<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. 16
AND
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
AMENDMENT NO. 19
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
IT IS PROPOSED THAT THIS FILING BECOME EFFECTIVE:
ON JANUARY 21, 2000, PURSUANT TO PARAGRAPH (B) OF RULE 485.
APPROXIMATE DATE OF PROPOSED PUBLIC OFFERING:
AS SOON AS PRACTICABLE AFTER THIS REGISTRATION STATEMENT BECOMES EFFECTIVE.
WE HAVE ELECTED TO REGISTER AN INDEFINITE NUMBER OF SECURITIES UNDER THE
SECURITIES ACT OF 1933 PURSUANT TO RULE 24F-2 OF THE INVESTMENT COMPANY ACT OF
1940. REGISTRANT FILED ITS RULE 24F-2 NOTICE FOR ITS FISCAL YEAR ENDED SEPTEMBER
30, 1999 WITH THE COMMISSION ON DECEMBER 29, 1999.
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<PAGE>
VANGUARD VARIABLE INSURANCE FUND
CROSS REFERENCE SHEET
<TABLE>
<CAPTION>
<S> <C> <C>
FORM N-1A
ITEM NUMBER
- -----------------------------------------------------------------------------------------------------
FORM N-1A
ITEM NUMBER LOCATION IN PROSPECTUS
- -----------------------------------------------------------------------------------------------------
Item 1. Front and Back Cover Pages .................Front and Back Cover Pages
Item 2. Risk/Return: Investments, Risk, and
Performance ................................Portfolio Profiles
Item 3. Risk/Return Summary: Fee Table .............Fee Tables
Item 4. Investment Objectives, Principal Investment
Strategies, and Related Risks ..............A Word About Risk; Primary Investment
Policies, Strategies, and Risks
Item 5. Management's Discussion of Fund
Performance ................................Herein incorporated by reference to
Registrant's Annual Report to Shareholders
dated September 30, 1999 filed with the
Securities & Exchange Commission's EDGAR
system December 2, 1999.
Item 6. Management, Organization, and Capital
Structure ..................................The Portfolios and Vanguard; Investment
Advisers
Item 7. Shareholder Information ....................Share Price; Taxes; General Information
Item 8. Distribution Arrangements ..................Not Applicable
Item 9. Financial Highlights Information ...........Financial Highlights
FORM N-1A LOCATION IN STATEMENT OF ADDITIONAL
ITEM NUMBER INFORMATION
- -----------------------------------------------------------------------------------------------------
Item 10. Cover Page and Table of Contents ...........Cover Page; Table of Contents
Item 11. Fund History ...............................Description of the Fund
Item 12. Description of the Fund and its Investments
and Risks ..................................Investment Policies; Description of the Fund;
Fundamental Investment Limitations
Item 13. Management of the Trust ....................Management of the Fund
Item 14. Control Persons and Principal Holders of
Securities .................................Management of the Fund
Item 15. Investment Advisory and Other Services .....Investment Advisory Services
Item 16. Brokerage Allocation and Other Practices ...Portfolio Transactions
Item 17. Capital Stock and Other Securities .........Description of the Fund
Item 18. Purchase, Redemption, and Pricing of Shares.Purchase of Shares; Redemption of Shares;
Share Price
Item 19. Taxation of the Fund .......................Description of the Fund
Item 20. Underwriters ...............................Not Applicable
Item 21. Calculation of Performance Data ............Calculation of Yield; Calculation of Total
Return; Yield and Total Return
Item 22. Financial Statements .......................Financial Statements
</TABLE>
<PAGE>
VANGUARD /(R)/
VARIABLE
INSURANCE FUND
Prospectus
January 21, 2000
- ------------------------------
This prospectus contains
financial data for the
Portfolios through the
fiscal year ended
September 30, 1999
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
[A MEMBER OF
THE VANGUARD GROUP
LOGO]
<PAGE>
VANGUARD VARIABLE INSURANCE FUND
Prospectus
January 21, 2000
- --------------------------------------------------------------------------------
CONTENTS
- --------------------------------------------------------------------------------
1 AN INTRODUCTION TO 20 INVESTMENT POLICIES, STRATEGIES,
VANGUARD VARIABLE INSURANCE FUND AND RISKS
2 PORTFOLIO PROFILES 20 MARKET RISK
2 MONEY MARKET PORTFOLIO 20 MANAGER RISK
3 SHORT-TERM CORPORATE PORTFOLIO 21 FUTURES AND OPTIONS CONTRACTS
4 HIGH-GRADE BOND PORTFOLIO 21 OVERVIEW OF THE MONEY MARKET
PORTFOLIO
6 HIGH YIELD BOND PORTFOLIO 22 OVERVIEW OF THE BOND PORTFOLIOS
7 BALANCED PORTFOLIO 27 OVERVIEW OF THE BALANCED PORTFOLIO
9 EQUITY INCOME PORTFOLIO 28 OVERVIEW OF THE STOCK PORTFOLIOS
11 DIVERSIFIED VALUE PORTFOLIO 38 TURNOVER RATE
11 EQUITY INDEX PORTFOLIO 38 THE PORTFOLIOS AND VANGUARD
13 MID-CAP INDEX PORTFOLIO 38 INVESTMENT ADVISERS
14 GROWTH PORTFOLIO 42 TAXES
15 SMALL COMPANY GROWTH PORTFOLIO 42 SHARE PRICE
17 INTERNATIONAL PORTFOLIO 43 FINANCIAL HIGHLIGHTS
19 REIT INDEX PORTFOLIO 51 GENERAL INFORMATION
20 A WORD ABOUT RISK GLOSSARY (inside back cover)
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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 to decide which portfolio, if any, is the
right investment for you. We suggest that you keep it for future reference.
- --------------------------------------------------------------------------------
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.
<PAGE>
1
AN INTRODUCTION TO VANGUARD VARIABLE INSURANCE FUND
This prospectus explains the objectives, risks, and strategies of 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 page you'll find Portfolio Profiles. Each Profile
summarizes important facts about a Portfolio, including information about its
investment objective, 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 in
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
THE 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.
- --------------------------------------------------------------------------------
<PAGE>
2
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.
BAR CHART AND PERFORMANCE TABLE
The bar chart and table below provide an indication of the risk 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. Keep in mind that the Portfolio's past performance does not indicate how
it will perform in the future.
<PAGE>
3
------------------------------------------------------------------
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%
------------------------------------------------------------------
During the period shown in the bar chart, the highest return for a calendar
quarter was 1.47% (quarter ended June 30, 1995) and the lowest return for a
quarter was 0.74% (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.
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
<PAGE>
4
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.
- - 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.
<PAGE>
5
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 bar chart and table below provide an indication of the risk 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. Keep in mind that the Portfolio's past performance does not indicate
how it will perform in the future.
------------------------------------------------------------------
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%
------------------------------------------------------------------
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).
<PAGE>
6
------------------------------------------------------------------
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>
7
BAR CHART AND PERFORMANCE TABLE
The bar chart and table below provide an indication of the risk 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. 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%
------------------------------------------------------------------
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 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.
<PAGE>
8
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- capitalization 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.
- - 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 bar chart and table below provide an indication of the risk 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. 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%
------------------------------------------------------------------
<PAGE>
9
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 Long
Corporate AA 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 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
<PAGE>
10
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 bar chart and table below provide an indication of the risk 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. 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%
------------------------------------------------------------------
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.
<PAGE>
11
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.
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.
<PAGE>
12
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-capitalization
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 bar chart and table below provide an indication of the risk 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 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. 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%
------------------------------------------------------------------
<PAGE>
13
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.
<PAGE>
14
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.
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 bar chart and table below provide an indication of the risk 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
<PAGE>
15
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. 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%
------------------------------------------------------------------
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).
------------------------------------------------------------------
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.
<PAGE>
16
INVESTMENT OBJECTIVE
The Small Company Growth Portfolio seeks to provide long-term growth of capital.
INVESTMENT STRATEGIES
The Portfolio invests primarily in stocks of smaller companies that appear to
offer favorable prospects for growth and price appreciation. These stocks are
expected to provide only minimal dividend income. The Portfolio's investment
adviser places stocks in three categories: (1) "Core" growth stocks, generally
representing 50%-80% of assets, are companies with demonstrated records of
growth and strong market positions based on a proprietary product or service;
(2) "Pioneers," 10%-25% of assets, generally have unique technology or other
innovations that may lead to new products or new markets; and (3) "Special
values," 10%-25% of assets, are companies whose stock prices are undervalued
given the adviser's view of their prospects for improvement over the next
several years.
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 bar chart and table below provide an indication of the risk 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. 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%
------------------------------------------------------------------
<PAGE>
17
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 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.
<PAGE>
18
BAR CHART AND PERFORMANCE TABLE
The bar chart and table below provide an indication of the risk 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. Keep in mind that the Portfolio's past performance does not
indicate how it will perform in the future.
------------------------------------------------------------------
ANNUAL TOTAL RETURNS
------------------------------------------------------------------
1995 15.90%
1996 14.60%
1997 3.34%
1998 18.83%
1999 25.39%
------------------------------------------------------------------
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.
<PAGE>
19
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.
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.
<PAGE>
20
================================================================================
A WORD ABOUT RISK
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 one or
more of the Portfolios, you should also take into account your personal
tolerance for the daily fluctuations of 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.
================================================================================
INVESTMENT POLICIES, STRATEGIES, AND RISKS
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 oversees the management of the Portfolios, and
may change the investment strategies 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 by investment advisers who use their
research and judgment in deciding which securities to buy and which to sell.
These nine 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 passively managed funds. In other words, each seeks to track a
securities market index by holding all--or a representative sample--of the
securities in the index. These Portfolios are
<PAGE>
21
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. 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 or 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 bond), an asset (such as a commodity
like gold), or a market index (such as the S&P 500 Index). Futures and options
are derivatives that have been trading on regulated exchanges for more than two
decades. These "traditional" derivatives are standardized contracts that can
easily be bought and sold, and whose market values are determined and published
daily. It is these characteristics that differentiate futures and options from
the relatively new types of derivatives. 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
<PAGE>
22
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
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.
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.
<PAGE>
23
- --------------------------------------------------------------------------------
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 bonds
such as those of the Government National Mortgage Association (GNMA). Each
issuer is responsible for paying back the bond's initial value as well as
periodic interest payments.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
PLAIN TALK ABOUT
BONDS AND INTEREST RATES
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 are offered with a
6% yield. With higher-yielding bonds available, you would have trouble selling
your 5% bond for the price you paid--causing you 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 of the Portfolios 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>
24
- --------------------------------------------------------------------------------
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. Bonds rated in one of the
four highest rating categories are considered "investment-grade." All things
being equal, the lower a bond's credit rating, the higher its yield should be to
compensate investors for assuming additional risk.
- --------------------------------------------------------------------------------
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 short- and intermediate-term
bonds issued by corporations, it also may invest in the following types of
investment-grade securities:
- - Bonds issued by the U.S. Treasury and U.S. government agencies and
instrumentalities.
- - Bonds issued by state and local governments and their agencies.
- - Bank obligations, including certificates of deposit and banker's
acceptances.
- - 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.
- - Commercial paper, a type of IOU issued by corporations.
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 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, 1999, these four types of bonds represented the following
proportions of the Portfolio's market value:
<PAGE>
25
--------------------------------------------------------------
PORTION OF PORTFOLIO'S
TYPE OF BOND MARKET VALUE
--------------------------------------------------------------
U.S. Treasury and agency securities 28%
Corporate bonds 33
Foreign U.S.-dollar obligations 5
Mortgage-backed securities 34
--------------------------------------------------------------
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 9.1 years on
September 30, 1999. 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.
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.
<PAGE>
26
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 considered riskier than
investment-grade bonds, high-yield bonds must pay higher interest yields 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 securities 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>
27
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 tend not to move in lockstep, 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
<PAGE>
28
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. The dollar-weighted average maturity of the bond holdings exceeds 15
years. 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: n 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 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.
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 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 35.)
<PAGE>
29
-----------------------------------------------------
U.S. STOCK MARKET RETURNS (1926-1998)
-----------------------------------------------------
1 YEAR 5 YEARS 10 YEARS 20 YEARS
-----------------------------------------------------
Best 54.2% 24.1% 19.9% 17.7%
Worst -43.1 -12.4 -0.8 3.1
Average 13.1 10.7 11.0 11.0
-----------------------------------------------------
The table covers all of the 1-, 5-, 10-, and 20-year periods from 1926
through 1998. You can see, for example, that while the average return on stocks
for all of the 5-year periods was 10.7%, returns for individual 5-year periods
ranged from a -12.4% average (from 1928 through 1932) to 24.1% (from 1994
through 1998). 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).
- --------------------------------------------------------------------------------
PASSIVE VERSUS ACTIVE MANAGEMENT
Three of the Portfolios--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
target 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.
Five of the Portfolios--EQUITY INCOME, DIVERSIFIED VALUE, GROWTH, SMALL
COMPANY GROWTH, and INTERNATIONAL--are actively managed, meaning that their
investment advisers buy and sell securities based on research and analysis in an
attempt to outperform the market as a whole.
[FLAG]THESE FIVE PORTFOLIOS ARE SUBJECT TO MANAGER RISK, WHICH IS THE CHANCE
THAT THEIR ADVISERS MAY DO A POOR JOB OF SELECTING STOCKS.
<PAGE>
30
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.
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 OF THE PORTFOLIOS IS SUBJECT TO INVESTMENT STYLE RISK, WHICH IS THE
CHANCE THAT RETURNS FROM ITS SEGMENT OF THE STOCK MARKET WILL TRAIL RETURNS
FROM OTHER ASSET CLASSES OR THE OVERALL MARKET. VARIOUS SEGMENTS OF THE
STOCK MARKET (FOR EXAMPLE, LARGE-CAP VALUE STOCKS, OR SMALL-CAP GROWTH
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
<PAGE>
31
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 into 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 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 75% 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 56% of its market
capitalization. As of September 30, 1999, the five largest companies in the
Index were:
<PAGE>
32
----------------------------------------------------
PERCENTAGE
COMPANY OF INDEX VALUE
----------------------------------------------------
Microsoft Corp. 4.37%
General Electric Co. 3.68
INTEL Corp. 2.33
Cisco Systems Inc. 2.11
IBM 2.07
----------------------------------------------------
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 34% of its market
capitalization. As of September 30, 1999, the five largest companies in the
Index were:
----------------------------------------------------
PERCENTAGE
COMPANY OF INDEX VALUE
----------------------------------------------------
Veritas Software Corp. 1.56%
Biogen Inc. 1.43
Xilinx Inc. 1.25
Linear Technology Corp. 1.08
Analog Devices Inc. 1.07
----------------------------------------------------
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 Portfolio's overall
makeup may differ substantially from that of the broad stock market in terms of
industry weightings and market capitalization.
<PAGE>
33
[FLAG]BECAUSE THE PORTFOLIO INVESTS A HIGHER PERCENTAGE OF ASSETS IN ITS TEN
LARGEST HOLDINGS THAN THE AVERAGE STOCK FUND DOES, THE PORTFOLIO IS SUBJECT
TO THE RISK THAT ITS PERFORMANCE MAY BE HURT DISPROPORTIONATELY BY THE POOR
PERFORMANCE OF RELATIVELY FEW STOCKS.
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 $40
billion.
The Portfolio's investment adviser categorizes stocks into three
categories: (1) "Core" growth stocks, representing 50% to 80% of assets, are
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,
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 companies whose stock prices are undervalued given the adviser's
view of their prospects for improvement over the next several years.
Besides common stocks, the Portfolio may invest in securities that are
convertible into 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 it is 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 their assets invested in the stocks of just
ten companies.
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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
<PAGE>
34
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 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 (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 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.
<PAGE>
35
-------------------------------------------------------
INTERNATIONAL STOCK MARKET RETURNS (1969-1998)
-------------------------------------------------------
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 14.7 13.6 14.9 14.7
-------------------------------------------------------
The table covers all of the 1-, 5-, 10-, and 20-year periods from 1969
through 1998. 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 match 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
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 directly owning properties--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.
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<PAGE>
36
[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 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, 1999, the Index included 128 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>
37
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, 1999, follows.
----------------------------------------------------
PERCENTAGE
TYPE OF REIT OF INDEX VALUE
----------------------------------------------------
Retail 24%
Residential Apartments 20
Office 19
Industrial 16
Hotels 11
Diversified 10
----------------------------------------------------
The Index's ten largest stocks make up more than 31% of its market value.
The Index's largest stocks, as of September 30, 1999, are listed below.
1. Equity Office Properties Trust REIT 6. Crescent Real Estate, Inc. REIT
2. Starwood Hotels & Resorts REIT 7. Archstone Communities Trust REIT
3. Simon Property Group, Inc. REIT 8. ProLogis Trust REIT
4. Equity Residential Properties Trust REIT 9. Vornado Realty Trust REIT
5. Public Storage, Inc. REIT 10. Spieker Properties, Inc. 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.
*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.
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 them 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.
<PAGE>
38
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 retain the right to 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.
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 $530 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, Pennsylvania,
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, 1999, the Fixed Income Group managed more than $140 billion in
total assets. The individuals responsible for overseeing the Portfolios'
investments are:
- - Ian A. MacKinnon, Managing Director of Vanguard; has worked in investment
management since 1974; primary responsibility for Vanguard's internal
fixed-income policy and strategy since 1981; B.A., Lafayette College;
M.B.A., Pennsylvania State University.
<PAGE>
39
- - David R. Glocke, Principal and (since 1997) Portfolio Manager of the Money
Market Portfolio; has worked in investment management since 1991; has
managed portfolio investments since 1997; B.S., University of Wisconsin.
- - Robert F. Auwaerter, Principal and (since its inception) Portfolio Manager
of the Short-Term Corporate Portfolio; has managed portfolio investments
since 1979; B.S., University of Pennsylvania; M.B.A., Northwestern
University.
- - Kenneth E. Volpert, CFA, Principal and (since 1992) Portfolio Manager of
the High-Grade Bond Portfolio; has managed portfolio investments since
1982; B.S., University of Illinois; M.B.A., University of Chicago.
For the fiscal year ended September 30, 1999, the Money Market Portfolio's
advisory costs represented an effective annual rate of 0.01% of the Portfolio's
average net assets.
The Short-Term Corporate Portfolio began operations on February 9, 1999.
For the period ended September 30, 1999, the Short-Term Corporate Portfolio's
advisory costs represented an effective annual rate of approximately 0.003% of
the Portfolio's average net assets.
For the fiscal year ended September 30, 1999, the High-Grade Bond
Portfolio's advisory costs represented an effective annual rate of 0.01% of the
Portfolio's average net assets.
Vanguard's Core Management Group provides advisory services for the EQUITY
INDEX, MID-CAP INDEX, and REIT INDEX PORTFOLIOS. Vanguard's Core Management
Group provides investment advisory services to many Vanguard funds; as of
September 30, 1999, the Core Management Group managed more than $180 billion in
total assets. The individual responsible for overseeing each Portfolio's
investments is:
- - George U. Sauter, Managing Director of Vanguard; has managed portfolio
investments with Vanguard since 1987; A.B., Dartmouth College; M.B.A.,
University of Chicago.
For the fiscal year ended September 30, 1999, the Equity Index Portfolio's
advisory costs represented an effective annual rate of 0.01% of the Portfolio's
average net assets.
The Mid-Cap Index Portfolio began operations on February 9, 1999. For the
period ended September 30, 1999, the Mid-Cap Index Portfolio's advisory costs
represented an effective annual rate of 0.04% of the Portfolio's average net
assets.
The REIT Index Portfolio began operations on February 9, 1999. For the
period ended September 30, 1999, the REIT Index Portfolio's advisory costs
represented an effective annual rate of 0.08% of the Portfolio's average net
assets.
Vanguard employs six independent investment advisers to manage the
remaining seven Portfolios.
WELLINGTON MANAGEMENT COMPANY, LLP
Wellington Management Company, LLP (Wellington Management), 75 State Street,
Boston, Massachusetts, provides advisory services for the HIGH YIELD BOND and
BALANCED PORTFOLIOS. Wellington Management, an investment advisory firm founded
in 1928, managed more than $217 billion in stock and bond portfolios as of
September 30, 1999.
The individual responsible for overseeing the HIGH YIELD BOND PORTFOLIO'S
investments is:
- - Earl E. McEvoy, Senior Vice President and Partner of Wellington Management;
has worked in investment management since 1972; with Wellington Management
since 1978; has managed the Portfolio since its inception; B.A., Dartmouth
College; M.B.A., Columbia University School of Business.
<PAGE>
40
The individuals responsible for overseeing the BALANCED PORTFOLIO'S
investments are:
- - Ernst H. von Metzsch, CFA, Senior Vice President and Partner of Wellington
Management; has worked in investment management since 1970; with Wellington
Management since 1973; has managed the Portfolio since 1995; M.Sc.,
University of Leiden, the Netherlands; Ph.D., Harvard University.
- - Paul D. Kaplan, Senior Vice President and Partner of Wellington Management;
has worked in investment management since 1974; with Wellington Management
since 1978; has assisted in the management of the Portfolio since 1994;
B.A., 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 based on a percentage of net assets. The basic advisory fee
may be increased or decreased by applying an adjustment formula based on the
investment performance of the Balanced Portfolio relative to that of a
"Composite Index," 65% of which is comprised of the Standard & Poor's Composite
Stock Price Index and 35% of which is comprised of the Lehman Long-Term
Corporate AA or Better Bond Index.
For the fiscal year ended September 30, 1999, the advisory fee paid to
Wellington Management with respect to the Balanced Portfolio represented an
effective annual rate of 0.09% of the Portfolio's average net assets, before a
decrease of 0.02% based on performance.
For the fiscal year ended September 30, 1999, 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, California,
provides advisory services for the EQUITY INCOME PORTFOLIO. Newell, an
investment advisory firm founded in 1986, currently manages about $2.5 billion
in assets.
The individual responsible for overseeing the Equity Income Portfolio's
investments is:
- - Roger D. Newell, Chairman of Newell; has worked in investment management
since 1958; with Newell since 1986; has managed the Portfolio since its
inception; B.A., University of Minnesota; J.D., Harvard Law School; M.A.,
University of Minnesota.
For the fiscal year ended September 30, 1999, 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, Texas, provides advisory services for
the DIVERSIFIED VALUE PORTFOLIO. Barrow, Hanley is owned by United Asset
Management, 1 International Place, Boston, Massachusetts. Barrow, Hanley
currently manages approximately $35 billion in stock and bond portfolios.
The individual responsible for overseeing the Diversified Value Portfolio's
investments is:
- - James P. Barrow, Partner of Barrow, Hanley; has worked in investment
management since 1965; with Barrow, Hanley since 1980; has managed the
Portfolio since its inception; B.S., University of South Carolina.
Barrow, Hanley's advisory fee is paid quarterly based on an annual
percentage rate of 0.125% applied to the average month-end net assets of the
Diversified Value Portfolio for the quarter.
<PAGE>
41
The basic advisory fee may be increased or decreased by applying an
adjustment formula based on the investment performance of the Diversified Value
Portfolio relative to that of the Standard & Poor's/BARRA Value Index.
The incentive/penalty fee will not be fully operable until the quarter
ending December 31, 2001. Until that date, the incentive/penalty will be
calculated using certain transition rules that are explained in the Statement of
Additional Information.
The Diversified Value Portfolio began operations on February 9, 1999. For
the period ended September 30, 1999, the advisory fee paid to Barrow, Hanley
represented an effective annual rate of 0.125% of the Portfolio's average net
assets.
LINCOLN CAPITAL MANAGEMENT COMPANY
Lincoln Capital Management Company (Lincoln), 200 South Wacker Drive, Chicago,
Illinois, provides advisory services for the GROWTH PORTFOLIO. Lincoln is an
investment advisory firm founded in 1967. As of September 30, 1999, Lincoln
managed more than $62 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; has worked in investment management since 1957; with Lincoln since
1971; has managed the Portfolio since its inception; B.A., Swarthmore
College; M.B.A., Harvard Business School.
- - David M. Fowler, Executive Vice President and Managing Director of Lincoln;
has worked in investment management since 1972; with Lincoln since 1984;
has managed the Portfolio since its inception; B.S., Loyola University;
M.B.A., Northwestern University.
- - John S. Cole, Principal; has worked in investment management since 1992;
with Lincoln since 1997; has managed the Portfolio since joining Lincoln;
B.S., Bentley College; M.B.A., University of Notre Dame.
For the fiscal year ended September 30, 1999, 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.
Granahan Investment Management, Inc. (Granahan), 275 Wyman Street, Waltham,
Massachusetts, provides investment advisory services for the SMALL COMPANY
GROWTH PORTFOLIO. Granahan is an investment advisory firm specializing in
small-company stock investments. Founded in 1985, Granahan currently manages
approximately $1.3 billion in assets.
The individuals responsible for overseeing the Small Company Growth
Portfolio's investments are:
- - John J. Granahan, CFA, Founder and President of Granahan; has worked in
investment management since 1963; founded Granahan in 1985; a manager of
the Portfolio since its inception; B.A., St. Joseph's University; Graduate
Fellow, Catholic University of America.
- - Gary C. Hatton, CFA, Executive Vice President of Granahan; has worked in
investment management since 1982; with Granahan since 1985; a manager of
the Portfolio since 1996; B.S., University of Rhode Island; M.S.,
University of Wisconsin.
- - Jane M. White, Executive Vice President of Granahan; has worked in
investment management since 1980; with Granahan since 1985; a manager of
the Portfolio since 1996; B.A., Boston University.
For the fiscal year ended September 30, 1999, the advisory fee paid to
Granahan represented an effective annual rate of 0.15% of the Portfolio's
average net assets, before an increase 0.01% based on performance.
<PAGE>
42
SCHRODER INVESTMENT MANAGEMENT NORTH AMERICA INC.
Schroder Investment Management North America Inc. (Schroder), provides
investment advisory services for the INTERNATIONAL PORTFOLIO. Schroder is the
London branch office of Schroder Investment Management North America Inc. which
is a wholly owned subsidiary of Schroder US Holdings Inc., 787 7th Avenue, New
York, New York. Schroder US Holdings Inc. is a wholly owned subsidiary of
Schroders PLC. As of September 30, 1999, Schroders PLC managed more than $190
billion in assets.
The individual responsible for overseeing the International Portfolio's
investments is:
- - Richard Foulkes, Executive Vice President and Deputy Chairman of Schroder;
has worked in investment management since 1968; with Schroder since 1968;
has managed the Portfolio since its inception; educated at the Sorbonne,
France; M.A., Cambridge University, England.
Schroder's advisory fee is paid quarterly based on a percentage of net
assets. The basic advisory fee may 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.
For the fiscal year ended September 30, 1999, the advisory fee paid to
Schroder represented an effective annual rate of 0.125% of the Portfolio's
average net assets, before an increase of 0.005% based on performance.
The advisers are authorized to choose brokers or dealers to handle the
purchase and sale of the Portfolios' securities, and to get the best available
price and most favorable execution from these brokers with respect to all
transactions. 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 or its Portfolios.
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 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 adding up the total value of each
Portfolio's investments and other assets, subtracting any of its liabilities
(debts), and then dividing by the number of Portfolio shares outstanding:
TOTAL ASSETS - LIABILITIES
NET ASSET VALUE = ------------------------------
NUMBER OF SHARES OUTSTANDING
<PAGE>
43
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 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.
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PLAIN TALK ABOUT
HOW TO READ THE FINANCIAL HIGHLIGHTS TABLES
This explanation uses the Money Market Portfolio as an example. The Portfolio
began fiscal 1999 with a net asset value (price) of $1.00 per share. During the
year, the Portfolio earned $.05 per share from investment income (interest and
dividends).
Shareholders received $.05 per share in the form of dividend distributions. The
earnings ($.05 per share) minus the distributions ($.05 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 5.09% for the year.
As of September 30, 1999, the Portfolio had $723 million in net assets. For the
year, its expense ratio was 0.20% ($2.00 per $1,000 of net assets); and its net
investment income amounted to 4.98% of its average net assets.
- --------------------------------------------------------------------------------
<PAGE>
44
FINANCIAL HIGHLIGHTS (CONTINUED)
- --------------------------------------------------------------------------------
MONEY MARKET PORTFOLIO
YEAR ENDED SEPTEMBER 30,
-----------------------------------------
1999 1998 1997 1996 1995
- --------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF YEAR $1.00 $1.00 $1.00 $1.00 $1.00
- --------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .050 .055 .054 .054 .056
Net Realized and Unrealized Gain
(Loss) on Investments -- -- -- -- --
-----------------------------------------
Total from Investment Operations .050 .055 .054 .054 .056
-----------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.050) (.055) (.054) (.054) (.056)
Distributions from Realized Capital
Gains -- -- -- -- --
-----------------------------------------
Total Distributions (.050) (.055) (.054) (.054) (.056)
- --------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $1.00 $1.00 $1.00 $1.00 $1.00
================================================================================
TOTAL RETURN 5.09% 5.60% 5.48% 5.49% 5.77%
================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $723 $590 $393 $285 $218
Ratio of Total Expenses to Average
Net Assets 0.20% 0.20% 0.21% 0.19% 0.23%
Ratio of Net Investment Income to
Average Net Assets 4.98% 5.46% 5.36% 5.36% 5.66%
================================================================================
- --------------------------------------------------------------------------------
SHORT-TERM CORPORATE PORTFOLIO
-------------------------------
FEB. 8* TO
SEP. 30, 1999
- --------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD $10.00
- --------------------------------------------------------------------------------
INVESTMENT OPERATIONS .355
Net Investment Income
Net Realized and Unrealized Gain (Loss) on Investments (.250)
--------------
Total from Investment Operations .105
--------------
DISTRIBUTIONS
Dividends from Net Investment Income (.355)
Distributions from Realized Capital Gains --
--------------
Total Distributions (.355)
- --------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $9.75
================================================================================
TOTAL RETURN 1.08%
================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $29
Ratio of Total Expenses to Average Net Assets 0.27%**
Ratio of Net Investment Income to Average Net Assets 5.74%**
Portfolio Turnover Rate 39%
================================================================================
*Inception.
**Annualized.
<PAGE>
45
- --------------------------------------------------------------------------------
HIGH-GRADE BOND PORTFOLIO
YEAR ENDED SEPTEMBER 30,
-----------------------------------------
1999 1998 1997 1996 1995
- --------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF YEAR $11.07 $10.57 $10.29 $10.47 $9.82
- --------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .646 .663 .678 .670 .663
Net Realized and Unrealized Gain
(Loss) on Investments (.700) .500 .280 (.180) .650
-----------------------------------------
Total from Investment Operations (.054) 1.163 .958 .490 1.313
-----------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.646) (.663) (.678) (.670) (.663)
Distributions from Realized Capital
Gains (.030) -- -- -- --
-----------------------------------------
Total Distributions (.676) (.663) (.678) (.670) (.663)
- --------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $10.34 $11.07 $10.57 $10.29 $10.47
================================================================================
TOTAL RETURN -0.49% 11.36% 9.60% 4.80% 13.83%
================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $337 $322 $188 $139 $120
Ratio of Total Expenses to Average
Net Assets 0.23% 0.28% 0.29% 0.25% 0.29%
Ratio of Net Investment Income to
Average Net Assets 6.06% 6.16% 6.51% 6.43% 6.58%
Portfolio Turnover Rate 69% 65% 40% 56% 29%
================================================================================
- --------------------------------------------------------------------------------
HIGH YIELD BOND PORTFOLIO
YEAR ENDED SEPTEMBER 30,
----------------------------- JUN. 3* TO
1999 1998 1997 Sep. 30, 1996
- --------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD $10.09 $10.59 $10.15 $10.00
- --------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .847 .895 .922 .299
Net Realized and Unrealized Gain
(Loss) on Investments (.573) (.485) .450 .150
--------------------------------------------
Total from Investment Operations .274 .410 1.372 .449
--------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.847) (.895) (.922) (.299)
Distributions from Realized
Capital Gains (.017) (.015) (.010) --
--------------------------------------------
Total Distributions (.864) (.910) (.932) (.299)
- --------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $ 9.50 $10.09 $10.59 $10.15
================================================================================
TOTAL RETURN 2.68% 3.85% 14.12% 4.56%
================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $146 $131 $85 $22
Ratio of Total Expenses to
Average Net Assets 0.29% 0.31% 0.31% 0.32%**
Ratio of Net Investment Income
to Average Net Assets 8.51% 8.45% 8.88% 9.29%**
Portfolio Turnover Rate 31% 38% 30% 8%
================================================================================
*Inception.
**Annualized.
<PAGE>
46
- --------------------------------------------------------------------------------
BALANCED PORTFOLIO
YEAR ENDED SEPTEMBER 30,
-----------------------------------------
1999 1998 1997 1996 1995
- --------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF YEAR $17.73 $17.97 $14.81 $13.33 $11.33
- --------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .63 .63 .60 .565 .51
Net Realized and Unrealized Gain
(Loss) on Investments .95 .56 3.31 1.420 2.07
-----------------------------------------
Total from Investment Operations 1.58 1.19 3.91 1.985 2.58
-----------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.62) (.60) (.19) (.505) (.50)
Distributions from Realized Capital
Gains (1.28) (.83) (.56) -- (.08)
-----------------------------------------
Total Distributions (1.90) (1.43) (.75) (.505) (.58)
- --------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $17.41 $17.73 $17.97 $14.81 $13.33
================================================================================
TOTAL RETURN 9.44% 7.26% 27.60% 15.26% 23.65%
================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $599 $553 $468 $330 $280
Ratio of Total Expenses to Average
Net Assets 0.29% 0.31% 0.32% 0.31% 0.36%
Ratio of Net Investment Income to
Average Net Assets 3.58% 3.72% 3.96% 4.04% 4.25%
Portfolio Turnover Rate 24% 31% 25% 36% 26%
================================================================================
- --------------------------------------------------------------------------------
EQUITY INCOME PORTFOLIO
YEAR ENDED SEPTEMBER 30,
-----------------------------------------
1999 1998 1997 1996 1995
- --------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF YEAR $19.69 $18.50 $13.71 $12.00 $10.05
- --------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .51 .490 .42 .48 .46
Net Realized and Unrealized Gain
(Loss) on Investments 1.50 1.475 4.69 1.75 2.02
-----------------------------------------
Total from Investment Operations 2.01 1.965 5.11 2.23 2.48
-----------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.49) (.400) (.15) (.46) (.48)
Distributions from Realized Capital
Gains (.11) (.375) (.17) (.06) (.05)
-----------------------------------------
Total Distributions (.60) (.775) (.32) (.52) (.53)
- --------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $21.10 $19.69 $18.50 $13.71 $12.00
================================================================================
TOTAL RETURN 10.36% 11.19% 38.05% 19.07% 25.69%
================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $429 $375 $271 $142 $91
Ratio of Total Expenses to Average
Net Assets 0.33% 0.36% 0.37% 0.35% 0.39%
Ratio of Net Investment Income to
Average Net Assets 2.44% 2.69% 3.11% 3.69% 4.28%
Portfolio Turnover Rate 6% 6% 8% 8% 10%
================================================================================
<PAGE>
47
- --------------------------------------------------------------------------------
DIVERSIFIED VALUE PORTFOLIO
----------------------------
FEB. 8* TO
SEP. 30, 1999
- --------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD $10.00
- --------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .11
Net Realized and Unrealized Gain (Loss) on Investments (.80)
--------------
Total from Investment Operations (.69)
--------------
DISTRIBUTIONS
Dividends from Net Investment Income --
Distributions from Realized Capital Gains --
--------------
Total Distributions --
- --------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $9.31
================================================================================
TOTAL RETURN -6.90%
================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $42
Ratio of Total Expenses to Average Net Assets 0.37%**
Ratio of Net Investment Income to Average Net Assets 2.38%**
Portfolio Turnover Rate 18%
================================================================================
*Inception.
**Annualized.
- --------------------------------------------------------------------------------
EQUITY INDEX PORTFOLIO
YEAR ENDED SEPTEMBER 30,
----------------------------------------
1999 1998 1997 1996 1995
- -------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF YEAR $26.94 $25.32 $18.32 $15.69 $12.47
- -------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .37 .37 .34 .34 .33
Net Realized and Unrealized Gain
(Loss) on Investments 7.04 1.83 6.94 2.75 3.26
-----------------------------------------
Total from Investment Operations 7.41 2.20 7.28 3.09 3.59
-----------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.37) (.34) (.19) (.33) (.29)
Distributions from Realized Capital
Gains (.13) (.24) (.09) (.13) (.08)
-----------------------------------------
Total Distributions (.50) (.58) (.28) (.46) (.37)
- --------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $33.85 $26.94 $25.32 $18.32 $15.69
================================================================================
TOTAL RETURN 27.84% 8.97% 40.31% 20.19% 29.51%
================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $1,365 $920 $718 $406 $276
Ratio of Total Expenses to Average
Net Assets 0.18% 0.20% 0.23% 0.22% 0.28%
Ratio of Net Investment Income to
Average Net Assets 1.21% 1.48% 1.78% 2.13% 2.53%
Portfolio Turnover Rate 4% 1% 1% 2% 2%
================================================================================
<PAGE>
48
- --------------------------------------------------------------------------------
MID-CAP INDEX PORTFOLIO
------------------------
FEB. 8* TO
SEP. 30, 1999
- --------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD $10.00
- --------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .04
Net Realized and Unrealized Gain (Loss) on Investments .61
--------------
Total from Investment Operations .65
--------------
DISTRIBUTIONS
Dividends from Net Investment Income --
Distributions from Realized Capital Gains --
--------------
Total Distributions --
- --------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $10.65
================================================================================
TOTAL RETURN 6.50%
================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $54
Ratio of Total Expenses to Average Net Assets 0.24%**
Ratio of Net Investment Income to Average Net Assets 1.03%**
Portfolio Turnover Rate 24%
================================================================================
*Initial share purchase date. All assets were held in money market instruments
until February 9, 1999, when performance measurement begins.
**Annualized.
- --------------------------------------------------------------------------------
GROWTH PORTFOLIO
YEAR ENDED SEPTEMBER 30,
-----------------------------------------
1999 1998 1997 1996 1995
- --------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF YEAR $24.33 $21.51 $17.58 $14.10 $10.79
- --------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .16 .16 .190 .18 .16
Net Realized and Unrealized Gain
(Loss) on Investments 6.16 3.43 4.615 3.65 3.26
-----------------------------------------
Total from Investment Operations 6.32 3.59 4.805 3.83 3.42
-----------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.16) (.20) (.180) (.16) (.11)
Distributions from Realized Capital
Gains (1.53) (.57) (.685) (.19) --
-----------------------------------------
Total Distributions (1.69) (.77) (.875) (.35) (.11)
- --------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $28.96 $24.33 $21.51 $17.58 $14.10
================================================================================
TOTAL RETURN 27.27% 17.37% 28.76% 27.79% 32.02%
================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $953 $631 $460 $276 $162
Ratio of Total Expenses to Average
Net Assets 0.35% 0.39% 0.38% 0.39% 0.47%
Ratio of Net Investment Income to
Average Net Assets 0.59% 0.74% 1.12% 1.29% 1.64%
Portfolio Turnover Rate 50% 48% 38% 42% 32%
================================================================================
<PAGE>
49
- --------------------------------------------------------------------------------
SMALL COMPANY GROWTH PORTFOLIO
YEAR ENDED SEPTEMBER 30,
------------------------ JUN. 3* TO
1999 1998 1997 Sep. 30, 1996
- --------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD $ 9.53 $11.97 $ 9.84 $10.00
- --------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .06 .06 .04 .04
Net Realized and Unrealized
Gain (Loss) on Investments 3.35 (2.46) 2.13 (.20)
-------------------------------------------
Total from Investment Operations 3.41 (2.40) 2.17 (.16)
-------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.06) (.04) (.04) --
Distributions from Realized
Capital Gains (.01) -- -- --
--------------------------------------------
Total Distributions (.07) (.04) (.04) --
- --------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $12.87 $ 9.53 $11.97 $ 9.84
================================================================================
TOTAL RETURN 35.98% -20.10% 22.16% -1.60%
================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $168 $111 $133 $44
Ratio of Total Expenses to
Average Net Assets 0.49% 0.42% 0.39% 0.45%**
Ratio of Net Investment Income to
Average Net Assets 0.58% 0.54% 0.67% 1.42%**
Portfolio Turnover Rate 85% 106% 72% 18%
================================================================================
*Inception.
**Annualized.
- --------------------------------------------------------------------------------
INTERNATIONAL PORTFOLIO
YEAR ENDED SEPTEMBER 30,
-----------------------------------------
1999 1998 1997 1996 1995
- --------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF YEAR $12.96 $14.55 $12.74 $11.40 $10.31
- --------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .23 .21 .17 .14 .16
Net Realized and Unrealized Gain
(Loss) on Investments 2.59 (1.48) 2.10 1.36 .99
-----------------------------------------
Total from Investment Operations 2.82 (1.27) 2.27 1.50 1.15
-----------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.20) (.18) (.14) (.16) (.06)
Distributions from Realized Capital
Gains -- (.14) (.32) -- --
-----------------------------------------
Total Distributions (.20) (.32) (.46) (.16) (.06)
- --------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $15.58 $12.96 $14.55 $12.74 $11.40
================================================================================
TOTAL RETURN 21.97% -8.74% 18.55% 13.36% 11.21%
================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $272 $217 $246 $162 $90
Ratio of Total Expenses to Average
Net Assets 0.46% 0.48% 0.46% 0.49% 0.54%
Ratio of Net Investment Income to
Average Net Assets 1.51% 1.48% 1.43% 1.42% 1.67%
Portfolio Turnover Rate 39% 38% 22% 19% 27%
================================================================================
<PAGE>
50
- --------------------------------------------------------------------------------
REIT INDEX PORTFOLIO
--------------------
FEB. 8* TO
SEP. 30, 1999
- --------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD $10.00
- --------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .28
Net Realized and Unrealized Gain (Loss) on Investments (.43)
--------------
Total from Investment Operations (.15)
--------------
DISTRIBUTIONS
Dividends from Net Investment Income --
Distributions from Realized Capital Gains --
--------------
Total Distributions --
- --------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $9.85
================================================================================
TOTAL RETURN -1.50%
================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $21
Ratio of Total Expenses to Average Net Assets 0.27%**
Ratio of Net Investment Income to Average Net Assets 6.26%**
Portfolio Turnover Rate 4%
================================================================================
*Initial share purchase date. All assets were held in money market instruments
until February 9, 1999, when performance measurement begins.
**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.
"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>
51
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>
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 the
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
fund's investments.
EXPENSE RATIO
The percentage of a fund'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 fund'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)
from the past year. A stock selling for $20, with earnings of $2 per share, has
a price/earnings ratio of 10.
PRINCIPAL
The amount of your own money you put into an investment.
TOTAL RETURN
A percentage change, over a specified time period, in a mutual fund's net asset
value, with the ending net asset value adjusted to account for 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>
(THIS PAGE INTENTIONALLY LEFT BLANK.)
<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 REPORT TO
SHAREHOLDERS
Additional information about the
Fund's investments is available in
the Fund's annual and semiannual
reports to shareholders. In these
reports, you will find a discussion
of the market conditions and
investment strategies that
significantly affected the Fund's
performance during the most recent
fiscal year.
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.
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 1-800-SEC-0330. Reports and
other information about the Fund are
also available on the SEC's website
(www.sec.gov), or you can receive
copies of this information, for a fee,
by writing the Public Reference
Section, Securities and Exchange
Commission, Washington, DC
20549-6009.
Fund's Investment Company Act
file number: 811-5962
(C) 2000 The Vanguard Group, Inc.
All rights reserved.
Vanguard Marketing Corporation,
Distributor.
P064N-01/21/2000
<PAGE>
PART B
VANGUARD/(R)/ VARIABLE INSURANCE FUND (THE FUND)
STATEMENT OF ADDITIONAL INFORMATION
JANUARY 21, 2000
This Statement is not a prospectus, but should be read in conjunction with the
Fund's current Prospectus (dated January 21, 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-25
COMPARATIVE INDEXES..............................................B-26
FINANCIAL STATEMENTS.............................................B-28
APPENDIX--DESCRIPTION OF SECURITIES AND RATINGS..................B-29
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,
Massachusetts 02109 (for International Portfolio); First Union National Bank,
PA4943, 530 Walnut Street, Philadelphia, Pennsylvania 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, Massachusetts 02110
(for Equity Income and Growth Portfolios); and The Bank of New York, One Wall
Street, New York, New York 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, 30 South 17th Street,
Philadelphia, Pennsylvania 19103, 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, Pennsylvania 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 Portfolio. 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. 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.
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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
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less than 100% of the value of the securities loaned, (b) the borrower add to
such collateral whenever the price of the securities loaned rises (i.e., the
borrower "marks to the market" on a daily basis), (c) the loan be made subject
to 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
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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, fixed commissions on many foreign stock
exchanges are generally higher than negotiated 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
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the particular CMO issuance. The "fastest-pay" group of bonds, as specified in
the prospectus for the issuance, 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 a 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. 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
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profits from fluctuations in the prices of underlying securities. The Portfolios
of the Fund intend to use futures contracts only for bona fide hedging purposes.
Regulations of the CFTC applicable to the Portfolios of the Fund require
that all of its futures transactions constitute bona fide hedging transactions
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
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up or down from the previous day's settlement price at the end of a trading
session. Once the daily limit has been reached in a particular type of contract,
no trades may be made on that day at a price beyond that limit. The daily limit
governs only price movement during a particular trading day and therefore does
not limit potential losses, because the limit may prevent the liquidation of
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 shares representing the lesser of: (i)
67% or more of the votes cast to approve a change, so long as shares
representing more than 50% of the Portfolios' net asset value are present or
represented by proxy; or (ii) shares representing more than 50% of the
Portfolios' net asset value.
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. 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.
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
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banker's 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 investment policies relating to commodities.
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 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 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
B-9
<PAGE>
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 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, 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.
B-10
<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.
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, 1999.
MONEY MARKET PORTFOLIO
9/30/1999
---------
Value of account at beginning of period .........$1.00000
Value of same account at end of period* .........$1.00101
========
Net change in account value .....................$0.00101
Annualized current net yield
(Net change X/ 365//\\7\\) / average net
asset value ................................... 5.26%
=====
Effective Yield
[(Net change) + 1]/365/7 /- 1 ................... 5.40%
=====
Average weighted maturity of investments ........ 63 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, 1999, is set forth below. Yields are
calculated daily for each Portfolio. Premiums and discounts on asset-backed
securities are not amortized.
Balanced Portfolio .......................... 4.32%
Diversified Value ........................... 3.00%
Equity Income Portfolio ..................... 2.89%
Equity Index Portfolio ...................... 1.53%
Growth Portfolio ............................ 0.84%
High Yield Bond Portfolio ................... 9.71%
High-Grade Bond Portfolio ................... 6.71%
International Portfolio ..................... N/A
Mid-Cap Index Portfolio ..................... 1.41%
REIT Index .................................. N/A
Short-Term Corporate Portfolio .............. 6.71%
Small Company Growth Portfolio .............. 0.99%
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
9/30/1999 9/30/1999 9/30/1999
--------- --------- ---------
Balanced Portfolio 9.44% 16.38% 13.24%*
Diversified Value Portfolio N/A N/A (6.90)%*
Equity Income Portfolio 20.45% N/A 10.36%
Equity Index Portfolio 27.84% 24.92% 18.27%*
Growth Portfolio 27.27% 26.54% 22.08%*
High Yield Bond Portfolio 7.52%* N/A 2.68%
High-Grade Bond Portfolio 7.70% 7.27%* (0.49)%
International Portfolio 10.72% 10.66%* 21.97%
Mid-Cap Index Portfolio N/A N/A 6.50%*
REIT Index Portfolio (1.50)%* N/A N/A
Short-Term Corporate
Portfolio N/A N/A 1.08%*
Small Company Growth
Portfolio 35.98% 8.36%* N/A
- ---------
* Since Inception:
Balanced Portfolio--May 23, 1991
Diversified Value Portfolio--February 9, 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--April 29,
1996
International Portfolio--June 3, 1994
Mid-Cap Index Portfolio--February 9, 1999
REIT Index Portfolio--February 9, 1999
Short-Term Corporate 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
B-13
<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 Trustees 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 103 investment companies administered by Vanguard (102 in the case of Mr.
Malkiel and 93 in the case of Mr. MacLaury). The mailing address of the Trustees
and officers of the Fund is Post Office Box 876, Valley Forge, Pennsylvania
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 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 Gestinova, Baker Fentress &
Co. (Investment Management), The Jeffrey Co. (Holding Company), 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).
JOHN C. SAWHILL, (DOB: 6/12/1936) Trustee
President and Chief Executive Officer of The Nature Conservancy (Non-Profit
Conservation Group); Director of Pacific Gas and Electric Co., Procter & Gamble
Co., NACCO Industries (Machinery/Coal/Appliances), and Newfield Exploration Co.
(Energy); formerly Director and Senior Partner of McKinsey & Co., and President
of New York University.
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 of Rohm & Haas Co. (Chemicals); Director of Cummins Engine Co.
(Diesel Engine Company), and The Mead Corp. (Paper Products); 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.
ROBERT D. SNOWDEN, (DOB: 9/4/1961) Controller*
Principal of The Vanguard Group, Inc.; Controller of each of the investment
companies in The Vanguard Group.
- ---------
*Officers of the Trust 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 distinct investment 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, 1999,
each Portfolio had contributed capital to Vanguard (included in other assets)
representing 0.02% (0.03% for the Short-Term Corporate Portfolio) of each
Portfolio's net assets. The total amount contributed by the Fund was $1,100,000,
which represented 1.11% of Vanguard's capitalization. The Amended and Restated
Funds' Service Agreement provides as follows: (a) each Vanguard fund may be
called upon to 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
the 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.
During the fiscal years ended September 30, 1997, 1998, and 1999, the
Portfolios incurred the following approximate amounts of Vanguard's management
(including transfer agency), distribution, and marketing expenses:
B-15
<PAGE>
PORTFOLIO 1997 1998 1999
--------- ---- ---- ----
Balanced Portfolio $ 824,000 $1,126,000 $1,240,000
Diversified Value Portfolio N/A N/A 42,000
Equity Income Portfolio 482,000 872,000 952,000
Equity Index Portfolio 1,189,000 1,653,000 2,111,000
Growth Portfolio 820,000 1,262,000 1,680,000
High Yield Bond Portfolio 114,000 288,000 314,000
High-Grade Bond Portfolio 364,000 555,000 663,000
International Portfolio 479,000 591,000 656,000
Mid-Cap Index Portfolio N/A N/A 32,000
Money Market Portfolio 629,000 810,000 1,082,000
REIT Index Portfolio N/A N/A 8,000
Short-Term Corporate Portfolio N/A N/A 21,000
Small Company Growth Portfolio 168,000 372,000 445,000
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" TRUSTEE. 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. All information shown is for the
fiscal year ended September 30, 1999:
B-16
<PAGE>
VANGUARD VARIABLE INSURANCE FUND COMPENSATION TABLE
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
PENSION OR TOTAL COMPENSATION
AGGREGATE RETIREMENT BENEFITS FROM ALL VANGUARD
COMPENSATION ACCRUED AS PART OF ESTIMATED ANNUAL FUNDS PAID TO
FROM THIS FUND'S BENEFITS UPON TRUSTEES
NAMES OF TRUSTEES THIS FUND EXPENSES RETIREMENT /(1)/
- ---------------------------------------------------------------------------------------------------------------------
John C. Bogle/(2)/ None None None None
John J. Brennan. None None None None
Barbara Barnes Hauptfuhrer/(2)/ $223 $28 $15,000 $0
JoAnn Heffernan Heisen $892 $49 $15,000 $80,000
Bruce K. MacLaury $922 $84 $12,000 $75,000
Burton G. Malkiel $898 $81 $15,000 $80,000
Alfred M. Rankin, Jr $892 $59 $15,000 $80,000
John C. Sawhill $892 $75 $15,000 $80,000
James O. Welch, Jr $892 $87 $15,000 $80,000
J. Lawrence Wilson $892 $63 $15,000 $80,000
</TABLE>
- ---------
/(1)/The amounts reported in this column reflect the total compensation paid to
each Trustee for their service as Trustee of 103 Vanguard funds (102 in the
case of Mr. Malkiel; 93 in the case of Mr. MacLaury).
/(2)/Mrs. Hauptfuhrer and Mr. Bogle have retired from the Fund's Board,
effective December 31, 1998 and December 31, 1999, respectively.
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
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, as provided above, shall be increased or decreased by
applying an incentive/penalty adjustment reflecting the investment performance
of the Balanced Portfolio relative to the investment performance of a "Composite
Index," 65% of which is comprised of the Standard & Poor's 500 Composite Stock
Price Index (the Stock Index) and 35% of which is comprised of the Lehman
Long-Term Corporate AA or Better Bond Index (the Bond Index).
B-17
<PAGE>
The following table sets forth the adjustment factors to the base advisory
fee payable by the Fund to Wellington Management with respect to the Balanced
Portfolio under this investment advisory agreement.
CUMULATIVE 36-MONTH
PERFORMANCE VS. THE PERFORMANCE FEE
COMPOSITE INDEX ADJUSTMENT*
--------------- -----------
Less than -6% -0.20 X Basic Fee
Between -6% and -3% -0.10 X Basic Fee
Between -3% and +3% 0 X Basic Fee
Between +3% and +6% +0.10 X Basic Fee
More than +6% +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.
For the purpose of determining the fee adjustment for investment
performance, as described above, the net assets of the Portfolio shall be
averaged over the same period as the investment performance of the Portfolio and
the investment record of the Composite Index are computed. 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.
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. Computation of these two components as the
Composite Index shall be made on the basis of 65% in the Stock Index and 35% in
the Bond Index at the beginning of each quarter.
During the fiscal years ended September 30, 1997, 1998, and 1999, the Fund
incurred investment advisory fees with respect to the Balanced Portfolio of
approximately $397,000 (before a decrease of $6,000 based on performance),
$514,000 (before a decrease of $68,000 based on performance), and $556,000
(before a decrease of $93,000 based on performance), respectively, to Wellington
Management.
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, 1997, 1998, and 1999, the Fund
incurred investment advisory fees with respect to the High Yield Bond Portfolio
of approximately $34,000, $74,000, and $90,000, 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.
B-18
<PAGE>
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.
The basic advisory fee may be increased or decreased by applying an
incentive/penalty 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. DECEMBER 29, 1998 THROUGH SEPTEMBER 30, 1999. The incentive/penalty fee
adjustment was not operable, and Barrow, Hanley was paid the Basic Fee set forth
above.
2. QUARTER ENDING DECEMBER 31, 1999 THROUGH QUARTER ENDING DECEMBER 31,
2001. The incentive penalty 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 December 31, 1998 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 December 31, 1999
to 9 percentage points and 6 percentage points, respectively, for the thirty-six
months ending December 31, 2001.
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, the Fund incurred investment advisory fees of
approximately $28,000 to Barrow, Hanley.
DESCRIPTION OF BARROW, HANLEY
Barrow, Hanley is a Nevada corporation controlled by the following officers of
Barrow, Hanley: James Purdy Barrow, Principal; Bryant Miller Hanley, Jr.,
President, Secretary, and Treasurer; Richard Albert Englander, Principal; and
Joseph Ray Nixon, Jr., 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.
B-19
<PAGE>
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, 1997, 1998, and 1999, the Fund
incurred investment advisory fees of approximately $203,000, $357,000, and
$436,000, respectively, to Newell.
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 an advisory
fee at the end of each fiscal quarter, calculated by applying a quarterly rate,
based on an annual rate of 0.15% to the Portfolio's average month-end net assets
for the quarter.
During the fiscal years ended September 30, 1997, 1998, and 1999, the Fund
incurred investment advisory fees of approximately $575,000, $859,000, and
$1,362,000, respectively, to Lincoln.
DESCRIPTION OF LINCOLN
Lincoln is an Illinois corporation in which a controlling interest is held by
the following persons: Timothy H. Ubben, Chairman; J. Parker Hall III, Chief
Executive Officer; Kenneth R. Meyer, President; David M. Fowler, Executive Vice
President; Richard W. Knee, Executive Vice President; and Jay H. Freedman,
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.
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:
THREE YEAR PERFORMANCE ANNUAL INCENTIVE (+)/
DIFFERENTIAL VS. EAFE PENALTY (-) 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%
B-20
<PAGE>
The incentive/penalty fee adjustment was not fully operable until the
quarter ended June 30, 1997, and, until that date, was calculated according to
certain transition rules. For quarters ended after March 31, 1995 and prior to
June 30, 1997, the incentive/penalty fee adjustment was computed based on a
comparison of the investment performance of the Portfolio and that of the EAFE
Index over the number of months that have elapsed between July 1, 1994 and the
end of the quarter for which the fee is computed. Since June 30, 1997, the
number of months used to calculate the incentive/penalty fee adjustments has
been 36.
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, 1997, 1998, and 1999, the Fund
incurred investment advisory fees of approximately $315,000 (including an
increase of $60,000 based on performance), $351,000 (including an increase of
$62,000 based on performance), and $332,000 (including an increase of $13,000
based on performance), respectively, to Schroder.
DESCRIPTION OF SCHRODER
Schroder is the London branch office of Schroder Investment Management North
America Inc. Schroder is a wholly-owned subsidiary of Schroder US Holdings Inc.
which is a wholly-owned subsidiary of Schroders PLC. Schroders PLC specializes
in providing investment management services, with funds under management
currently in excess of $190 billion. Schroder's London branch was established in
1979 to manage international portfolios for U.S. institutions.
THE SMALL COMPANY GROWTH PORTFOLIO INVESTMENT ADVISORY AGREEMENT
The Fund entered into an investment advisory agreement with Granahan Investment
Management, Inc. (Granahan) under which Granahan manages the investment and
reinvestment of the Small Company Growth 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.
B-21
<PAGE>
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 Portfolio for the quarter.
The basic advisory fee may be increased or decreased by applying an
incentive/penalty adjustment to the basic fee reflecting the investment
performance of the Portfolio relative to the investment record of the Small
Company Growth Fund Stock Index (the Index) over the same 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.
Until the quarter ending December 31, 2000, the performance adjustment for
Granahan will be calculated according to the following transition rules:
1. QUARTER ENDED MARCH 31, 1998. Granahan's performance fee adjustment was
determined by linking the investment performance of the Russell 2000 for the
eleven quarters ended December 31, 1997 with that of the Index for the quarter
ended March 31, 1998.
2. QUARTER ENDED JUNE 30, 1998. Granahan's performance fee adjustment was
determined by linking the investment performance of the Russell 2000 for the ten
quarters ended December 31, 1997 with that of the Index for the two quarters
ended June 30, 1998.
3. QUARTER ENDED SEPTEMBER 30, 1998. Granahan's performance fee adjustment
was determined by linking the investment performance of the Russell 2000 for the
nine quarters ended December 31, 1997 with that of the Index for the three
quarters ended September 30, 1998.
4. QUARTER ENDED DECEMBER 31, 1998. Granahan's performance fee adjustment
was determined by linking the investment performance of the Russell 2000 for the
eight quarters ended December 31, 1997 with that of the Index for the four
quarters ended December 31, 1998.
5. QUARTER ENDED MARCH 31, 1999. Granahan's performance fee adjustment was
determined by linking the investment performance of the Russell 2000 for the
seven quarters ended December 31, 1997 with that of the Index for the five
quarters ended March 31, 1999.
6. QUARTER ENDED JUNE 30, 1999. Granahan's performance fee adjustment was
determined by linking the investment performance of the Russell 2000 for the six
quarters ended December 31, 1997 with that of the Index for the six quarters
ended June 30, 1999.
7. QUARTER ENDED SEPTEMBER 30, 1999. Granahan's performance fee adjustment
was determined by linking the investment performance of the Russell 2000 for the
five quarters ended December 31, 1997 with that of the Index for the seven
quarters ended September 30, 1999.
8. QUARTER ENDING DECEMBER 31, 1999. Granahan's performance fee adjustment
shall be determined by linking the investment performance of the Russell 2000
for the four quarters ended December 31, 1997 with that of the Index for the
eight quarters ending December 31, 1999.
9. QUARTER ENDING MARCH 31, 2000. Granahan's performance fee adjustment
shall be determined by linking the investment performance of the Russell 2000
for the three quarters ended December 31, 1997 with that of the Index for the
nine quarters ending March 31, 2000.
10. QUARTER ENDING JUNE 30, 2000. Granahan's performance fee adjustment
shall be determined by linking the investment performance of the Russell 2000
for the two quarters ended December 31, 1997 with that of the Index for the ten
quarters ending June 30, 2000.
B-22
<PAGE>
11. QUARTER ENDING SEPTEMBER 30, 2000. Granahan's performance fee
adjustment shall be determined by linking the investment performance of the
Russell 2000 for the quarter ended December 31, 1997 with that of the Index for
the eleven quarters ending September 30, 2000.
12. QUARTER ENDING DECEMBER 31, 2000. The performance adjustment rate shall
be fully operable.
During the fiscal years ended September 30, 1997, 1998, and 1999, the
Fund incurred investment advisory fees of approximately $107,000 (before a
decrease of $22,000 based on performance), $196,000 (before a decrease of
$55,000 based on performance), and $229,000 (after an increase of $9,000 based
on performance), respectively, to Granahan.
DESCRIPTION OF GRANAHAN
Granahan is a professional investment advisory firm founded in 1985. As of
September 30, 1999, Granahan held discretionary management authority with
respect to approximately $1.3 billion in assets. John J. Granahan is portfolio
manager of the assets of the Small Company Growth Portfolio, and Gary C. Hatton
and Jane M. White are assistant portfolio managers.
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 Core Management 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.
During the fiscal years ended September 30, 1997, 1998, and 1999, the
Portfolios managed by Vanguard incurred expenses for investment advisory
services in the following amounts:
PORTFOLIO 1997 1998 1999
--------- ---- ---- ----
Equity Index Portfolio $12,000 $22,000 $93,000
High-Grade Bond Portfolio 24,000 30,000 42,000
Mid-Cap Index Portfolio N/A N/A 7,000
Money Market Portfolio 53,000 58,000 74,000
REIT Index Portfolio N/A N/A 7,000
Short-Term Corporate Portfolio N/A N/A 1,000
B-23
<PAGE>
DURATION AND TERMINATION OF INVESTMENT ADVISORY AGREEMENTS
The Fund's current agreements with Wellington Management, Barrow, Hanley,
Newell, Lincoln, Schroder, Granahan, and Vanguard are renewable for successive
one year periods, only if each renewal is specifically approved by a vote of the
Fund's Board of Trustees, including the affirmative votes of a majority of the
Trustees who are not parties to the contract 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. An agreement is automatically terminated
if assigned, and may be terminated without penalty at any time (1) either by
vote of the Board of Trustees of the Fund on 60 days' written notice to the
adviser, or (2) by the adviser upon 90 days' written notice to the Fund.
PORTFOLIO TRANSACTIONS
The investment advisory agreements authorize Wellington Management, Lincoln,
Newell, Granahan, Schroder, Barrow, Hanley, Vanguard's Core Management 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 the 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
commissions if they believe this to be in the best interest of the Portfolios.
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.
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.
B-24
<PAGE>
During the fiscal years ended September 30, 1997, 1998, and 1999, the
Portfolios paid brokerage commissions in the following amounts:
PORTFOLIO 1997 1998 1999
--------- ---- ---- ----
Balanced Portfolio $116,000 $165,000 $155,000
Diversified Value Portfolio N/A N/A 54,000
Equity Income Portfolio 112,000 135,000 105,000
Equity Index Portfolio 40,000 42,000 65,000
Growth Portfolio 266,000 437,000 736,000
High Yield Bond Portfolio 0 0 0
High-Grade Bond Portfolio 0 0 0
International Portfolio 322,000 341,000 417,000
Mid-Cap Index Portfolio N/A N/A 17,000
Money Market Portfolio 0 0 0
REIT Index Portfolio N/A N/A 12,000
Short-Term Corporate Portfolio N/A N/A 0
Small Company Growth Portfolio 126,000 215,000 219,000
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.
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.
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 EQUITY 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 EQUITY 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.
B-25
<PAGE>
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.
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 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 CORPORATE 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.
LEHMAN BROTHERS LONG-TERM CORPORATE BOND INDEX--is a subset of the Lehman
Corporate 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).
LEHMAN LONG-TERM CORPORATE AA OR BETTER BOND INDEX--consists of all publicly
issued, fixed rate, nonconvertible investment grade, dollar-denominated,
SEC-registered corporate debt rated AA or AAA.
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.
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LIPPER SMALL COMPANY GROWTH FUND AVERAGE--the average performance of small
company growth funds as defined by Lipper Inc. Lipper defines a small company
growth fund as a fund that by prospectus or portfolio practice, limits its
investments to companies on the basis of the size of the company. From time to
time, Vanguard may advertise using the average performance and/or the average
expense ratio of the small company growth funds. (This fund category was first
established in 1982. For years prior to 1982, the results of the Lipper Small
Company Growth category were estimated using the returns of the Funds that
constituted the Group at its inception.)
LIPPER 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, 1999, appearing in the Vanguard Variable Insurance Fund
Annual Report 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 Report to
Shareholders, which may be obtained without charge.
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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.
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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.
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SAI064-01/21/2000
