U.S. government debt instruments.
LEHMAN BROTHERS AGGREGATE BOND INDEX--is a market-weighted index that contains
individually priced investment-grade corporate bonds and foreign
dollar-denominated bonds rated BBB or better, U.S. Treasury and agency issues
and mortgage pass-through securities. The index has a market value of over $5
trillion.
LEHMAN BROTHERS LONG-TERM TREASURY BOND INDEX--is a market-weighted index that
contains individually priced U.S. Treasury securities with maturities of 10
years or greater.
LEHMAN BROTHERS HIGH YIELD BOND INDEX--includes all fixed-income securities
having a maximum quality rating of Ba1 (including defaulted issues); with at
least $100 million principal outstanding, and at least one year to maturity;
payment-in-kind bonds and Eurobonds are excluded.
MERRILL LYNCH CORPORATE & GOVERNMENT BOND INDEX--consists of over 4,500 U.S.
Treasury, agency, and investment grade corporate bonds.
LEHMAN BROTHERS CREDIT BOND INDEX--all publicly offered fixed-rate,
nonconvertible domestic corporate bonds rated Baa by Moody's, with a maturity
longer than 1 year and with more than $100 million outstanding. This index
includes over 1,500 issues.
B-30
<PAGE>
LEHMAN BROTHERS LONG CREDIT A OR BETTER BOND INDEX--consists of all publicly
issued, fixed rate, nonconvertible investment grade, dollar-denominated,
SEC-registered corporate debt rated AA or AAA.
LEHMAN BROTHERS LONG CREDIT BOND INDEX--is a subset of the Lehman Brothers
Credit Bond Index covering all corporate, publicly issued, fixed-rate,
nonconvertible U.S. debt issues rated at least Baa, with at least $100 million
principal outstanding and maturity greater than 10 years.
BOND BUYER MUNICIPAL BOND INDEX--is a yield index on current coupon high-grade
general-obligation municipal bonds.
STANDARD & POOR'S PREFERRED INDEX--is a yield index based upon the average yield
of four high grade, non-callable preferred stock issues.
NASDAQ INDUSTRIAL INDEX--is composed of more than 3,000 industrial issues. It is
a value-weighted index calculated on price change only and does not include
income.
COMPOSITE INDEX--70% Standard & Poor's 500 Index and 30% NASDAQ Industrial
Index.
COMPOSITE INDEX--65% Standard & Poor's 500 Index and 35% Lehman Long-Term
Corporate AA or Better Bond Index.
COMPOSITE INDEX--65% Lehman Long-Term Corporate AA or Better Bond Index and a
35% weighting in a blended equity composite (75% Standard & Poor's/BARRA Value
Index, 12.5% Standard & Poor's Utilities Index and 12.5% Standard & Poor's
Telephone Index).
LIPPER BALANCED FUND AVERAGE--an industry benchmark of average balanced funds
with similar investment objectives and policies, as measured by Lipper Inc.
LIPPER NON-GOVERNMENT MONEY MARKET FUND AVERAGE--an industry benchmark of
average non-government money market funds with similar investment objectives and
policies, as measured by Lipper Inc.
LIPPER GOVERNMENT MONEY MARKET FUND AVERAGE--an industry benchmark of average
government money market funds with similar investment objectives and policies,
as measured by Lipper Inc.
LIPPER VARIABLE INVESTMENT PRODUCT PERFORMANCE ANALYSIS--a monthly publication
that lists variable annuity and variable life separate accounts, and provides
information on assets, asset rankings, unit values (month-end), performance, and
performance rankings.
LIPPER GENERAL EQUITY FUND AVERAGE--an industry benchmark of average general
equity funds with similar investment objectives and policies, as measured by
Lipper Inc.
LIPPER FIXED INCOME FUND AVERAGE--an industry benchmark of average fixed income
funds with similar investment objectives and policies, as measured by Lipper
Inc.
VARDS AVERAGE CONTRACT EXPENSE--tables that list the average total expenses of
variable annuity contracts sold in the United States. The average is based upon
a hypothetical $25,000 investment in each variable annuity contract covered by
the study.
MORNINGSTAR'S BENCHMARK-VARIABLE ANNUITY--average total expenses of variable
annuity contracts sold in the United States. With respect to the contract
charges, Morningstar lists a dollar amount which Vanguard converts to basis
points for comparison. This conversion is based on a $25,000 investment in a
variable annuity.
FINANCIAL STATEMENTS
The Fund's Financial Statements and financial highlights, for the fiscal year
ended September 30, 2000, appearing in the Vanguard Variable Insurance Fund's
Annual Reports to Shareholders, and the report thereon of PricewaterhouseCoopers
LLP, independent accountants, also appearing therein, are incorporated by
reference in this Statement of Additional Information. For a more complete
discussion of the performance, please see the Fund's Annual Reports to
Shareholders, which may be obtained without charge.
B-31
<PAGE>
APPENDIX--DESCRIPTION OF SECURITIES AND RATINGS
A-1 AND PRIME-1 COMMERCIAL PAPER RATINGS
Commercial paper rated A-1 by Standard & Poor's has the following
characteristics: (1) liquidity ratios are adequate to meet cash requirements;
(2) long-term senior debt is rated "A" or better; (3) the issuer has access to
at least two additional channels of borrowing; (4) basic earnings and cash flow
have an upward trend with allowance made for unusual circumstances; (5)
typically, the issuer's industry is well established and the issuer has a strong
position within the industry; and (6) the reliability and quality of management
are unquestioned. Relative strength or weakness of the above factors determine
whether the issuer's commercial paper is A-1, A-2, or A-3. The rating Prime-1 is
the highest commercial paper rating assigned by Moody's. Among the factors
considered by Moody's in assigning ratings are the following: (1) evaluation of
the management of the issuer; (2) economic evaluation of the issuer's industry
or industries and the appraisal of speculative-type risks which may be inherent
in certain areas; (3) evaluation of the issuer's products in relation to
competition and customer acceptance; (4) liquidity; (5) amount and quality of
long-term debt; (6) trend of earnings over a period of ten years; (7) financial
strength of a parent company and the relationships which exist with the issuer;
and (8) recognition by the management of obligations which may be present or may
arise as a result of public interest questions and preparations to meet such
obligations.
VARIABLE AMOUNT MASTER DEMAND NOTES
Variable amount master demand notes are demand obligations that permit the
investment of fluctuating amounts at varying market rates of interest pursuant
to an arrangement between the issuer and a commercial bank acting as agent for
the payees of such notes, whereby both parties have the right to vary the amount
of the outstanding indebtedness on the notes. Because variable amount master
demand notes are direct lending arrangements between a lender and a borrower, it
is not generally contemplated that such instruments will be traded, and there is
no secondary market for these notes, although they are redeemable (and thus
immediately repayable by the borrower) at face value, plus accrued interest, at
any time. In connection with a Portfolio's investment in variable amount master
demand notes, Vanguard's investment management staff will monitor, on an ongoing
basis, the earning power, cash flow and other liquidity ratios of the issuer,
and the borrower's ability to pay principal and interest on demand.
BOND RATINGS
Excerpts from Moody's Investors Service, Inc. description of its four highest
preferred bond ratings:
AAA--judged to be of the best quality. AA--judged to be of high quality by
all standards. Together with the Aaa group they comprise what are generally
known as high-grade bonds. A--possess many favorable investment attributes and
are to be considered as "upper-medium-grade obligations." BAA--considered as
medium-grade obligations (i.e., they are neither highly protected nor poorly
secured). Interest payments and principal security appear adequate for the
present but certain protective elements may be lacking or may be
characteristically unreliable over any great length of time. Such bonds lack
outstanding investment characteristics and in fact have speculative
characteristics as well.
Moody's applies numerical modifiers 1, 2, and 3 in each generic rating
classification from AA through B. The modifier 1 indicates that the obligation
ranks in the higher end of its generic rating category; the modifier 2 indicates
a mid-range ranking; and 3 indicates a ranking in the lower end of that generic
rating category.
B-32
<PAGE>
Excerpts from Standard & Poor's Corporation description of its four highest bond
ratings:
AAA--highest rating assigned. Capacity to pay interest and repay principal
is extremely strong. AA--a very strong capacity to pay interest and repay
principal and differs from the highest rated issues only in small degree. A--has
a strong capacity to pay interest and repay principal although it is somewhat
more susceptible to the adverse effects of changes in circumstances and economic
conditions than debt in higher rated categories. BBB--regarded as having an
adequate capacity to pay interest and repay principal. Whereas it normally
exhibits adequate protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay interest and
repay principal for debt in this category than in higher rated categories.
Standard & Poor's may apply indicators "+", no character and "-" to its
rating categories from AA to CCC. The indicators show relative standing within
the major rating categories.
B-33
<PAGE>
SAI064 122000
<PAGE>
PART C
VANGUARD VARIABLE INSURANCE FUND
OTHER INFORMATION
ITEM 23. EXHIBITS
(a) Declaration of Trust**
(b) By-Laws**
(c) Reference is made to Articles III and V of the Registrant's Declaration
of Trust
(d) Investment Advisory Contracts**
(e) Not applicable
(f) Reference is made to the section entitled "Management of the Fund" in the
Registrant's Statement of Additional Information
(g) Custodian Agreements**
(h) Amended and Restated Funds' Service Agreement**
(i) Legal Opinion**
(j) Consent of Independent Accountants+
(k) Not Applicable
(l) Not Applicable
(m) Not Applicable
(n) Not Applicable
(o) Not Applicable
(p) Codes of Ethics*
----------
*Filed previously for Grantham, Mayo, Van Otterloo & Co. LLC; filed herewith
for all other advisers.
**Filed previously.
+Filed herewith.
ITEM 24. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT
Registrant is not controlled by or under common control with any person.
ITEM 25. INDEMNIFICATION
The Registrant's organizational documents contain provisions indemnifying
trustees and officers against liability incurred in their official capacity.
Article VII, Section 2 of the Declaration of Trust provides that the Registrant
may indemnify and hold harmless each and every trustee and officer from and
against any and all claims, demands, costs, losses, expenses, and damages
whatsoever arising out of or related to the performance of his or her duties as
a trustee or officer. However, this provision does not cover any liability to
which a trustee or officer would otherwise be subject by reason of willful
misfeasance, bad faith, gross negligence, or reckless disregard of the duties
involved in the conduct of his or her office. Article VI of the By-Laws
generally provides that the Registrant shall indemnify its trustees and officers
from any liability arising out of their past or present service in that
capacity. Among other things, this provision excludes any liability arising by
reason of willful misfeasance, bad faith, gross negligence, or the reckless
disregard of the duties involved in the conduct of the trustee's or officer's
office with the Registrant.
ITEM 26. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER
Investment advisory services are provided to six Portfolios of the Registrant on
an at cost basis by The Vanguard Group, Inc., a jointly-owned subsidiary of the
Registrant and the other Funds in the Group. See the information concerning The
Vanguard Group set forth in Parts A and B.
C-1
<PAGE>
Investment advisory services are provided to the HIGH YIELD BOND and
BALANCED PORTFOLIOS by Wellington Management Company, LLP (Wellington).
Wellington is an investment adviser registered under the Investment Advisers Act
of 1940, as amended (the Advisers Act). The list required by this Item 26 of
officers and partners of Wellington, together with any information as to any
business profession, vocation, or employment of a substantial nature engaged in
by such officers and partners during the past two years, is incorporated herein
by reference from Schedules B and D of Form ADV filed by Wellington pursuant to
the Advisers Act (SEC File No. 801-15908).
Investment advisory services are provided to the EQUITY INCOME PORTFOLIO by
Newell Associates (Newell). Newell is an investment adviser registered under the
Advisers Act. The list required by this Item 26 of officers and directors of
Newell, together with any information as to any business profession, vocation,
or employment of a substantial nature engaged in by such officers and directors
during the past two years, is incorporated herein by reference from Schedules B
and D of Form ADV filed by Newell pursuant to the Advisers Act (SEC File No.
801-26949).
Investment advisory services are provided to the GROWTH PORTFOLIO by
Lincoln Capital Management Company (Lincoln). Lincoln is an investment adviser
registered under the Advisers Act. The list required by this Item 26 of officers
and directors of Lincoln, together with any information as to any business
profession, vocation, or employment of a substantial nature engaged in by such
officers and directors during the past two years, is incorporated herein by
reference from Schedules B and D of Form ADV filed by Lincoln pursuant to the
Advisers Act (SEC File No. 801-11417).
Investment advisory services are provided to the SMALL COMPANY GROWTH
PORTFOLIO by Granahan Investment Management, Inc. (Granahan). Granahan is an
investment adviser registered under the Advisers Act. The list required by this
Item 26 of officers and directors of Granahan, together with any information as
to any business profession, vocation, or employment of a substantial nature
engaged in by such officers and directors during the past two years, is
incorporated herein by reference from Schedules B and D of Form ADV filed by
Granahan pursuant to the Advisers Act (SEC File No. 801-23705).
Investment advisory services are provided to the SMALL COMPANY GROWTH
PORTFOLIO by Grantham, Mayo, Van Otterloo & Co. LLC (GMO). GMO is an investment
adviser registered under the Advisers Act. The list required by this Item 26 of
officers and directors of GMO, together with any information as to any business
profession, vocation, or employment of a substantial nature engaged in by such
officers and directors during the past two years, is incorporated herein by
reference from Schedules B and D of Form ADV filed by GMO pursuant to the
Advisers Act (SEC File No. 801-15028).
Investment advisory services are provided to the INTERNATIONAL PORTFOLIO by
Schroder Investment Management North America, Inc. (Schroder). Schroder is an
investment adviser registered under the Advisers Act. The list required by this
Item 26 of officers and directors of Schroder, together with any information as
to any business profession, vocation, or employment of a substantial nature
engaged in by such officers and directors during the past two years, is
incorpo-rated herein by reference from Schedules B and D of Form ADV filed by
Schroder pursuant to the Advisers Act (SEC File No. 801-15834).
Investment advisory services are provided to the DIVERSIFIED VALUE
PORTFOLIO by Barrow, Hanley, Mewhinney & Strauss, Inc. (Barrow, Hanley). Barrow,
Hanley is an investment adviser registered under the Advisers Act. The list
required by this Item 26 of officers and directors of Barrow, Hanley, together
with any information as to any business profession, vocation, or employment of a
substantial nature engaged in by such officers and directors during the past two
years, is incorporated herein by reference from Schedules B and D of Form ADV
filed by Barrow, Hanley pursuant to the Advisers Act (SEC File No. 801-31237).
ITEM 27. PRINCIPAL UNDERWRITERS
(a) Not Applicable
(b) Not Applicable
(c) Not Applicable
C-2
<PAGE>
ITEM 28. LOCATION OF ACCOUNTS AND RECORDS
The books, accounts, and other documents required to be maintained by Section 31
(a) of the Investment Company Act and the rules promulgated thereunder will be
maintained at the offices of Registrant; Registrant's Transfer Agent, The
Vanguard Group, Inc., Malvern, Pennsylvania; and the Registrant's Custodians,
Brown Brothers Harriman & Co., Boston, Massachusetts, First Union National Bank,
Philadelphia, Pennsylvania, State Street Bank and Trust Company, Boston,
Massachusetts, and The Bank of New York, New York, New York.
ITEM 29. MANAGEMENT SERVICES
Other than as set forth under the description of The Vanguard Group in Part B of
this Registrant Statement, the Registrant is not a party to any
management-related service contract.
ITEM 30. UNDERTAKINGS
Not Applicable
C-3
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the Investment
Company Act of 1940, the Registrant hereby certifies that it meets all
requirements of this Registration Statement pursuant to Rule 485(b) under the
Securities Act of 1933 and has duly caused this Registration Statement to be
signed on its behalf by the undersigned, thereunto duly authorized, in the Town
of Malvern and the Commonwealth of Pennsylvania, on the 27th day of December,
2000.
VANGUARD VARIABLE INSURANCE FUND
BY:_________________________________
(signature)
(HEIDI STAM)
JOHN J. BRENNAN*
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
Pursuant to the requirements of the Securities Act of 1933, this
Post-Effective Amendment to the Registration Statement has been signed below by
the following persons in the capacities and on the date indicated:
SIGNATURE TITLE DATE
--------------------------------------------------------------------------------
By:/S/ JOHN J. BRENNAN President, Chairman, Chief December 27, 2000
---------------------------Executive Officer, and Trustee
(Heidi Stam)
John J. Brennan*
By:/S/ JOANN HEFFERNAN HEISEN Trustee December 27, 2000
---------------------------
(Heidi Stam)
JoAnn Heffernan Heisen*
By:/S/ BRUCE K. MACLAURY Trustee December 27, 2000
---------------------------
(Heidi Stam)
Bruce K. MacLaury*
By:/S/ BURTON G. MALKIEL Trustee December 27, 2000
---------------------------
(Heidi Stam)
Burton G. Malkiel*
By:/S/ ALFRED M. RANKIN, JR. Trustee December 27, 2000
---------------------------
(Heidi Stam)
Alfred M. Rankin, Jr.*
By:/S/ JAMES O. WELCH, JR. Trustee December 27, 2000
---------------------------
(Heidi Stam)
James O. Welch, Jr.*
By:/S/ J. LAWRENCE WILSON Trustee December 27, 2000
---------------------------
(Heidi Stam)
J. Lawrence Wilson*
By:/S/ THOMAS J. HIGGINS Treasurer, Principal Financial December 27, 2000
--------------------------- Officer, and Principal
(Heidi Stam) Accounting Officer
Thomas J. Higgins*
*By Power of Attorney. See File Number 33-4424, filed on January 25, 1999.
Incorporated by Reference.
<PAGE>
INDEX TO EXHIBITS
Consent of Independent Accountants. . . . . . . . . . . . . . . . . .Ex-99.BJ
Codes of Ethics.. . . . . . . . . . . . . . . . . . . . . . . . . . .Ex-99.BP