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PROSPECTUS May 1, 1997
THE ENDEAVOR ML VARIABLE ANNUITY
Issued Through
PFL ENDEAVOR VARIABLE ANNUITY ACCOUNT
by
PFL LIFE INSURANCE COMPANY
The Endeavor ML Variable Annuity Policy is a Flexible Premium Variable
Annuity that is offered by PFL Life Insurance Company ("PFL"). You can use the
Policy to accumulate funds for retirement or other long-term financial
planning purposes. You are generally not taxed on any earnings on amounts you
invest until you withdraw them or begin to receive annuity payments. The
Policy is a "variable" annuity because the value of your investments can go up
or down based on the performance of mutual fund portfolios that you select. It
is a flexible premium policy because after you purchase it you can generally
make additional investments of any amount of $50 or more, until the Annuity
Commencement Date when PFL begins making annuity payments to you.
You have fifteen investment options to choose from. They include these
fourteen mutual fund portfolios:
MERRILL LYNCH VARIABLE SERIES FUNDS, ENDEAVOR SERIES TRUST:
INC.: TCW Managed Asset Allocation Portfolio
Basic Value Focus Fund TCW Money Market Portfolio
High Current Income Fund T. Rowe Price International Stock
Developing Capital Markets Focus Fund Portfolio
T. Rowe Price Equity Income Portfolio
WRL SERIES FUND, INC.: T. Rowe Price Growth Stock Portfolio
WRL Growth Portfolio, Dreyfus Small Cap Value Portfolio
managed by Janus Capital Corporation Dreyfus U.S. Government Securities
Portfolio
Value Equity Portfolio
Opportunity Value Portfolio
Enhanced Index Portfolio
YOU AS THE OWNER OF THE POLICY, BEAR THE ENTIRE INVESTMENT RISK FOR ALL
AMOUNTS THAT YOU ALLOCATE TO ANY OF THE MUTUAL FUNDS. THIS MEANS THAT YOU
COULD LOSE THE AMOUNT THAT YOU INVEST. But if the mutual fund shares increase
in value, then the value of your Policy will also increase.
The fifteenth investment option is the Fixed Account. If you invest in one
of the alternatives offered in the Fixed Account, then PFL guarantees to
return your investment with interest at rates that PFL will declare from time
to time.
Of course, you can choose any combination of these investment options. You
can also transfer amounts among these options (subject to some restrictions).
LIKE ALL SECURITIES, THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED
BY THE SECURITIES AND EXCHANGE COMMISSION, NOR HAS THE SECURITIES AND EXCHANGE
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
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You should only purchase a Policy as a long-term investment. However, you do
have access to all or some of the current cash value of your investments at
any time before the Annuity Commencement Date. But, if you do withdraw cash
from your Policy, there may be a surrender charge. You may also have to pay
income taxes on some or all of the amount you withdraw, and if you are under
the age 59 1/2 there may also be a tax penalty. Finally, there may be an
interest penalty if you make a premature withdrawal from the Fixed Account
(this is called an "Excess Interest Adjustment," and it could also result in
you earning extra interest). PFL has the right to postpone withdrawals from
the Fixed Account.
Prospectuses for the mutual fund portfolios are attached to the back of this
prospectus. This prospectus and the mutual fund prospectuses give you vital
information about the Policies and the mutual funds. Please read them
carefully before you invest. Keep them for future reference.
PLEASE NOTE THAT THE POLICIES AND THE MUTUAL FUNDS: ARE NOT BANK DEPOSITS,
ARE NOT FEDERALLY INSURED, ARE NOT ENDORSED BY ANY BANK OR GOVERNMENT AGENCY
AND ARE NOT GUARANTEED TO ACHIEVE THEIR GOAL.
This Prospectus sets forth the information that a prospective purchaser
should consider before purchasing a Policy. A Statement of Additional
Information about the Policy and the Mutual Fund Account which has the same
date as this Prospectus has been filed with the Securities and Exchange
Commission and is incorporated herein by reference. The Statement of
Additional Information is available at no cost to any person requesting a copy
by writing PFL at the Administrative and Service Office or by calling 1-800-
525-6205. The table of contents of the Statement of Additional Information is
included at the end of this Prospectus.
This Prospectus and the Statement of Additional Information generally
describe only the Policies and the Mutual Fund Account, except when the Fixed
Account is specifically mentioned.
Administrative and Service Office:
Financial Markets Division--Variable Annuity Department
PFL Life Insurance Company
4333 Edgewood Road, N.E.
Cedar Rapids, Iowa 52499-0001
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TABLE OF CONTENTS
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DEFINITIONS................................................................ 5
SUMMARY.................................................................... 9
CONDENSED FINANCIAL INFORMATION............................................ 24
FINANCIAL STATEMENTS....................................................... 26
HISTORICAL PERFORMANCE DATA................................................ 26
Standardized Performance Data............................................ 26
TCW Money Market Subaccount.............................................. 27
Other Subaccounts........................................................ 27
Merrill Lynch Variable Series Funds, Inc.--Hypothetical Data............. 30
WRL Growth Subaccount--Hypothetical Data................................. 31
Opportunity Value and Equity Index Portfolios............................ 31
Non-Standardized Performance Data........................................ 32
PUBLISHED RATINGS.......................................................... 34
PFL LIFE INSURANCE COMPANY................................................. 34
THE ENDEAVOR ACCOUNTS...................................................... 35
The Mutual Fund Account.................................................. 35
The Fixed Account........................................................ 40
Guaranteed Periods..................................................... 40
Dollar Cost Averaging Fixed Account Option............................. 41
Guaranteed Interest Rates.............................................. 41
Transfers................................................................ 42
Reinstatements........................................................... 43
Telephone Transactions................................................... 44
Dollar Cost Averaging (DCA).............................................. 44
Asset Rebalancing........................................................ 45
THE POLICY................................................................. 46
Policy Application and Issuance of Policies--Premium Payments............ 46
Additional Premium Payments............................................ 46
Maximum Total Premium Payments......................................... 47
Allocation of Premium Payments......................................... 47
Payment Not Honored by Bank............................................ 47
Policy Value............................................................. 47
The Mutual Fund Account Value.......................................... 48
Amendments............................................................... 48
Non-participating Policy................................................. 48
DISTRIBUTIONS UNDER THE POLICY............................................. 48
Surrenders............................................................... 48
Nursing Care and Terminal Condition Withdrawal Option.................... 50
Excess Interest Adjustment (EIA)......................................... 50
Systematic Payout Option................................................. 51
Annuity Payments......................................................... 51
Annuity Commencement Date.............................................. 51
Election of Payment Option............................................. 52
Premium Tax............................................................ 53
Supplementary Policy................................................... 53
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Annuity Payment Options.................................................. 53
Death Benefit............................................................ 56
Death of Annuitant Prior to Annuity Commencement Date.................. 56
Death On or After Annuity Commencement Date............................ 58
Beneficiary............................................................ 58
Death of Owner........................................................... 59
Restrictions Under the Texas Optional Retirement Program................. 59
Restrictions Under Section 403(b) Plans.................................. 59
Restrictions Under Qualified Policies.................................... 59
CHARGES AND DEDUCTIONS..................................................... 59
Surrender Charge......................................................... 60
Mortality and Expense Risk Fee........................................... 60
Administrative Charges................................................... 61
Distribution Financing Charge............................................ 62
Premium Taxes............................................................ 62
Federal, State and Local Taxes........................................... 62
Transfer Charge.......................................................... 62
Other Expenses Including Investment Advisory Fees........................ 62
Employee and Agent Purchases............................................. 63
CERTAIN FEDERAL INCOME TAX CONSEQUENCES.................................... 63
Tax Status of the Policy................................................. 64
Taxation of Annuities.................................................... 64
DISTRIBUTOR OF THE POLICIES................................................ 70
VOTING RIGHTS.............................................................. 70
LEGAL PROCEEDINGS.......................................................... 71
STATEMENT OF ADDITIONAL INFORMATION........................................ 71
Appendix A............................................................... A-1
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DEFINITIONS
Accumulation Unit--An accounting unit of measure used in calculating the
Policy Value in the Mutual Fund Account before the Annuity Commencement Date.
Adjusted Policy Value--An amount equal to the Policy Value increased or
decreased by any Excess Interest Adjustment applied at the time of surrender
or on the Annuity Commencement Date.
Administrative and Service Office--Financial Markets Division--Variable
Annuity Department, PFL Life Insurance Company, 4333 Edgewood Road, N.E.,
Cedar Rapids, Iowa 52499-0001.
Annuitant--The person entitled to receive Annuity Payments after the Annuity
Commencement Date and during whose life any Annuity Payments involving life
contingencies will continue.
Annuity Commencement Date--The date upon which Annuity Payments are to
commence. This date may not be later than the last day of the policy month
starting after the Annuitant attains age 85, except as expressly allowed by
PFL, but in no event later than the last day of the month following the month
in which the Annuitant attains age 95.
Annuity Payment Option or Payment Option--A method of receiving a stream of
Annuity Payments selected by the Owner.
Annuity Unit--An accounting unit of measure used in the calculation of the
amount of the second and each subsequent Variable Annuity Payment after the
Annuity Commencement Date.
Beneficiary--The person who has the right to the death benefit set forth in
the Policy.
Business Day--Any day when the New York Stock Exchange is open for business.
Cash Value--The Policy Value increased or decreased by any Excess Interest
Adjustment, less the Surrender Charge, if any.
Code--The Internal Revenue Code of 1986, as amended.
Current Interest Rate--The interest rate or rates currently guaranteed to be
credited on amounts under a Policy allocated to the Fixed Account. This
interest rate will always equal or exceed a minimum of 3%.
Due Proof of Death--A certified copy of a death certificate, a certified
copy of a decree of a court of competent jurisdiction as to the finding of
death, a written statement by the attending physician, or any other proof
satisfactory to PFL will constitute Due Proof of Death.
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Distribution Financing Charge--a daily charge for the first seven Policy
Years equal to an effective annual rate of 0.15% of the Mutual Fund Account's
net assets.
Excess Interest Adjustment--A positive or negative adjustment to amounts
withdrawn upon partial withdrawal or surrenders, to amounts transferred by the
Owner from the Fixed Account Guaranteed Period Options, or to amounts applied
to Annuity Payment Options. The adjustment reflects changes in the interest
rates declared by PFL since the date any payment was received by or an amount
was transferred to the Guaranteed Period Option. The Excess Interest
Adjustment (EIA) can either decrease or increase the amount to be received by
the Owner upon surrender or commencement of Annuity Payments, depending upon
whether there has been an increase or decrease in interest rates,
respectively.
Fixed Account--A group of Investment Options under the Policy, other than
the Mutual Fund Account, that are part of the general assets of PFL that are
not in separate accounts.
Fixed Annuity Payments--Payments made pursuant to an Annuity Payment Option
which do not fluctuate in amount.
Guaranteed Period Options--The various guaranteed interest rate periods
which may be offered by PFL under the Fixed Account into which premiums may be
paid or amounts transferred.
Investment Options--Any of the Guaranteed Period Options of the Fixed
Account, the Dollar Cost Averaging Fixed Account Option, and any of the
Subaccounts of the Mutual Fund Account.
Mutual Fund Account--The PFL Endeavor Variable Annuity Account, which
comprises a portion of the PFL Endeavor VA Separate Account, a separate
account established and registered as a unit investment trust under the
Investment Company Act of 1940 to which Premium Payments under the Policies
may be allocated and which invests in the Growth Portfolio of the WRL Series
Fund, Inc., the portfolios of the Endeavor Series Trust, certain portfolios of
the Merrill Lynch Variable Series Funds, Inc. and such other mutual funds as
PFL may determine from time-to-time.
Nonqualified Policy--A Policy other than a Qualified Policy.
PFL--PFL Life Insurance Company, the issuer of the Policies.
Policy--One of the variable annuity policies offered by this Prospectus.
Policy Anniversary--Each anniversary of the Policy Date.
Policy Date--The date shown on the Policy data page attached to the Policy
and the date on which the Policy becomes effective.
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Policy Owner or Owner--The person who may exercise all rights and privileges
under the Policy. The Policy Owner during the lifetime of the Annuitant and
prior to the Annuity Commencement Date is the person designated as the Policy
Owner or a Successor Owner in the application.
Policy Value--On or before the Annuity Commencement Date, this is an amount
equal to (a) the Premium Payments; minus (b) partial withdrawals taken
(including any applicable Excess Interest Adjustments and Surrender Charges on
such partial withdrawals); plus (c) interest credited in the Fixed Account;
plus or minus (d) accumulated gains or losses in the Mutual Fund Account;
minus (e) any applicable service charges, premium taxes, and transfer fees, if
any.
Policy Year--Each 12-month period beginning on the Policy Date shown on the
Policy Data page and each Policy Anniversary thereafter.
Premium Payment--An amount paid to PFL by the Policy Owner or on the Policy
Owner's behalf as consideration for the benefits provided by the Policy.
Qualified Policy--A Policy issued in connection with retirement plans that
qualify for special Federal income tax treatment under the Code.
Service Charge--An annual charge on each Policy Anniversary (and a charge at
the time of surrender during any Policy Year) for Policy maintenance and
related administrative expenses. This annual charge is the lesser of 2% of the
Policy Value or $35.
Subaccount--A subdivision within the Mutual Fund Account, the assets of
which are invested in a specified Portfolio of the Underlying Funds.
Successor Policy Owner--A person appointed by the Policy Owner to succeed to
ownership of the Policy in the event of the death of the Policy Owner (if the
Policy Owner is not the Annuitant) before the Annuity Commencement Date.
Surrender Charge--A percentage of each Premium Payment in an amount from 7%
to 0% depending upon the length of time from the date of each Premium Payment.
The Surrender Charge is assessed on surrenders of, or partial withdrawals
from, the Policy. A Surrender Charge may also be referred to as a "Contingent
Deferred Sales Charge."
Underlying Funds--The Growth Portfolio of the WRL Series Fund, Inc., the
portfolios of the Endeavor Series Trust, and certain portfolios of the Merrill
Lynch Variable Insurance Series Funds, Inc.
Valuation Period--The period of time from one determination of Accumulation
Unit and Annuity Unit values to the next subsequent determination of values.
Such determination is made on each Business Day.
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Variable Annuity Payments--Payments made pursuant to an Annuity Payment
Option which fluctuate as to dollar amount or payment term in relation to the
investment performance of the specified Subaccounts within the Mutual Fund
Account.
Written Notice or Written Request--Written notice, signed by the Policy
Owner, that gives PFL the information it requires and is received at the
Administrative and Service Office. For some transactions, PFL may accept an
electronic notice such as telephone instructions. Such electronic notice must
meet the requirements PFL establishes for such notices.
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THE ENDEAVOR ML VARIABLE ANNUITY
SUMMARY
The following summary is intended to provide a brief overview of the Policy.
More detailed information can be found in the sections of this Prospectus that
follow, all of which should be read in their entirety.
THE POLICY
The Endeavor ML Variable Annuity is a Flexible Premium Variable Annuity
which can be purchased as a Nonqualified Policy or as a Qualified Policy. The
Owner allocates the Premium Payments among the two Endeavor Accounts of PFL:
the PFL Endeavor Variable Annuity Account, (the "Mutual Fund Account") and the
Fixed Account. Certain features described in this Prospectus may only be
available to Policies purchased after the effective date of the Policy form
used. (See "Variations in Policy Provisions," p. 22.)
THE ACCOUNTS
The Mutual Fund Account. The Mutual Fund Account is a separate account of
PFL, which invests exclusively in shares of certain portfolios of the Merrill
Lynch Variable Series Funds, Inc., the ten portfolios of the Endeavor Series
Trust, and the Growth Portfolio of the WRL Series Fund, Inc., (collectively,
the "Underlying Funds"). The Merrill Lynch Variable Series Funds, Inc. is an
investment company, whose investment adviser is Merrill Lynch Asset
Management, L.P. ("MLAM"), an indirect wholly owned subsidiary of Merrill
Lynch & Co., Inc. A separate prospectus accompanies this Prospectus for the
portfolios advised by MLAM, which describe further information about MLAM and
the Merrill Lynch Variable Series Funds, Inc. The Endeavor Series Trust is a
mutual fund managed by Endeavor Investment Advisers, a general partnership
between Endeavor Management Co. and AUSA Financial Markets, Inc. (an affiliate
of PFL), which contracts with several subadvisers (as described in separate
prospectuses that accompany this Prospectus) for investment advisory services.
The WRL Growth Portfolio is a portfolio within the WRL Series Fund, Inc. The
WRL Series Fund, Inc. is a mutual fund whose investment adviser is WRL
Investment Management, Inc., a subsidiary of Western Reserve Life Assurance
Co. of Ohio ("Western Reserve"), (an affiliate of PFL). WRL Investment
Management, Inc. contracts with Janus Capital Corporation as a sub-adviser to
the WRL Growth Portfolio for investment advisory services, as described in a
separate portfolio prospectus that accompanies this Prospectus.
The Underlying Funds currently comprise fourteen separate Portfolios: three
funds of the Merrill Lynch Variable Series Funds, Inc.: the Merrill Lynch
Basic Value Focus Fund, the Merrill Lynch Developing Capital Markets Fund, and
the Merrill Lynch High Current Income Fund; the ten portfolios under the
Endeavor Series Trust: the TCW Managed Asset Allocation Portfolio; the TCW
Money Market Portfolio; the T. Rowe Price
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International Stock Portfolio; the Value Equity Portfolio; the Dreyfus Small
Cap Value Portfolio; the Dreyfus U.S. Government Securities Portfolio; the T.
Rowe Price Equity Income Portfolio; the T. Rowe Price Growth Stock Portfolio;
the Opportunity Value Portfolio; and the Enhanced Index Portfolio; and one
portfolio under the WRL Series Fund, Inc., the WRL Growth Portfolio, managed
by Janus Capital Corporation. Each of the fourteen Subaccounts of the Mutual
Fund Account invests solely in a corresponding Portfolio of the Underlying
Funds. Because the Policy Value may depend on the investment experience of the
selected Subaccounts, the Owner bears the entire investment risk with respect
to Premium Payments allocated to, and amounts transferred to, the Mutual Fund
Account. (See "THE ENDEAVOR ACCOUNTS--The Mutual Fund Account," p. 35.)
The Fixed Account. The Fixed Account guarantees an annual effective interest
rate of at least 3% on: Premium Payments and transfers to, less partial
withdrawals and transfers from, the Fixed Account (see Appendix "B" for
variations in the minimum guaranteed effective annual interest rate for prior
versions of Policies and for Policies offered in certain states). PFL may, in
its sole discretion, declare a higher Current Interest Rate. A Current
Interest Rate is guaranteed for at least one year. Upon surrender, PFL
guarantees return of at least the Premium Payments made to, less prior Partial
Withdrawals and transfers from, the Fixed Account. (See "THE ENDEAVOR
ACCOUNTS--The Fixed Account," p. 40.)
PREMIUM PAYMENTS
A Nonqualified Policy may be purchased with an initial Premium Payment of at
least $5,000, and a Qualified Policy generally may be purchased with an
initial Premium Payment of at least $1,000. A Policy purchased and used in
connection with a Tax Deferred 403(b) Annuity may be purchased with an initial
premium payment in any amount chosen by the purchaser, however, PFL must
receive the initial Premium Payment within 90 days following the Policy Date,
otherwise the Policy will be canceled. An Owner may make subsequent additional
Premium Payments of at least $50 each at any time before the Annuity
Commencement Date. The maximum total Premium Payments allowed without prior
approval of PFL is $1,000,000. At the time of each Premium Payment no charges
or fees are deducted, so the entire Premium Payment is invested immediately.
(See "CHARGES AND DEDUCTIONS--Surrender Charge," p. 60 and "CHARGES AND
DEDUCTIONS--Premium Taxes," p. 62.)
The Owner must allocate the initial Premium Payment among the Investment
Options (that is, among the options available under the Fixed Account or the
Subaccounts of the Mutual Fund Account or a combination of those options)
according to allocation percentages in the Policy application or transmittal
form. Any allocation must be in whole percents, and the total allocation must
equal 100%. Allocations specified by the Owner for the Initial Premium Payment
will be used for Subsequent Additional Premium Payments unless the Owner
requests a change in allocation. Allocations of additional Premium Payments
may be changed by sending
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Written Notice to PFL's Administrative and Service Office. (See "THE POLICY--
Policy Application and Issuance of Policies--Premium Payments," p. 46.)
RIGHT TO CANCEL PERIOD
The Owner may, until the end of the period of time specified in the Policy
(the Right to Cancel period), examine the Policy and return it for a refund.
The applicable period will depend on the state in which the Policy is issued.
In most states the period is ten (10) days after the Policy is delivered to
the Owner. Several states allow for a longer period to return the Policy. The
amount of the refund will also depend on the state in which the Policy is
issued. Ordinarily the amount of the refund will be the Policy Value. However,
some states may require a return of the Premium Payments, or the greater of
the Premium Payments or the Policy Value. PFL will pay the refund within seven
(7) days after it receives written notice of cancellation and the returned
Policy. The Policy will then be deemed void.
TRANSFERS BEFORE THE ANNUITY COMMENCEMENT DATE
An Owner may transfer Policy Values from one Subaccount to another within
the Mutual Fund Account or to the Fixed Account, or may transfer Policy Values
or an amount equal to the interest credited from the Guaranteed Period Options
of the Fixed Account to the Mutual Fund Account. Transfers of amounts equal to
interest credited to a Guaranteed Period Option are referred to as "interest
transfers." Except for interest transfers, before the end of the Guaranteed
Period, any Policy Values transferred out of the Fixed Account are subject to
an Excess Interest Adjustment. The minimum amount which may be transferred is
$500, or the entire Subaccount (or Guaranteed Period Option) Policy Value,
whichever is less. However, following a transfer out of a particular
Subaccount or Guaranteed Period Option, at least $500 must remain in that
Subaccount or Guaranteed Period Option, otherwise PFL reserves the right to
include remaining amounts in the transfer. Transfers currently may be made
either by telephone (subject to the provisions described below under
"Telephone Transactions," p. 44) or by sending Written Notice to the
Administrative and Service Office. Due to the manner of crediting interest in
the Fixed Account, however, interest transfers may affect the rate of interest
credited on funds remaining in the Fixed Account. (See "THE ENDEAVOR
ACCOUNTS--Transfers," p. 42.)
An Owner may choose which Guaranteed Period Option to or from transfers may
be made. Transfers of Policy Value from a Guaranteed Period Option prior to
the end of a Guaranteed Period are subject to an Excess Interest Adjustment
which may increase or decrease the amount removed from the Guaranteed Period
Option in order to honor the transfer amount requested. "Interest transfers"
are not subject to an Excess Interest Adjustment. (See "DISTRIBUTIONS UNDER
THE POLICY--Excess Interest Adjustment (EIA)," p. 50 and "THE ENDEAVOR
ACCOUNTS--Transfers," p. 42.)
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Transfers from the Dollar Cost Averaging Fixed Account Option, except
through automatic Dollar Cost Averaging transfers, are not allowed. (see "THE
ENDEAVOR ACCOUNTS--Dollar Cost Averaging Fixed Account Option," p. 41.)
Policies issued in certain states may have additional restrictions on
transfers. See the Policy or endorsement for details.
A $10 charge may be imposed for each transfer in excess of 12 transfers per
Policy Year. Currently PFL does not charge for any transfers. (See "THE
ENDEAVOR ACCOUNTS--Transfers," p. 42.)
SURRENDERS AND PARTIAL WITHDRAWALS
The Owner may elect to surrender the Policy or make a partial withdrawal
from the Policy ($500 minimum) in exchange for a cash payment from PFL at any
time prior to the earlier of the Annuitant's death or the Annuity Commencement
Date. A surrender or partial withdrawal may be subject to deductions for
Surrender Charges, Excess Interest Adjustments, and Service Charges. (See
"CHARGES AND DEDUCTIONS," p. 59.) A surrender or partial withdrawal request
must be made by Written Request, and a request for a partial withdrawal must
specify the Subaccounts or Guaranteed Period Options from which the withdrawal
is requested. There is currently no limit on the frequency or timing of
partial withdrawals. (See "DISTRIBUTIONS UNDER THE POLICY--Surrenders," p.
48). For Qualified Policies the retirement plan or applicable law may restrict
or penalize partial withdrawals. In addition to the applicable charges and
deductions under the Policy, surrenders and partial withdrawals may be subject
to premium taxes, income taxes and a 10% Federal penalty tax.
NURSING CARE AND TERMINAL CONDITION WITHDRAWAL OPTION
If the Owner or Owner's spouse (or Annuitant or Annuitant's spouse if the
Owner is not a natural person): (1) has been confined in a hospital or nursing
facility for 30 consecutive days or (2) has been diagnosed as having a
terminal condition, as defined in the Policy or endorsement (generally a life
expectancy of not more than 12 months), then partial withdrawals or surrenders
may be taken with no Surrender Charge and no Excess Interest Adjustment. (This
benefit may not be available in all states or for all policy forms. See the
Policy or endorsement for details.) (See "DISTRIBUTIONS UNDER THE POLICY--
Nursing Care and Terminal Condition Withdrawal Option," p. 50.)
CHARGES AND DEDUCTIONS
Surrender Charge. In order to permit investment of the entire Premium
Payment, PFL does not deduct sales or other charges at the time the Policy is
purchased. However, a Surrender Charge of up to 7% of the amount withdrawn is
imposed on certain surrenders or partial withdrawals of Premium Payments in
order to cover expenses relating to the sale of the Policies. The applicable
Surrender Charge is based on the period of time elapsed since payment of the
Premium Payment(s) being withdrawn. There
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is no Surrender Charge imposed seven or more years after a Premium Payment was
paid. For purposes of determining the applicable Surrender Charge, Premium
Payments are considered to be withdrawn on a "first in-, first-out" basis.
(See "CHARGES AND DEDUCTIONS--Surrender Charge," p. 60.) Note that for income
tax purposes, however, gains are deemed to be withdrawn first. (See "CERTAIN
FEDERAL INCOME TAX CONSEQUENCES," p. 63.) After the first Policy Year, up to
10% of the Policy Value may be withdrawn once per Policy Year without an
Excess Interest Adjustment and without a Surrender Charge if it is the first
withdrawal in that Policy Year.
Excess Interest Adjustment. Surrenders, partial withdrawals and transfers
(other than "10% Withdrawals" and "interest transfers") out of Fixed Account
Guaranteed Period Options, which occur prior to the end of the Guaranteed
Period, may be subject to an Excess Interest Adjustment, which could eliminate
all credited interest in excess of the minimum guaranteed effective annual
interest rate of 3%. The Excess Interest Adjustment, if a positive adjustment,
could also result in the crediting of additional interest. (See "DISTRIBUTIONS
UNDER THE POLICY--Excess Interest Adjustment (EIA)," p. 50.)
Account Charges. PFL deducts a daily charge equal to a percentage of the net
assets in the Mutual Fund Account for the mortality and expense risks assumed
by PFL. For Guaranteed Minimum Death Benefit Options "A" (5% Annually
Compounding Death Benefit) and "B" (Annual Step-Up Death Benefit), the
effective annual rate of this charge is 1.25% of the value of the Mutual Fund
Account's net assets. For Guaranteed Minimum Death Benefit Option "C" (Return
of Premium Death Benefit), the effective annual rate of this charge is 1.10%
of the value of the Mutual Fund Account's net assets. (See "CHARGES AND
DEDUCTIONS--Mortality and Expense Risk Fee," p. 60, and "DISTRIBUTIONS UNDER
THE POLICY--Death Benefit," p. 56.)
PFL also deducts a daily Administrative Charge from the net assets of the
Mutual Fund Account to partially cover expenses incurred by PFL in connection
with the administration of the Mutual Fund Account and the Policies. The
effective annual rate of this charge is .15% of the value of the Mutual Fund
Account's net assets. (See "CHARGES AND DEDUCTIONS--Administrative Charges,"
p. 61.)
PFL guarantees that the account charges for mortality and expense risks and
administrative expenses will not exceed a total of 1.40% for the 5% Annually
Compounding Death Benefit or the Annual Step Up Death Benefit, and 1.25% for
the Return of Premium Death Benefit.
Service Charge. Prior to the Annuity Commencement Date, there is an annual
Service Charge on each Policy Anniversary (and a charge at the time of
surrender during any Policy Year) for Policy maintenance and related
administrative expenses. This annual charge is the lesser of 2% of the Policy
Value or $35. The Service Charge is deducted from each Investment Option in
proportion to each Investment Option's percentage of the Policy Value just
prior to such charge. This charge is waived if either the Policy Value or
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the sum of all Premium Payments less the sum of all partial withdrawals equals
or exceeds $50,000 on a Policy Anniversary (or date of surrender). PFL
guarantees that this charge will not be increased in the future. (See "CHARGES
AND DEDUCTIONS--Administrative Charges," p. 61.)
Distribution Financing Charges. During the first seven Policy Years, PFL
imposes a daily Distribution Financing Charge equal to an effective annual
rate of .15% of the Mutual Fund Account's net assets. This charge is used by
PFL to defray a portion of the cost of distribution of the Policies. The sum
of the cumulative Distribution Financing Charges and the Surrender Charges
will never exceed 8.5% of the cumulative Premium Payments. (See "CHARGES AND
DEDUCTIONS--Distribution Financing Charge," p. 62.)
Taxes. PFL may incur premium taxes relating to the Policies. When permitted
by state law, PFL will not deduct any premium taxes related to a particular
Policy from the Policy Value until the time of surrender, payment of the death
benefit, or the Annuity Commencement Date. Premium taxes currently range from
0% to 3.50% of Premium Payments. (See "CHARGES AND DEDUCTIONS--Premium Taxes,"
p. 62.)
No charges are currently made against the Fixed Account or the Mutual Fund
Account for federal, state, or local income taxes. Should PFL determine that
any such taxes may be imposed, PFL may deduct such taxes from amounts held in
the relevant Account. (See "CHARGES AND DEDUCTIONS--Federal, State and Local
Taxes," p. 62.)
Charges Against the Underlying Funds. The value of the net assets of the
Subaccounts of the Mutual Fund Account will reflect the investment advisory
fee and other expenses incurred by the Underlying Funds. Those fees and
expenses are detailed in the prospectuses for the Underlying Funds that
accompany this Prospectus.
- 14 -
<PAGE>
Expense Data. The charges and deductions are summarized in the following
tables. This tabular information regarding expenses assumes that the entire
Policy Value is in the Mutual Fund Account.
<TABLE>
<CAPTION>
MERRILL LYNCH VARIABLE
SERIES FUNDS, INC.(/5/) ENDEAVOR SERIES TRUST(/4/)
------------------------ --------------------------------------
DEVELOPING TCW T. ROWE
BASIC CAPITAL HIGH TCW MANAGED PRICE
VALUE MARKETS CURRENT MONEY ASSET INTERNATIONAL VALUE
FOCUS FOCUS INCOME MARKET ALLOCATION STOCK EQUITY
----- ---------- ------- ------ ---------- ------------- ------
<S> <C> <C> <C> <C> <C> <C> <C>
POLICY OWNER TRANSACTION
EXPENSES
Sales Load On Purchase
Payments(/1/).......... 0 0 0 0 0 0 0
Maximum Surrender Charge
(as a % of Premium
Payment
Surrendered)(/2/)...... 7 7 7 7 7 7 7
Surrender Fees.......... 0 0 0 0 0 0 0
------------------------------------------------------------------
Annual Service
Charge(/1/)............ $35 Per Policy
Transfer Fee(/1/)....... Currently no fee
------------------------------------------------------------------
MUTUAL FUND ACCOUNT
ANNUAL EXPENSES
(AS A % OF ACCOUNT
VALUE)
Mortality and Expense
Risk Fees(/3/)......... 1.25 1.25 1.25 1.25 1.25 1.25 1.25
Administrative Charge... 0.15 0.15 0.15 0.15 0.15 0.15 0.15
Distribution Financing
Charge................. 0.15 0.15 0.15 0.15 0.15 0.15 0.15
---- ---- ---- ---- ---- ---- ----
Total Mutual Fund
Account Annual
Expenses............... 1.55 1.55 1.55 1.55 1.55 1.55 1.55
UNDERLYING FUNDS ANNUAL
EXPENSES(/4/)(5)(6)
(as a % of average net
assets and after
expense reimbursements)
Management Fees......... 0.60 1.00 0.49 0.50 0.75 0.90 0.80
Other Expenses.......... 0.06 0.25 0.05 0.10 0.10 0.28 0.11
---- ---- ---- ---- ---- ---- ----
Total Underlying Funds
Annual Expenses........ 0.66 1.25 0.54 0.60 0.85 1.18 0.91
</TABLE>
- 15 -
<PAGE>
<TABLE>
<CAPTION>
WRL
SERIES
FUND,
ENDEAVOR SERIES TRUST(/4/) INC.(/6/)
--------------------------------------------------------- --------------------------
DREYFUS
U.S. T. ROWE T. ROWE
DREYFUS GOVERNMENT PRICE PRICE
SMALL CAP SECURITIES EQUITY GROWTH OPPORTUNITY ENHANCED WRL
VALUE PORTFOLIO INCOME STOCK VALUE INDEX GROWTH
--------- ---------- ------- ------- ----------- -------- ------
<S> <C> <C> <C> <C> <C> <C> <C>
POLICY OWNER TRANSACTION
EXPENSES
Sales Load On Purchase
Payments(/1/).......... 0 0 0 0 0 0 0
Maximum Surrender Charge
(as a % of Premium
Payments
Surrendered)(/2/)...... 7 7 7 7 7 7 7
Surrender Fees.......... 0 0 0 0 0 0 0
Annual Service
Charge(/1/)............
-------------------------------------------------------------------------------------------
Transfer Fee(/1/) ...... Currently no fee
-------------------------------------------------------------------------------------------
MUTUAL FUND ACCOUNT
ANNUAL EXPENSES
(AS A % OF ACCOUNT
VALUE)
Mortality and Expense
Risk Fees(/3/)......... 1.25 1.25 1.25 1.25 1.25 1.25 1.25
Administrative Charge... 0.15 0.15 0.15 0.15 0.15 0.15 0.15
Distribution Financing
Charge................. 0.15 0.15 0.15 0.15 0.15 0.15 0.15
---- ---- ---- ---- ---- ---- ----
Total Mutual Fund
Account Annual
Expenses............... 1.55 1.55 1.55 1.55 1.55 1.55 1.55
UNDERLYING FUNDS ANNUAL
EXPENSES(/4/)(5)(6)
(as a % of average net
assets and after
expense reimbursements)
Management Fees......... 0.80 0.65 0.80 0.80 0.80 0.75 0.80
Other Expenses.......... 0.12 0.17 0.16 0.21 0.50 0.55 0.08
---- ---- ---- ---- ---- ---- ----
Total Underlying Funds
Annual Expense(/1/).... 0.92 0.82 0.96 1.01 1.30 1.30 0.88
</TABLE>
- ----------------------------------
(1) The Surrender Charge and Transfer Fee, if any is imposed, apply to each
Policy, regardless of how the Policy Value is allocated among the Mutual
Fund Account and the Fixed Account. The Service Charge applies to both the
Fixed Account and the Mutual Fund Account, and is assessed on a prorata
basis relative to each Account's Policy Value as a percentage of the
Policy's total Policy Value. The Service Charge is deducted on each Policy
Anniversary and at the time of surrender, if surrender occurs during a
Policy Year. (See "CHARGES AND DEDUCTIONS--Other Expenses Including
Investment Advisory Fees," p. 62.)
(2) The Surrender Charge is decreased based on the number of years since the
premium payment date in which the withdrawal is made, from 7% in the first
year in which the Premium Payment was made to 0% in the eighth year after
the Premium Payment was made.
(3) The Mortality and Expense Risk Fees shown (1.25%) are for the 5% Annually
Compounding Death Benefit and the Annual Step Up Death Benefit. The
corresponding Fee for the Return of Premium Death
- 16 -
<PAGE>
Benefit is 1.10% for each Subaccount. (See "DISTRIBUTIONS UNDER THE
POLICY--Death Benefit," p. 56.)
(4) Endeavor Investment Advisers has agreed, until terminated by Endeavor
Investment Advisers, to assume expenses of the Endeavor Series Trust
Portfolios that exceed the following rates: TCW Money Market--0.99%; TCW
Managed Asset Allocation--1.25%; T. Rowe Price International Stock--1.53%;
Value Equity--1.30%; Dreyfus Small Cap Value--1.30%; Dreyfus U.S.
Government Securities--1.00%; T. Rowe Price Equity Income--1.30%; T. Rowe
Price Growth Stock--1.30%; Opportunity Value--1.30%; Enhanced Index--
1.30%. Amounts shown for the Enhanced Index Portfolios are estimated for
1997. During 1996, Endeavor Investment Advisers waived fees relative to,
or reimbursed, the Opportunity Value Portfolio. The annualized operating
expense ratio before waiver/reimbursement by Endeavor Investment Advisers
for the period ended December 31, 1996, was 12.69%.
(5) These are estimates of expenses for 1997. Reimbursement agreements are in
effect that limit operating expenses paid by each portfolio of the Merrill
Lynch Variable Series Funds, Inc. in a given year to 1.25% of its average
daily net assets. Any expenses in excess of 1.25% of the average daily net
assets will be reimbursed to the portfolio by MLAM, which in turn will be
reimbursed by Merrill Lynch Life Agency, Inc., an affiliate of MLAM.
During 1996, MLAM waived management fees and reimbursed expenses totaling
0.06% for the Developing Capital Markets Focus Fund.
(6) Effective January 1, 1997, the WRL Series Fund, Inc. has adopted a Plan of
Distribution pursuant to Rule 12b-1 under the Investment Company Act of
1940 (the "1940 Act") ("Distribution Plan") and pursuant to the
Distribution Plan, has entered into a Distribution Agreement with
InterSecurities, Inc. ("ISI"), principal underwriter for the WRL Series
Fund, Inc. Under the Distribution Plan, the WRL Series Fund, Inc., on
behalf of the WRL Growth Portfolio, is authorized to pay to various
service providers, as direct payment for expenses incurred in connection
with the distribution of the Portfolio's shares, amounts equal to actual
expenses associated with distributing the Portfolio's shares, up to a
maximum rate of 0.15% (fifteen one-hundredths of one percent) on an
annualized basis of the average daily net assets. This fee is measured and
accrued daily and paid monthly. ISI has determined that it will not seek
payment by the WRL Series Fund, Inc. of distribution expenses with respect
to any portfolio (including the WRL Growth Portfolio) during the fiscal
year ending December 31, 1997. Owners will be notified in advance prior to
ISI's seeking such reimbursement.
- 17 -
<PAGE>
EXAMPLES
I. An Owner would pay the following expenses on a $1,000 investment, assuming
Return of Premium Death Benefit, a hypothetical 5% annual return on assets,
and assuming the entire Policy Value is in the applicable Subaccount:
1. If the Policy is surrendered at the end of the applicable time period:
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
Merrill Lynch Basic Value Focus Fund.......... $91 $111 $140 $239
Merrill Lynch Developing Capital Markets Focus
Fund........................................ $97 $129 $170 $298
Merrill Lynch High Current Income Fund........ $90 $107 $134 $227
TCW Money Market Portfolio.................... $91 $109 $137 $233
TCW Managed Asset Allocation Portfolio........ $93 $117 $150 $259
T. Rowe Price International Stock Portfolio... $97 $127 $166 $292
Value Equity Portfolio........................ $94 $118 $153 $265
Dreyfus Small Cap Value Portfolio............. $94 $119 $153 $266
Dreyfus U.S. Government Securities Portfolio.. $93 $116 $148 $256
T. Rowe Price Equity Income Portfolio......... $94 $120 $155 $270
T. Rowe Price Growth Stock Portfolio.......... $95 $121 $158 $275
Opportunity Value Portfolio................... $98 $130 $172 $303
Enhanced Index Portfolio...................... $98 $130 $172 $303
WRL Growth Portfolio.......................... $94 $117 $151 $262
</TABLE>
2. If the Policy is annuitized at the end of the applicable time period:
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
Merrill Lynch Basic Value Focus Fund.......... $21 $66 $114 $239
Merrill Lynch Developing Capital Markets Focus
Fund........................................ $27 $84 $143 $298
Merrill Lynch High Current Income Fund........ $20 $63 $108 $227
TCW Money Market Portfolio.................... $21 $64 $111 $233
TCW Managed Asset Allocation Portfolio........ $23 $72 $123 $259
T. Rowe Price International Stock Portfolio... $27 $82 $140 $292
Value Equity Portfolio........................ $24 $74 $126 $265
Dreyfus Small Cap Value Portfolio............. $24 $74 $127 $266
Dreyfus U.S. Government Securities Portfolio.. $23 $71 $122 $256
T. Rowe Price Equity Income Portfolio......... $24 $75 $129 $270
T. Rowe Price Growth Stock Portfolio.......... $25 $77 $131 $275
Opportunity Value Portfolio................... $28 $85 $146 $303
Enhanced Index Portfolio...................... $28 $85 $146 $303
WRL Growth Portfolio.......................... $24 $73 $125 $262
</TABLE>
- 18 -
<PAGE>
3. If the Policy is not surrendered or annuitized:
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
Merrill Lynch Basic Value Focus Fund.......... $21 $66 $114 $239
Merrill Lynch Developing Capital Markets Focus
Fund........................................ $27 $84 $143 $298
Merrill Lynch High Current Income Fund........ $20 $63 $108 $227
TCW Money Market Portfolio.................... $21 $64 $111 $233
TCW Managed Asset Allocation Portfolio........ $23 $72 $123 $259
T. Rowe Price International Stock Portfolio... $27 $82 $140 $292
Value Equity Portfolio........................ $24 $74 $126 $265
Dreyfus Small Cap Value Portfolio............. $24 $74 $127 $266
Dreyfus U.S. Government Securities Portfolio.. $23 $71 $122 $256
T. Rowe Price Equity Income Portfolio......... $24 $75 $129 $270
T. Rowe Price Growth Stock Portfolio.......... $25 $77 $131 $275
Opportunity Value Portfolio................... $28 $85 $146 $303
Enhanced Index Portfolio...................... $28 $85 $146 $303
WRL Growth Portfolio.......................... $24 $73 $125 $262
II. An Owner would pay the following expenses on a $1,000 investment, assuming
5% Annually Compounding Death Benefit or Annual Step-Up Death Benefit, a
hypothetical 5% annual return on assets, and assuming the entire Policy Value
is in the applicable Subaccount:
1. If the Policy is surrendered at the end of the applicable time period:
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
Merrill Lynch Basic Value Focus Fund.......... $93 $115 $148 $255
Merrill Lynch Developing Capital Markets Focus
Fund........................................ $99 $133 $177 $313
Merrill Lynch High Current Income Fund........ $92 $112 $142 $242
TCW Money Market Portfolio.................... $92 $114 $145 $248
TCW Managed Asset Allocation Portfolio........ $95 $121 $157 $274
T. Rowe Price International Stock Portfolio... $98 $131 $174 $306
Value Equity Portfolio........................ $95 $123 $160 $280
Dreyfus Small Cap Value Portfolio............. $96 $123 $161 $281
Dreyfus U.S. Government Securities Portfolio.. $95 $120 $156 $271
T. Rowe Price Equity Income Portfolio......... $96 $124 $163 $285
T. Rowe Price Growth Stock Portfolio.......... $96 $126 $165 $290
Opportunity Value Portfolio................... $99 $135 $180 $318
Enhanced Index Portfolio...................... $99 $135 $180 $318
WRL Growth Portfolio.......................... $95 $122 $159 $277
</TABLE>
- 19 -
<PAGE>
2. If the Policy is annuitized at the end of the applicable time period:
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
Merrill Lynch Basic Value Focus Fund.......... $23 $71 $121 $255
Merrill Lynch Developing Capital Markets Focus
Fund........................................ $29 $88 $151 $313
Merrill Lynch High Current Income Fund........ $22 $67 $115 $242
TCW Money Market Portfolio.................... $22 $69 $118 $248
TCW Managed Asset Allocation Portfolio........ $25 $77 $131 $274
T. Rowe Price International Stock Portfolio... $28 $86 $147 $306
Value Equity Portfolio........................ $25 $78 $134 $280
Dreyfus Small Cap Value Portfolio............. $26 $79 $134 $281
Dreyfus U.S. Government Securities Portfolio.. $25 $76 $129 $271
T. Rowe Price Equity Income Portfolio......... $26 $80 $136 $285
T. Rowe Price Growth Stock Portfolio.......... $26 $81 $139 $290
Opportunity Value Portfolio................... $29 $90 $153 $318
Enhanced Index Portfolio...................... $29 $90 $153 $318
WRL Growth Portfolio.......................... $25 $77 $132 $277
3. If the Policy is not surrendered or annuitized:
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
Merrill Lynch Basic Value Focus Fund.......... $23 $71 $121 $255
Merrill Lynch Developing Capital Markets Focus
Fund........................................ $29 $88 $151 $313
Merrill Lynch High Current Income Fund........ $22 $67 $115 $242
TCW Money Market Portfolio.................... $22 $69 $118 $248
TCW Managed Asset Allocation Portfolio........ $25 $77 $131 $274
T. Rowe Price International Stock Portfolio... $28 $86 $147 $306
Value Equity Portfolio........................ $25 $78 $134 $280
Dreyfus Small Cap Value Portfolio............. $26 $79 $134 $281
Dreyfus U.S. Government Securities Portfolio.. $25 $76 $129 $271
T. Rowe Price Equity Income Portfolio......... $26 $80 $136 $285
T. Rowe Price Growth Stock Portfolio.......... $26 $81 $139 $290
Opportunity Value Portfolio................... $29 $90 $153 $318
Enhanced Index Portfolio...................... $29 $90 $153 $318
WRL Growth Portfolio.......................... $25 $77 $132 $277
</TABLE>
The above tables are intended to assist the Owner in understanding the costs
and expenses that will be borne, directly or indirectly. These include the
expenses of the Underlying Funds. (See "CHARGES AND DEDUCTIONS," p. 59, and
the Underlying Funds' prospectuses.) In addition to the expenses listed above,
premium taxes may be applicable.
- 20 -
<PAGE>
THESE EXAMPLES SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE
EXPENSES, AND ACTUAL EXPENSES MAY BE GREATER OR LESSER THAN THOSE SHOWN. THE
ASSUMED 5% ANNUAL RETURN IS HYPOTHETICAL AND SHOULD NOT BE CONSIDERED A
REPRESENTATION OF PAST OR FUTURE ANNUAL RETURNS, WHICH COULD BE GREATER OR
LESS THAN THE ASSUMED RATE. The figures and data for the Underlying Fund
annual expenses have been provided by WRL Investment Management, Inc.,
Endeavor Investment Advisers, and Merrill Lynch Asset Management, L.P. and
while PFL does not dispute these figures, PFL has not independently verified
their accuracy.
In these examples, the $35 Annual Service Charge is reflected as a charge of
.0547% based on average Policy Value of $64,005. Normally, the $35 Service
Charge would be waived if the Premium Payment(s) less partial withdrawals, or
the Policy Value is at least $50,000. However, it was included in these
examples for illustrative purposes.
These examples include the 1.25% Mortality and Expense Risk Fee for the 5%
Annually Compounding and Annual Step-Up Death Benefits; and the 1.10%
Mortality and Expense Risk Fee for the Return of Premium Death Benefit.
DEATH BENEFIT
Upon receipt of proof that the Annuitant, who is the Owner, has died before
the Annuity Commencement Date, the Death Benefit is calculated and is payable
to the Beneficiary when PFL receives due proof of death, an election of the
method of settlement and return of the Policy. The Death Benefit is only paid
if the Owner and Annuitant are the same person, and that person dies prior to
the Annuity Commencement Date. In the event that the Annuitant who is not the
Owner dies prior to the Annuity Commencement Date, the Owner will generally
become the Annuitant unless the Owner specifically requests on the application
or in writing prior to Annuitant's death that the death benefit be paid upon
the Annuitant's death and PFL agrees to such an election.
The amount of the Death Benefit will depend on the state where the Policy is
purchased and will depend on the Death Benefit option elected by the Owner.
However, the Death Benefit will always be at least equal to the greater of the
Policy Value or the Cash Value on the date PFL receives the documentation it
needs to process the Death Benefit.
The Death Benefit is not paid on the death of an Owner if the Owner is not
the Annuitant. If an Owner who is not the Annuitant dies before the Annuity
Commencement Date, the amount payable under the Policy upon surrender will be
the Adjusted Policy Value. (See "DISTRIBUTIONS UNDER THE POLICY--Death
Benefit," p. 56, or the Policy or endorsement for details.)
The Owner has the "one-time" option of choosing a Guaranteed Minimum Death
Benefit at the time of purchase of the Policy. The Owner may choose among the
"5% Annually Compounding Death Benefit," the
- 21 -
<PAGE>
"Annual Step-Up Death Benefit," or the "Return of Premium Death Benefit."
Certain age restrictions may apply, and prior versions of the Policy or
Policies offered in certain states may not offer all Guaranteed Minimum Death
Benefit Options. See the Policy or endorsement for details. If no Guaranteed
Minimum Death Benefit Option election is made by the Owner, the contract will
be issued with the Return of Premium Death Benefit. The Death Benefit may be
paid as either a lump sum cash benefit or as an annuity as permitted by
federal or state law.
VARIATIONS IN POLICY PROVISIONS
Certain provisions of the Policies (sold before May 1, 1997) offered in
certain states may vary from the descriptions in this Prospectus in order to
comply with different state laws. Any such state variations will be included
in the Policy itself or in riders or endorsements attached to the Policy. See
the Policy or endorsement for details.
New Jersey residents: Annuity payments must begin on or before the Policy
Anniversary that is closest to the Annuitant's 70th birthday or the 10th
Policy Anniversary, whichever occurs last. The Owner may not select a
Guaranteed Period Option that would extend beyond that date. The Owner's
options at the Annuity Commencement Date are to elect a lump sum payment, or
elect to receive annuity payments under one of the Fixed Payment Options. New
Jersey residents cannot elect Variable Payment Options. Consult your agent and
the policy form itself for details regarding these and other terms applicable
to policies sold in New Jersey.
FEDERAL INCOME TAX CONSEQUENCES OF INVESTMENT IN THE POLICY
With respect to Owners who are natural persons, there should be no federal
income tax on increases in the Policy Value until a distribution under the
Policy occurs (for example, a surrender, partial withdrawal, or Annuity
Payment) or is deemed t occur (for example, a pledge or assignment of a
Policy). Generally, a portion of any distribution or deemed distribution will
be taxable as ordinary income. The taxable portion of certain distributions
will be subject to withholding unless the recipient elects otherwise. In
addition, a penalty tax may apply to certain distributions or deemed
distributions under the Policy. (See "CERTAIN FEDERAL INCOME TAX
CONSEQUENCES," p. 63.)
* * *
Note: The foregoing summary is qualified in its entirety by the more detailed
information in the remainder of this Prospectus, in the Statement of
Additional Information, in the prospectuses for the Underlying Funds, and in
the Policy itself. Prospective purchasers should refer to those sources before
purchasing a Policy. This Prospectus generally describes only the Policy and
the Mutual Fund Account. Separate prospectuses describe the Underlying Funds.
(There is no prospectus for the Fixed Ac count since interests in the Fixed
Account are not securities. See "THE ENDEAVOR ACCOUNTS--The Fixed Account," p.
40.)
- 22 -
<PAGE>
INQUIRIES, WRITTEN NOTICES AND WRITTEN REQUESTS
Any questions about procedures or the Policy, or any Written Notice or
Written Request required to be sent to PFL, should be sent to the
Administrative and Service Office, Financial Markets Division--Variable
Annuity Department, 4333 Edgewood Road, N.E., Cedar Rapids, Iowa 52499-0001.
Telephone requests and inquiries may be made by calling 800-525-6205. All
inquiries, Notices and Requests should include the Policy number, the Owner's
name and the Annuitant's name.
- 23 -
<PAGE>
CONDENSED FINANCIAL INFORMATION
The Accumulation Unit Values and the number of Accumulation Units
outstanding for each Subaccount from the date of inception:
<TABLE>
<CAPTION>
TCW MONEY MARKET SUBACCOUNT*
--------------------------------------------------
ACCUMULATION ACCUMULATION NUMBER OF
UNIT VALUE AT UNIT VALUE AT ACCUMULATION UNITS
BEGINNING OF YEAR END OF YEAR AT END OF YEAR
----------------- ------------- ------------------
<S> <C> <C> <C>
1996......................... $1.11571 $1.15422 26,461,099.190
1995......................... $1.07242 $1.11571 21,103,926.232
1994......................... $1.05150 $1.07242 17,836,839.874
1993......................... $1.04313 $1.05150 12,190,857.625
1992......................... $1.02803 $1.04313 4,334,947.760
1991(/1/).................... $1.00000 $1.02803 1,855,372.177
<CAPTION>
TCW MANAGED ASSET ALLOCATION SUBACCOUNT**
--------------------------------------------------
ACCUMULATION ACCUMULATION NUMBER OF
UNIT VALUE AT UNIT VALUE AT ACCUMULATION UNITS
BEGINNING OF YEAR END OF YEAR AT END OF YEAR
----------------- ------------- ------------------
<S> <C> <C> <C>
1996......................... $1.577873 $1.833135 124,998,927.667
1995......................... $1.301669 $1.577873 122,974,873.030
1994......................... $1.393488 $1.301669 130,909,987.116
1993......................... $1.209859 $1.393488 69,252,242.665
1992......................... $1.125386 $1.209859 11,637,563.615
1991(/1/).................... $1.000000 $1.125386 3,775,618.731
<CAPTION>
T. ROWE PRICE INTERNATIONAL STOCK SUBACCOUNT
--------------------------------------------------
ACCUMULATION ACCUMULATION NUMBER OF
UNIT VALUE AT UNIT VALUE AT ACCUMULATION UNITS
BEGINNING OF YEAR END OF YEAR AT END OF YEAR
----------------- ------------- ------------------
<S> <C> <C> <C>
1996......................... $1.171039 $1.330640 91,462,303.686
1995......................... $1.073958 $1.171039 75,065,177.549
1994......................... $1.156482 $1.073958 76,518,044.179
1993......................... $0.989782 $1.156482 45,569,234.403
1992......................... $1.041235 $0.989782 6,368,485.858
1991(/1/).................... $1.000000 $1.041235 3,068,279.081
<CAPTION>
VALUE EQUITY SUBACCOUNT***
--------------------------------------------------
ACCUMULATION ACCUMULATION NUMBER OF
UNIT VALUE AT UNIT VALUE AT ACCUMULATION UNITS
BEGINNING OF YEAR END OF YEAR AT END OF YEAR
----------------- ------------- ------------------
<S> <C> <C> <C>
1996......................... $1.387903 $1.694854 65,227,195.342
1995......................... $1.045610 $1.387903 46,194,663.692
1994......................... $1.018576 $1.045610 30,512,231.489
1993(/3/).................... $1.000000 $1.018576 10,958,836.984
<CAPTION>
DREYFUS SMALL CAP VALUE SUBACCOUNT****
--------------------------------------------------
ACCUMULATION ACCUMULATION NUMBER OF
UNIT VALUE AT UNIT VALUE AT ACCUMULATION UNITS
BEGINNING OF YEAR END OF YEAR AT END OF YEAR
----------------- ------------- ------------------
<S> <C> <C> <C>
1996......................... $1.206843 $1.496065 51,124,831.634
1995......................... $1.072941 $1.206843 40,635,696.978
1994......................... $1.107747 $1.072941 32,607,348.474
1993(/4/).................... $1.000000 $1.107747 11,449,956.948
</TABLE>
- 24 -
<PAGE>
<TABLE>
<CAPTION>
DREYFUS U.S. GOVERNMENT SECURITIES SUBACCOUNT*****
-----------------------------------------------------
ACCUMULATION ACCUMULATION NUMBER OF
UNIT VALUE AT UNIT VALUE AT ACCUMULATION UNITS
BEGINNING OF YEAR END OF YEAR AT END OF YEAR
----------------- ------------- ---------------------
<S> <C> <C> <C>
1996...................... $ 1.124292 $ 1.128769 17,561,825.527
1995...................... $ 0.985803 $ 1.124292 8,456,764.729
1994(/5/)................. $ 0.998670 $ 0.985803 3,102,671.789
<CAPTION>
T. ROWE PRICE EQUITY INCOME SUBACCOUNT
-----------------------------------------------------
ACCUMULATION ACCUMULATION NUMBER OF
UNIT VALUE AT UNIT VALUE AT ACCUMULATION UNITS AT
BEGINNING OF YEAR END OF YEAR END OF YEAR
----------------- ------------- ---------------------
<S> <C> <C> <C>
1996...................... $ 1.287240 $ 1.521680 42,673,040.677
1995(/6/)................. $ 1.000000 $ 1.287240 14,943,358.393
<CAPTION>
T. ROWE PRICE GROWTH STOCK SUBACCOUNT
-----------------------------------------------------
ACCUMULATION ACCUMULATION NUMBER OF
UNIT VALUE AT UNIT VALUE AT ACCUMULATION UNITS AT
BEGINNING OF YEAR END OF YEAR END OF YEAR
----------------- ------------- ---------------------
<S> <C> <C> <C>
1996...................... $ 1.353339 $ 1.611613 30,237,847.748
1995(/6/)................. $ 1.000000 $ 1.353339 14,196,707.745
<CAPTION>
OPPORTUNITY VALUE SUBACCOUNT
-----------------------------------------------------
ACCUMULATION ACCUMULATION NUMBER OF
UNIT VALUE AT UNIT VALUE AT ACCUMULATION UNITS AT
BEGINNING OF YEAR END OF YEAR END OF YEAR
----------------- ------------- ---------------------
<S> <C> <C> <C>
1996(/7/)................. $ 1.000000 $ 1.004355 314,119.406
<CAPTION>
ENHANCED INDEX SUBACCOUNT
-----------------------------------------------------
ACCUMULATION ACCUMULATION NUMBER OF
UNIT VALUE AT UNIT VALUE AT ACCUMULATION UNITS AT
BEGINNING OF YEAR END OF YEAR END OF YEAR
----------------- ------------- ---------------------
<S> <C> <C> <C>
1996(/8/)................. -- -- --
<CAPTION>
WRL GROWTH SUBACCOUNT
-----------------------------------------------------
ACCUMULATION ACCUMULATION NUMBER OF
UNIT VALUE AT UNIT VALUE AT ACCUMULATION UNITS
BEGINNING OF YEAR END OF YEAR AT END OF YEAR
----------------- ------------- ---------------------
<S> <C> <C> <C>
1996...................... $14.583843 $16.964068 15,174,482.394
1995...................... $10.051117 $14.583843 13,337,196.679
1994...................... $11.114865 $10.051117 12,758,957.591
1993...................... $10.839753 $11.114865 9,252,403.800
1992(/2/)................. $10.000000 $10.839753 1,119,066,376
<CAPTION>
MERRILL LYNCH BASIC VALUE FOCUS SUBACCOUNT (/8/)
-----------------------------------------------------
ACCUMULATION ACCUMULATION NUMBER OF
UNIT VALUE AT UNIT VALUE AT ACCUMULATION UNITS
BEGINNING OF YEAR END OF YEAR AT END OF YEAR
----------------- ------------- ---------------------
<S> <C> <C> <C>
1996...................... N/A N/A N/A
</TABLE>
- 25 -
<PAGE>
<TABLE>
<CAPTION>
MERRILL LYNCH DEVELOPING CAPITAL MARKETS FOCUS
SUBACCOUNT (/8/)
--------------------------------------------------
ACCUMULATION ACCUMULATION NUMBER OF
UNIT VALUE AT UNIT VALUE AT ACCUMULATION UNITS
BEGINNING OF YEAR END OF YEAR AT END OF YEAR
----------------- ------------- ------------------
<S> <C> <C> <C>
1996......................... N/A N/A N/A
<CAPTION>
MERRILL LYNCH HIGH CURRENT INCOME SUBACCOUNT (/8/)
--------------------------------------------------
ACCUMULATION ACCUMULATION NUMBER OF
UNIT VALUE AT UNIT VALUE AT ACCUMULATION UNITS
BEGINNING OF YEAR END OF YEAR AT END OF YEAR
----------------- ------------- ------------------
<S> <C> <C> <C>
1996......................... N/A N/A N/A
</TABLE>
- ----------------------------------
(1) Period from April 8, 1991 through December 31, 1991.
(2) Period from July 1, 1992 through December 31, 1992.
(3) Period from May 27, 1993 through December 31, 1993.
(4) Period from May 4, 1993 through December 31, 1993.
(5) Period from May 9, 1994 through December 31, 1994.
(6) Period from January 3, 1995 through December 31, 1995.
(7) Period from November 18, 1996, through December 31, 1996.
(8) The offerings of the Enhanced Index Subaccount, the Merrill Lynch Basic
Value Focus Subaccount, the Merrill Lynch Developing Capital Markets
Focus Subaccount and the Merrill Lynch High Current Income Subaccount are
expected to commence on or about the date of this Prospectus.
Accordingly, no comparable data is available for those Subaccounts.
* Prior to May 1, 1996, known as the Money Market Subaccount.
** Prior to May 1, 1996, known as the Managed Asset Allocation Subaccount.
*** Prior to May 1, 1996, known as the Quest for Value Equity Subaccount.
**** Prior to October 29, 1996, known as the Value Small Cap Subaccount, and
prior to May 1, 1996, known as the Quest for Value Small Cap Subaccount.
***** Prior to May 1, 1996, known as the U.S. Government Securities
Subaccount.
FINANCIAL STATEMENTS
The financial statements of the Mutual Fund Account and PFL and the
independent auditors' reports thereon are in the Statement of Additional
Information which is available free upon request to the Administrative and
Service Office.
HISTORICAL PERFORMANCE DATA
STANDARDIZED PERFORMANCE DATA
From time to time, PFL may advertise historical yields and total returns for
the Subaccounts of the Mutual Fund Account. In addition, PFL may advertise the
effective yield of the Subaccount investing in the TCW Money Market Portfolio
(the "TCW Money Market Subaccount"). These figures will be calculated
according to standardized methods prescribed by the Securities and Exchange
Commission ("SEC"). They will be based on historical earnings and are not
intended to indicate future performance.
- 26 -
<PAGE>
TCW MONEY MARKET SUBACCOUNT
The yield of the TCW Money Market Subaccount for a Policy refers to the
annualized income generated by an investment under a Policy in the Subaccount
over a specified seven-day period. The yield is calculated by assuming that
the income generated for that seven-day period is generated each seven-day
period over a 52-week period and is shown as a percentage of the investment.
The effective yield is calculated similarly but, when annualized, the income
earned by an investment under a Policy in the Subaccount is assumed to be
reinvested. The effective yield will be slightly higher than the yield because
of the compounding effect of this assumed reinvestment.
OTHER SUBACCOUNTS
The yield of a Subaccount of the Mutual Fund Account (other than the TCW
Money Market Subaccount) for a Policy refers to the annualized income
generated by an investment under a Policy in the Subaccount over a specified
thirty-day period. The yield is calculated by assuming that the income
generated by the investment during that thirty-day period is generated each
thirty-day period over a 12-month period and is shown as a percentage of the
investment.
The total return of a Subaccount of the Mutual Fund Account refers to return
quotations assuming an investment under a Policy has been held in the
Subaccount for various periods of time including, but not limited to, a period
measured from the date the Subaccount commenced operations. When a Subaccount
has been in operation for one, five, and ten years, respectively, the total
return for these periods will be provided. The total return quotations for a
Subaccount will represent the average annual compounded rates of return that
equate an initial investment of $1,000 in the Subaccount to the redemption
value of that investment as of the first day of each of the periods for which
total return quotations are provided.
The yield and total return calculations for a Subaccount do not reflect the
effect of any premium taxes that may be applicable to a particular Policy. The
yield calculations also do not reflect the effect of any Surrender Charge that
may be applicable to a particular Policy. To the extent that any or all of a
premium tax and/or Surrender Charge is applicable to a particular Policy, the
yield and/or total return of that Policy will be reduced. For additional
information regarding yields and total returns calculated using the standard
formats briefly summarized above, please refer to the Statement of Additional
Information, a copy of which may be obtained from the Administrative and
Service Office upon request.
Based on the method of calculation described in the Statement of Additional
Information, the average annual total returns for periods from inception of
the Subaccounts to December 31, 1996, and for the one and five year periods
ended December 31, 1996 were as follows:
- 27 -
<PAGE>
AVERAGE ANNUAL TOTAL RETURNS
Return of Premium Death Benefit (Total Mutual Fund Account Annual Expenses:
1.40%)
<TABLE>
<CAPTION>
ONE
YEAR FIVE INCEPTION
PERIOD YEARS OF THE
ENDED ENDED SUBACCOUNT SUBACCOUNT
12/31/96 12/31/96 TO 12/31/96 INCEPTION DATE
-------- -------- ----------- -----------------
<S> <C> <C> <C> <C>
SUBACCOUNT
- ----------
TCW Managed Asset Allocation.. 10.80% 9.95% 10.91% April 8, 1991
T. Rowe Price International
Stock(/1/).................. 8.24% 4.68% 4.81% April 8, 1991
Value Equity.................. 16.77% N/A 15.08% May 27, 1993
Dreyfus Small Cap Value....... 18.63% N/A 10.86% May 4, 1993
Dreyfus U.S. Government
Securities.................. -5.07% N/A 3.09% May 9, 1994
T. Rowe Price Equity Income... 12.84% N/A 21.26% January 3, 1995
T. Rowe Price Growth Stock.... 13.72% N/A 24.94% January 3, 1995
Opportunity Value............. N/A N/A -6.56% November 18, 1996
Enhanced Index(/2/)........... N/A N/A N/A --
WRL Growth.................... 10.94% N/A 12.01% July 1, 1992
Merrill Lynch Basic Value
Focus(/2/).................. N/A N/A N/A --
Merrill Lynch Developing
Capital Markets Focus(/2/).. N/A N/A N/A --
Merrill Lynch High Current
Income(/2/)................. N/A N/A N/A --
</TABLE>
- 28 -
<PAGE>
5% Annually Compounding Death Benefit or Annual Step-Up Death Benefit (Total
Mutual Fund Account Annual Expenses: 1.55%)
<TABLE>
<CAPTION>
ONE
YEAR FIVE INCEPTION
PERIOD YEARS OF THE
ENDED ENDED SUBACCOUNT SUBACCOUNT
12/31/96 12/31/96 TO 12/31/96 INCEPTION DATE
SUBACCOUNT -------- -------- ----------- -----------------
<S> <C> <C> <C> <C>
TCW Managed Asset Allocation.. 10.63% 9.79% 10.74% April 8, 1991
T. Rowe Price International
Stock(/1/).................. 8.07% 4.52% 4.65% April 8, 1991
Value Equity.................. 16.59% N/A 14.91% May 27, 1993
Dreyfus Small Cap Value....... 18.38% N/A 10.73% May 4, 1993
Dreyfus U.S. Government
Securities.................. -5.22% N/A 2.93% May 9, 1994
T. Rowe Price Equity Income... 12.71% N/A 21.07% January 3, 1995
T. Rowe Price Growth Stock.... 13.54% N/A 24.75% January 3, 1995
Opportunity Value............. N/A N/A -6.56% November 18, 1996
Enhanced Index(/2/)........... N/A N/A N/A --
WRL Growth.................... 10.79% N/A 11.85% July 1, 1992
Merrill Lynch Basic Value
Focus(/2/).................. N/A N/A N/A --
Merrill Lynch Developing
Capital Markets Focus(/2/).. N/A N/A N/A --
Merrill Lynch High Current
Income(/2/)................. N/A N/A N/A --
</TABLE>
- ----------------------------------
(1) Effective January 1, 1995, Rowe Price-Fleming International, Inc. became
the new adviser to the Global Growth Portfolio. The Portfolio's name
changed to the T. Rowe Price International Stock Portfolio and the
Portfolio's shareholders approved a change in investment objective from
investments in small capitalization companies on a global basis to
investments in a broad range of companies on an international basis (that
is, non-U.S. companies).
(2) The Enhanced Index Subaccount, the Merrill Lynch Basic Value Focus
Subaccount, the Merrill Lynch Developing Capital Markets Focus Subaccount,
and the Merrill Lynch High Current Income Subaccount are expected to begin
operations on or about the date of this Prospectus, therefore, comparable
information is not available.
The figures for the "five year" and "from inception" periods in the above
tables reflect waiver of advisory fees and reimbursement of other expenses for
all portfolios except the T. Rowe Price Equity Income Portfolio and the T.
Rowe Price Growth Stock Portfolio. In the absence of such waivers, the average
annual total return figures above from the five year and from inception
periods would have been lower.
- 29 -
<PAGE>
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HYPOTHETICAL DATA
The Merrill Lynch Basic Value Focus Subaccount, the Merrill Lynch Developing
Capital Markets Focus Subaccount, and the Merrill Lynch High Current Income
Subaccounts (the "Merrill Lynch Subaccounts") have not commenced operations
prior to the date of this Prospectus. However, the following is standardized
average annual total return information based on the hypothetical assumption
that those Subaccounts have been available to the PFL Endeavor Variable
Annuity Account since inception of the underlying portfolios.
Return of Premium Death Benefit (Total Mutual Fund Account Annual Expenses:
1.40%)
<TABLE>
<CAPTION>
10 YEAR OR
SUBACCOUNT ONE YEAR FIVE YEAR INCEPTION
- ---------- -------- --------- ----------
<S> <C> <C> <C>
Merrill Lynch Basic Value Focus.................. 13.88% N/A 13.79%
Merrill Lynch Developing Capital Markets Focus... 3.70% N/A -1.90%
Merrill Lynch High Current Income................ 4.38% 10.42% 9.85%
5% Annually Compounding Death Benefit or Annual Step-Up Death Benefit (Total
Mutual Fund Account Annual Expenses: 1.55%)
<CAPTION>
10 YEAR OR
SUBACCOUNT ONE YEAR FIVE YEAR INCEPTION
- ---------- -------- --------- ----------
<S> <C> <C> <C>
Merrill Lynch Basic Value Focus.................. 13.62% N/A 13.69%
Merrill Lynch Developing Capital Markets Focus... 3.54% N/A -2.07%
Merrill Lynch High Current Income................ 4.22% 10.26% 9.69%
</TABLE>
- ----------------------------------
* The performance data for periods prior to the date the Merrill Lynch
Subaccounts commenced operations is based on the performance of the
underlying portfolios and the assumption that the Merrill Lynch Subaccounts
were in existence for the same period as the corresponding portfolios, with
a level of charges equal to those currently assessed against the Subaccount
or against Owners' contract values under the Policies. The Merrill Lynch
Basic Value Fund commenced operations on July 1, 1993; the Merrill Lynch
Developing Capital Markets Focus Fund commenced operations on May 2, 1994;
and the Merrill Lynch High Current Income Fund commenced operations on April
20, 1982. For purposes of the calculation of the performance data prior to
dates of inception of the underlying portfolios, the deductions for the
Mortality and Expense Risk Fee, and Administrative Charge are made on a
monthly basis, rather than a daily basis. The monthly deduction is made at
the beginning of each month and generally approximates the performance which
would have resulted if the Merrill Lynch Subaccounts had actually been in
existence since the inception of the underlying portfolios. Performance data
for periods of less than seven years reflect deduction of the Surrender
Charge.
- 30 -
<PAGE>
WRL GROWTH SUBACCOUNT--HYPOTHETICAL DATA
Prior to July 1, 1992, the WRL Growth Subaccount had not yet commenced
operations. However, the following is standardized average annual total return
information based on the hypothetical assumption that the WRL Growth
Subaccount had been available to the PFL Endeavor Variable Annuity Account
since inception of the WRL Growth Portfolio:
Return of Premium Death Benefit (Total Mutual Fund Account Annual Expenses:
1.40%)
<TABLE>
<CAPTION>
FIVE YEARS 10 YEARS
ENDED ENDED
SUBACCOUNT 12/31/96 12/31/96
- ---------- ---------- --------
<S> <C> <C>
WRL Growth.................................................. 9.10% 16.19%
</TABLE>
5% Annually Compounding Death Benefit or Annual Step-Up Death Benefit (Total
Mutual Fund Account Annual Expenses: 1.55%)
<TABLE>
<CAPTION>
FIVE YEARS 10 YEARS
ENDED ENDED
SUBACCOUNT 12/31/96 12/31/96
- ---------- ---------- --------
<S> <C> <C>
WRL Growth.................................................. 8.94% 16.02%
</TABLE>
- ----------------------------------
* The performance data for periods prior to the date the WRL Growth Subaccount
commenced operations (July 1, 1992) is based on the performance of the WRL
Growth Portfolio and the assumption that the WRL Growth Subaccount was in
existence for the same period as the WRL Growth Portfolio, with a level of
charges equal to those currently assessed against the Subaccount or against
Owners' contract values under the Policies. The WRL Growth Portfolio,
commenced operations on October 2, 1986. For purposes of the calculation of
the performance data prior to July 1, 1992, the deductions for the Mortality
and Expense Risk Fee, and Administrative Charge are made on a monthly basis,
rather than a daily basis. The monthly deduction is made at the beginning of
each month and generally approximates the performance which would have
resulted if the Subaccount had actually been in existence since the
inception of the WRL Growth Portfolio. Performance data for periods of less
than seven years reflect deduction of the Surrender Charge.
OPPORTUNITY VALUE AND EQUITY INDEX PORTFOLIOS
The Opportunity Value Portfolio and the Equity Index Portfolio are new and
therefore do not have (in the case of the Opportunity Value Portfolio, no
significant) historical performance data. However, their investment managers
(OpCap Advisors and J.P. Morgan Investment Management, Inc. respectively) have
years of experience managing very similar portfolios with substantially the
same investment objectives and policies. Historical performance data showing
the results the investment managers achieved for those other portfolios is in
the prospectus for the Endeavor Series Trust, which is included with this
Prospectus. See "Performance Information" in the Endeavor Series Trust's
prospectus. That performance information in the Endeavor Series Trust's
prospectus does not take into account the fees
- 31 -
<PAGE>
and charges under the Policy; if those fees and charges were reflected, the
investment returns would be lower.
NON-STANDARDIZED PERFORMANCE DATA
PFL may from time to time also advertise or disclose average annual total
return or other performance data in non-standard formats for a Subaccount of
the Mutual Fund Account. The non-standard performance data may assume that no
Surrender Charge is applicable, and may also make other assumptions such as
the amount invested in a Subaccount, differences in time periods to be shown,
or the effect of partial withdrawals or annuity payments.
The following non-standardized average annual total return figures are based
on the assumption that the Policy is not surrendered, and therefore the
Surrender Charge is not imposed.
AVERAGE ANNUAL TOTAL RETURNS
(ASSUMING NO SURRENDER CHARGE)
Return of Premium Death Benefit (Total Mutual Fund Account Annual Expenses:
1.40%)
<TABLE>
<CAPTION>
INCEPTION
ONE YEAR FIVE OF THE
PERIOD YEARS SUBACCOUNT
ENDED ENDED TO SUBACCOUNT
SUBACCOUNT 12/31/96 12/31/96 12/31/96 INCEPTION DATE
- ---------- -------- -------- ---------- -----------------
<S> <C> <C> <C> <C>
TCW Managed Asset Allocation... 16.10% 10.18% 11.08% April 8, 1991
T. Rowe Price International
Stock(/1/)................... 13.55% 4.97% 5.05% April 8, 1991
Value Equity................... 22.04% N/A 15.72% May 27, 1993
Dreyfus Small Cap Value........ 23.88% N/A 11.56% May 4, 1993
Dreyfus U.S. Government
Securities................... 0.33% N/A 4.66% May 9, 1994
T. Rowe Price Equity Income.... 18.14% N/A 23.35% January 3, 1995
T. Rowe Price Growth Stock..... 19.01% N/A 26.95% January 3, 1995
Opportunity Value.............. N/A N/A 0.44% November 18, 1996
Enhanced Index(/2/)............ N/A N/A N/A --
WRL Growth..................... 16.24% N/A 12.38% July 1, 1992
Merrill Lynch Basic Value Focus
Fund(/2/).................... N/A N/A N/A --
Merrill Lynch Developing
Capital Markets Focus
Fund(/2/).................... N/A N/A N/A --
Merrill Lynch High Current
Income Fund(/2/)............. N/A N/A N/A --
</TABLE>
- 32 -
<PAGE>
5% Annually Compounding Death Benefit or Annual Step-Up Death Benefit (Total
Mutual Fund Account Annual Expenses: 1.55%)
<TABLE>
<CAPTION>
ONE
YEAR FIVE INCEPTION
PERIOD YEARS OF THE
ENDED ENDED SUBACCOUNT SUBACCOUNT
SUBACCOUNT 12/31/96 12/31/96 TO 12/31/96 INCEPTION DATE
- ---------- -------- -------- ----------- -----------------
<S> <C> <C> <C> <C>
TCW Managed Asset Allocation.. 15.93% 10.02% 10.92% April 8, 1991
T. Rowe Price International
Stock(/1/).................. 13.39% 4.81% 4.89% April 8, 1991
Value Equity.................. 21.86% N/A 15.55% May 27, 1993
Dreyfus Small Cap Value....... 23.64% N/A 11.43% May 4, 1993
Dreyfus U.S. Government
Securities.................. 0.18% N/A 4.51% May 9, 1994
T. Rowe Price Equity Income... 18.01% N/A 23.24% January 3, 1995
T. Rowe Price Growth Stock.... 18.83% N/A 26.76% January 3, 1995
Opportunity Value............. N/A N/A 0.44% November 18, 1996
Enhanced Index(/2/)........... --
WRL Growth.................... 16.09% N/A 12.22% July 1, 1992
Merrill Lynch Basic Value
Focus Fund(/2/)............. N/A N/A N/A --
Merrill Lynch Developing
Capital Markets Focus
Fund(/2/)................... N/A N/A N/A --
Merrill Lynch High Current
Income Fund(/2/)............ N/A N/A N/A --
</TABLE>
- ----------------------------------
(1) Effective January 1, 1995, Rowe Price-Fleming International, Inc. became
the new adviser to the Global Growth Portfolio. The Portfolio's name
changed to the T. Rowe Price International Stock Portfolio and the
Portfolio's shareholders approved a change in investment objective from
investments in small capitalization companies on a global basis to
investments in a broad range of companies on an international basis (that
is, non-U.S. companies).
(2) The Enhanced Index Subaccount, the Merrill Lynch Basic Value Focus Fund
Subaccount, the Merrill Lynch Developing Capital Markets Focus Subaccount,
and the Merrill Lynch High Current Income Subaccount are expected to begin
operations on or about the date of this Prospectus, therefore, comparable
information is not available.
The figures for the "five year" and "from inception" periods in the above
tables reflect waiver of advisory fees and reimbursement of other expenses for
all portfolios except the T. Rowe Price Equity Income Portfolio and the T.
Rowe Price Growth Stock Portfolio. In the absence of such waivers, the average
annual total return figures above from the five year and from inception
periods would have been lower.
- 33 -
<PAGE>
All non-standard performance data will be advertised only if the standard
performance data is also disclosed. For additional information regarding the
calculation of other performance data, please refer to the Statement of
Additional Information, a copy of which may be obtained from the
Administrative and Service office upon request.
PUBLISHED RATINGS
PFL may from time to time publish in advertisements, sales literature and
reports to Owners, the ratings and other information assigned to it by one or
more independent rating organizations such as A.M. Best Company, Standard &
Poor's Insurance Ratings Services, Moody's Investors Service and Duff & Phelps
Credit Rating Co. The purpose of the ratings is to reflect the financial
strength and/or claims-paying ability of PFL and should not be considered as
bearing on the investment performance of assets held in the Mutual Fund
Account or of the safety or riskiness of an investment in the Mutual Fund
Account. Each year the A.M. Best Company reviews the financial status of
thousands of insurers, culminating in the assignment of Best's ratings. These
ratings reflect their current opinion of the relative financial strength and
operating performance of an insurance company in comparison to the norms of
the life/health insurance industry. In addition, the claims-paying ability of
PFL as measured by Standard & Poor's Insurance Ratings Services, Moody's
Investors Service or Duff & Phelps Credit Rating Co. may be referred to in
advertisements or sales literature or in reports to Owners. These ratings are
opinions of an operating insurance company's financial capacity to meet the
obligations of its insurance policies in accordance with their terms. Claims-
paying ability ratings do not refer to an insurer's ability to meet non-policy
obligations (i.e., debt/commercial paper).
PFL LIFE INSURANCE COMPANY
PFL Life Insurance Company ("PFL"), 4333 Edgewood Road, N.E., Cedar Rapids,
Iowa 52499-0001, is a stock life insurance company. It was incorporated under
the name NN Investors Life Insurance Company, Inc. under the laws of the State
of Iowa on April 19, 1961. It is principally engaged in the sale of life
insurance and annuity policies, and is licensed in the District of Columbia,
Guam, and in all states except New York. As of December 31, 1996, PFL had
assets of approximately $7.9 billion. PFL i s a wholly-owned indirect
subsidiary of AEGON USA, Inc., which conducts substantially all of its
operations through subsidiary companies engaged in the insurance business or
in providing non-insurance financial services. All of the stock of AEGON USA,
Inc . is indirectly owned by AEGON n.v. of the Netherlands. AEGON n.v., a
holding company, conducts its business through subsidiary companies engaged
primarily in the insurance business.
- 34 -
<PAGE>
THE ENDEAVOR ACCOUNTS
Premium Payments made under a Policy may be allocated to the Mutual Fund
Account, to the Fixed Account, or to a combination of these Accounts.
THE MUTUAL FUND ACCOUNT
The PFL Endeavor Variable Annuity Account comprises a portion of the PFL
Endeavor VA Separate Account of PFL Life Insurance Company (the "Mutual Fund
Account"). The PFL Endeavor VA Separate Account was established as a separate
investment account under the laws of the State of Iowa on January 19, 1990.
The Mutual Fund Account receives and invests the Premium Payments under the
Policies that are allocated to it for investment in shares of certain
portfolios of the Merrill Lynch Variable Series Funds, Inc., the Endeavor
Series Trust, and the WRL Growth Portfolio.
The Mutual Fund Account currently is divided into fourteen Subaccounts.
Additional Subaccounts may be established in the future at the discretion of
PFL. Each Subaccount invests exclusively in shares of one of the Portfolios of
the Underlying Funds. Under Iowa law, the assets of the Mutual Fund Account
are owned by PFL, but they are held separately from the other assets of PFL.
To the extent that these assets are attributable to the Policy Value of the
Policies, these assets are not chargeable with liabilities incurred in any
other business operation of PFL. Income, gains, and losses incurred on the
assets in the Subaccounts of the Mutual Fund Account, whether or not realized,
are credited to or charged against that Subaccount without regard to other
income, gains or losses of any other Account or Subaccount of PFL. Therefore,
the investment performance of any Subaccount is entirely independent of the
investment performance of PFL's general account assets or any other Account or
Subaccount maintained by PFL.
The Mutual Fund Account is registered with the SEC under the 1940 Act as a
unit investment trust and meets the definition of a separate account under
federal securities laws. However, the SEC does not supervise the management or
the investment practices or policies of the Mutual Fund Account or PFL.
Underlying Funds. The Mutual Fund Account will invest exclusively in shares
of Endeavor Series Trust and the Growth Portfolio of the WRL Series Fund, Inc.
(collectively the "Underlying Funds"). The WRL Series Fund, Inc., and the
Endeavor Series Trust are each a series-type mutual fund registered with the
SEC under the 1940 Act as an open-end, diversified management investment
company. The registration of the Underlying Funds does not, however, involve
supervision of the management or investment practices or policies of the
Underlying Funds by the SEC.
The Underlying Funds currently issue shares of the following Portfolios:
Three portfolios under the Merrill Lynch Variable Series Funds, Inc.: the
Merrill Lynch Basic Value Focus Fund, the Merrill Lynch Developing Capital
Markets Focus Fund, and the Merrill Lynch High Current Income Fund; ten
portfolios under the Endeavor Series Trust, the TCW Managed Asset
- 35 -
<PAGE>
Allocation, the TCW Money Market Portfolio, the T. Rowe Price International
Stock Portfolio, the Value Equity Portfolio, the Dreyfus Small Cap Value
Portfolio, the Dreyfus U.S. Government Securities Portfolio, the T. Rowe Price
Equity Income Portfolio, the T. Rowe Price Growth Stock Portfolio, the
Opportunity Value Portfolio, and the Enhanced Index Portfolio; and one
portfolio under the WRL Series Fund, Inc., the WRL Growth Portfolio, managed
by Janus Capital Corporation. The assets of each Portfolio are held separate
from the assets of the other Portfolios, and each Portfolio has its own
distinct investment objectives and policies. Each Portfolio operates as a
separate investment fund, and the income or losses of one Port folio generally
have no effect on the investment performance of any other Portfolio.
Merrill Lynch Asset Management, L.P. is the Adviser for the portfolios of
the Merrill Lynch Variable Series Funds, Inc. including the Merrill Lynch
Basic Value Focus Fund, the Merrill Lynch Developing Capital Markets Focus
Fund, and the Merrill Lynch High Current Income Fund.
Endeavor Investment Advisers, an investment adviser registered with the SEC
under the Investment Advisers Act of 1940, is the Endeavor Series Trust's
manager. Endeavor Investment Advisers selects and contracts with advisers for
investment services for the Portfolios of Endeavor Series Trust, reviews the
advisers' activities, and otherwise performs administerial and managerial
functions for the Endeavor Series Trust. Six advisers (the "Advisers") each
perform investment advisory services for particular Portfolios of Endeavor
Series Trust.
TCW Funds Management, Inc. (a wholly-owned subsidiary of The TCW Group,
Inc.), is the Adviser for the TCW Managed Asset Allocation Portfolio and the
TCW Money Market Portfolio. T. Rowe Price Associates, Inc. is the Adviser for
the T. Rowe Price Equity Income Portfolio and the T. Rowe Price Growth Stock
Portfolio. Rowe Price-Fleming International, Inc. (a joint venture between T.
Rowe Price Associates, Inc. and Robert Fleming Holdings Limited), is the
Adviser for the T. Rowe Price International Stock Portfolio. OpCap Advisors
(formerly known as Quest for Value Advisors), is the Adviser for the Value
Equity Portfolio and the Opportunity Value Portfolio. J.P. Morgan Investment
Management Inc. ("Morgan") (a wholly owned subsidiary of J.P. Morgan and Co.
Incorporated) is the Adviser for the Enhanced Index Portfolio. The Dreyfus
Corporation (a wholly owned subsidiary of Mellon Bank, N.A.), as successor to
The Boston Company Asset Management, Inc., is the Adviser for the Dreyfus U.S.
Government Securities Portfolio, and the Dreyfus Small Cap Value Portfolio.
WRL Investment Management, Inc., a subsidiary of Western Reserve Life
Assurance Co. of Ohio, (an affiliate of PFL), is the Adviser for the WRL
Series Fund, Inc. and contracts with Janus Capital Corporation (also an
"Adviser") as a sub-adviser to the WRL Growth Portfolio.
The Adviser of a Portfolio is responsible for selecting the investments of
the Portfolio consistent with the investment objectives and policies of the
Portfolio, and will conduct securities trading for the Portfolio. All Advisers
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are investment advisers registered with the SEC under the Investment Advisers
Act of 1940. The investment objectives of each Portfolio are summarized as
follows:
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.
Merrill Lynch Basic Value Focus Fund--seeks capital appreciation and,
secondarily, income by investment in securities, primarily equities, that
management of the Fund believes are undervalued and therefore represent basic
investment value.
Merrill Lynch Developing Capital Markets Focus Fund--seeks long-term capital
appreciation by investing in securities, principally equities, of issuers in
countries having smaller capital markets. Investing on an international basis
involves special considerations. Investing in smaller capital markets entails
the risk of significant volatility in the Fund's security prices. See "Other
Portfolio Strategies-Foreign Securities" in the Merrill Lynch Variable Series
Funds, Inc. prospectus.
Merrill Lynch High Current Income Fund--seeks as a primary objective high a
level of current income as is consistent with its investment policies and
prudent investment management, and as a secondary objective capital
appreciation to the extent consistent with its primary objective. The Fund
invests principally in fixed-income securities that are rated in the lower
rating categories of the established rating services or in unrated securities
of comparable quality. These securities (known as "junk bonds") present
special risks. Because investment in such high-yield securities entail
relatively greater risk of loss of income or principal, an investment in the
High Current Income Fund may not be appropriate as the exclusive investment to
fund the Contracts for all Contract Owners. See "Risks of High Yield
Securities" in the Merrill Lynch Variable Series Funds, Inc. prospectus.
ENDEAVOR SERIES TRUST.
TCW Money Market Portfolio--seeks current income, preservation of capital
and maintenance of liquidity through investment in short-term money market
securities. The Portfolio seeks to maintain a constant net asset value of
$1.00 per share although no assurances can be given that such constant net
asset value will be maintained.
TCW Managed Asset Allocation Portfolio--seeks high total return through a
managed asset allocation portfolio of equity, fixed income and money market
securities.
T. Rowe Price International Stock Portfolio--seeks long-term growth of
capital through investments primarily in common stocks of established non-U.S.
companies.
Value Equity Portfolio--seeks long-term capital appreciation through
investment in securities (primarily equity securities) of companies that are
believed by the Portfolio's Adviser to be undervalued in the marketplace in
relation to factors such as the companies' assets or earnings.
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Dreyfus Small Cap Value Portfolio--seeks capital appreciation through
investments in a diversified portfolio consisting primarily of equity
securities of companies with a median capitalization of approximately $750
million, provided that under normal market conditions at least 75% of the
Portfolio's investments will be in equity securities of companies with
capitalizations at the time of purchase between $150 million and $1.5 billion.
Dreyfus U.S. Government Securities Portfolio--seeks as high a level of total
return as is consistent with prudent investment strategies by investing under
normal circumstances at least 65% of its assets in debt obligations and
mortgage-backed securities issued or guaranteed by the U.S. Government, its
agencies or instrumentalities.
T. Rowe Price Equity Income Portfolio--seeks to provide substantial dividend
income and also capital appreciation by investing primarily in dividend paying
stocks of established companies.
T. Rowe Price Growth Stock Portfolio--seeks long-term growth of capital and
to increase dividend income through investment primarily in common stocks of
well established growth companies.
Opportunity Value Portfolio--seeks growth of capital over time through
investment in a portfolio consisting of common stocks, bonds and cash
equivalents, the percentages of which will vary based upon the Portfolio
Adviser's assessment of relative values.
Enhanced Index Portfolio--seeks to earn a total return modestly in excess of
the total return performance of the S&P 500 Composite Stock Index (the "S&P
500 Index") while maintaining a volatility of return similar to the S&P 500
Index.
WRL SERIES FUND, INC.
WRL Growth Portfolio managed by Janus Capital Corporation--seeks growth of
capital. At most times, this Portfolio will be invested primarily in equity
securities which are selected solely for their capital growth potential;
investment income is not a consideration.
THERE IS NO ASSURANCE THAT ANY PORTFOLIO WILL ACHIEVE ITS STATED OBJECTIVE.
MORE DETAILED INFORMATION, INCLUDING A DESCRIPTION OF EACH PORTFOLIO'S
INVESTMENT OBJECTIVE AND POLICIES AND A DESCRIPTION OF RISKS INVOLVED IN
INVESTING IN EACH OF THE PORTFOLIOS AND OF EACH PORTFOLIO'S FEES AND EXPENSES
IS CONTAINED IN THE PROSPECTUSES FOR THE UNDERLYING FUNDS, CURRENT COPIES OF
WHICH ARE ATTACHED TO THIS PROSPECTUS. INFORMATION CONTAINED IN THE UNDERLYING
FUNDS' PROSPECTUSES SHOULD BE READ CAREFULLY BEFORE INVESTING IN A SUBACCOUNT
OF THE MUTUAL FUND ACCOUNT.
PFL may receive expense reimbursements or other revenues from the Underlying
Fund or their investment advisors.
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An investment in the Mutual Fund Account, and in any Subaccount or
Portfolio, including the TCW Money Market Portfolio and the Dreyfus U.S.
Government Securities Portfolio, is not insured or guaranteed by the U.S.
government or any government agency.
Addition, Deletion, or Substitution of Investments. PFL cannot and does not
guarantee that any of the Portfolios will always be available for Premium
Payments, allocations, or transfers. PFL retains the right, subject to any
applicable law, to make certain changes in the Mutual Fund Account and its
investments. PFL reserves the right to eliminate the shares of any Portfolio
held by a Subaccount and to substitute shares of another Portfolio of the
Underlying Funds, or of another registered open-end management investment
company for the shares of any Portfolio, if the shares of the Portfolio are no
longer available for investment or if, in PFL's judgment, investment in any
Portfolio would be inappropriate in view of the purposes of the Mutual Fund
Account. To the extent required by the 1940 Act, substitutions of shares
attributable to an Owner's interest in a Subaccount will not be made without
prior notice to the Owner and the prior approval of the SEC. Nothing contained
herein shall prevent the Mutual Fund Account from purchasing other securities
for other series or classes of variable annuity policies, or from effecting an
exchange between series or classes of variable annuity policies on the basis
of requests made by Owners.
New Subaccounts may be established when, in the sole discretion of PFL,
marketing, tax, investment or other conditions warrant. Any new Subaccounts
may be made available to existing Owners on a basis to be determined by PFL.
Each additional Subaccount will purchase shares in a mutual fund portfolio or
other investment vehicle. PFL may also eliminate one or more Subaccounts if,
in its sole discretion, marketing, tax, investment or other conditions warrant
such change. In the event any Subaccount is eliminated, PFL will notify Owners
and request a reallocation of the amounts invested in the eliminated
Subaccount. If no such reallocation is provided by the Owner, PFL will
reinvest the amounts invested in the eliminated Subaccount in the Subaccount
that invests in the TCW Money Market Portfolio (or in a similar portfolio of
money market instruments) or in another Subaccount, if appropriate.
In the event of any such substitution or change, PFL may, by appropriate
endorsement, make such changes in the Policies as may be necessary or
appropriate to reflect such substitution or change. Furthermore, if deemed to
be in the best interests of persons having voting rights under the Policies,
the Mutual Fund Account may be (i) operated as a management company under the
1940 Act or any other form permitted by law, (ii) deregistered under the 1940
Act in the event such registration is no longer required or (iii) combined
with one or more other separate accounts. To the extent permitted by
applicable law, PFL also may transfer the assets of the Mutual Fund Account
associated with the Policies to another account or accounts.
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<PAGE>
THE FIXED ACCOUNT
This Prospectus is generally intended to serve as a disclosure document only
for the Policy and the Mutual Fund Account. For more complete details
regarding the Fixed Account, see the Policy itself.
Premium Payments allocated and amounts transferred to the Fixed Account
become part of the general account of PFL, which supports insurance and
annuity obligations. Interests in the general account have not been registered
under the Securities Act of 1933 (the "1933 Act"), nor is the general account
registered as an investment company under the 1940 Act. Accordingly, neither
the general account nor any interests therein are generally subject to the
provisions of the 1933 or 1940 Acts and PFL has been advised that the staff of
the SEC has not reviewed the disclosures in this Prospectus which relate to
the Fixed Account.
The Fixed Account is part of the general assets of PFL, other than those in
the Mutual Fund Account or in any other segregated asset account. The Policy
Owner may allocate Premium Payments to the Fixed Account at the time of
Premium Payment or by subsequent transfers from the Mutual Fund Account.
Instead of the Policy Owner bearing the investment risk, as is the case for
Policy Value in the Mutual Fund Account, PFL bears the full investment risk
for all Policy Value in the Fixed Account. PFL has sole discretion to invest
the assets of its general account, including the Fixed Account, subject to
applicable law. While PFL bears the full investment risk for all Policy Value
in the Fixed Account, the Owner bears the risk that PFL would not be able to
satisfy its contractual obligations.
Premium payments applied to and any amounts transferred to the Fixed Account
will reflect a fixed interest rate. The interest rates PFL sets will be
credited for increments of at least one year measured from each premium
payment or transfer date. These rates will never be less than a minimum
effective annual interest rate of 3%. Prior versions of the Policy and
Policies offered in certain states will have the minimum effective annual
interest rates specified in the Policy.
Upon Surrender of the Policy, the Owner will receive at least the Premium
Payments applied to, less prior Partial Withdrawals and transfers from, the
Fixed Account.
Guaranteed Periods. PFL may offer optional guaranteed interest rate periods
("Guaranteed Period Options" or "GPOs") into which Premium Payments may be
paid or amounts transferred. For example, PFL may, from time to time, offer
Guaranteed Period Options for periods of 1, 5, or 7 years. The current
interest rate PFL sets for funds placed in each Guaranteed Period Option will
apply to those funds until the end of the Guaranteed Period. At the end of the
Guaranteed Period, the Premium Payment or amount transferred into the
Guaranteed Period Option less any partial withdrawals or transfers from that
Guaranteed Period Option, including the effect of any Excess Interest
Adjustment or Surrender Charge due to partial withdrawals or transfers prior
to the end of the Guaranteed Period, plus accrued interest, will be rolled
into a new Guaranteed Period Option.
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<PAGE>
The Owner may choose the Guaranteed Period Option into which the funds are
to be placed by giving PFL notice within 30 days before the end of the
expiring Guaranteed Period. In the absence of such election, the new
Guaranteed Period will be the same as the expiring one. If that Guaranteed
Period Option is no longer offered by PFL, the next shorter Guaranteed Period
Option then being offered will be used. PFL reserves the right, for new
Premium Payments, transfers, or rollovers, whether or not to offer any
Guaranteed Period Option. PFL will, however, always offer at least a one-year
Guaranteed Period Option.
Surrenders, partial withdrawals and transfers from a Guaranteed Period
Option prior to the end of the Guaranteed Period may be subject to an Excess
Interest Adjustment. An Excess Interest Adjustment may result in a loss of
interest credited, but the Owner's Fixed Account Policy Values will always be
credited with an effective annual interest rate of at least 3%. Surrender
charges, if any, are applied after the Excess Interest Adjustment. However,
upon full surrender the Owner is guaranteed return of Premium Payments to the
Fixed Account, less Partial Withdrawals and transfers from the Fixed Account.
(See "DISTRIBUTIONS UNDER THE POLICY--Excess Interest Adjustment (EIA)," p.
50.)
For purposes of crediting interest, the oldest Premium Payment or transfer
into a Guaranteed Period Option within the Fixed Account, plus interest
allocable to that Premium Payment or transfer, is considered to be withdrawn
or transferred out first; the next oldest Premium Payment plus interest is
considered to be transferred out next, and so on (this is a "first-in, first-
out" procedure).
Dollar Cost Averaging Fixed Account Option. PFL may offer a Dollar Cost
Averaging Fixed Account Option separate from the Guaranteed Period Option(s).
This option will have a one-year interest rate guarantee and will only be
available under a Dollar Cost Averaging (DCA) program. The current interest
rate PFL credits for the DCA Fixed Account may differ from the rates credited
on other Guaranteed Period Option(s) in the Fixed Account.
Prior to the Annuity Commencement Date, the Owner can instruct PFL to make
automatic transfers from the Dollar Cost Averaging Fixed Account to one or
more subaccounts of the Mutual Fund Account. Transfers must be scheduled for
at least six but not more than 24 months, or for at least four, but not more
than eight quarters. No changes to the automatic amount transferred will be
allowed, but changes can be made to the Subaccounts to which these transfers
are allocated. Dollar Cost Averaging transfers from the Dollar Cost Averaging
Fixed Account will not be subject to an Excess Interest Adjustment. (See
"Dollar Cost Averaging (DCA)" p. 44.)
Guaranteed Interest Rates. PFL periodically will establish an applicable
Guaranteed Interest Rate for each of the Guaranteed Period Options within the
Fixed Account, and the Dollar Cost Averaging Fixed Account Option. Current
Guaranteed Interest Rate may be changed by PFL frequently or infrequently
depending on interest rates on investments available to PFL and other factors
as described below, but once established,
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the rate will be guaranteed for the entire duration of the Guaranteed Period.
However, except for limited situations, any amount withdrawn or transferred
will be subject to an Excess Interest Adjustment, except at the end of the
Guaranteed Period Option. (See "Excess Interest Adjustment (EIA)," p. 50.)
The Guaranteed Interest Rate will not be less than 3% per year, regardless
of any application of the Excess Interest Adjustment. PFL has no specific
formula for determining the rate of interest that it will declare as a
Guaranteed Interest Rate, as this rate will be reflective of interest rates
available on the types of debt instruments in which PFL intends to invest
amounts allocated to the Fixed Account. In addition, PFL's management may
consider other factors in determining Guaranteed Interest Rates for a
particular Guaranteed Period including but not limited to: regulatory and tax
requirements; sales commissions and administrative expenses borne by the
Company; general economic trends; and competitive factors. There is no
obligation to declare a rate in excess of 3%; the Policy Owner assumes the
risk that declared rates will not exceed 3%. PFL has complete discretion to
declare any rate of at least 3%, regardless of market interest rates, the
amounts earned by PFL on its investments, or any other factors.
PFL'S MANAGEMENT HAS COMPLETE AND SOLE DISCRETION TO DETERMINE THE
GUARANTEED INTEREST RATES. PFL CANNOT PREDICT OR GUARANTEE THE LEVEL OF FUTURE
GUARANTEED INTEREST RATES, EXCEPT THAT PFL GUARANTEES THAT FUTURE GUARANTEED
EFFECTIVE INTEREST RATES WILL NOT BE BELOW 3% PER YEAR.
TRANSFERS
An Owner can transfer Policy Values from one Investment Option to another
within certain limits. In addition, transfers (from the Guaranteed Period
Option(s) of the Fixed Account) of an amount equal to the interest credited
(that is, "interest transfers") are not subject to an Excess Interest
Adjustment, but may affect the interest crediting rates on the remaining funds
in the Guaranteed Period Option.
Subject to the limitations and restrictions described below, transfers from
an Investment Option may be made, up to thirty days prior to the Annuity
Commencement Date, by sending Written Notice, signed by the Owner, to the
Administrative and Service Office. The minimum amount which may be transferred
is the lesser of $500 or the entire Subaccount or Guaranteed Period Option
Value. If the Subaccount or Guaranteed Period Option Value remaining after a
transfer is less than $500, PFL reserves the right, at its discretion, either
to deny the transfer request or to include that amount as part of the
transfer.
If the Excess Interest Adjustment (at time of a transfer request) from any
Guaranteed Period Option is a negative adjustment, then the maximum amount of
Policy Value that can be transferred is 25% of the Guaranteed
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Period Option's Policy Value, less amounts previously transferred out of that
Guaranteed Period Option during the current Policy Year. No maximum will apply
to amounts transferred from any Guaranteed Period Option if the Excess
Interest Adjustment is a positive adjustment at the time of transfer. The
Owner must notify PFL within 30 days prior to the end of any expiring
Guaranteed Period Option to instruct PFL regarding any transfers to be
performed at that time.
Transfers prior to the Annuity Commencement Date currently may be made
without charge as often as the Owner wishes, subject to the minimum amount
specified above. PFL reserves the right to limit these transfers to no more
than 12 per Policy Year in the future or to charge up to $10 per transfer in
excess of 12 per Policy Year.
The Owner may transfer an amount up to the interest credited in any of the
Guaranteed Period Option(s) to any Subaccount(s) of the Mutual Fund Account
prior to the end of the Guaranteed Period. No Excess Interest Adjustment will
apply to such interest transfers. Interest transfers may affect the interest
crediting rates on the remaining funds in the Guaranteed Period Option. This
is because interest transfers may have the effect of reducing or eliminating
principal amounts in the Guaranteed Period Options since, for purposes of
crediting interest, PFL considers the oldest Premium Payment or transfer into
the Guaranteed Period Option, plus interest allocable to that particular
Premium Payment or transfer, to be withdrawn first.
Transfers out of the Dollar Cost Averaging Fixed Account, except through an
automatic Dollar Cost Averaging program, are not allowed.
After the Annuity Commencement Date, transfers out of the Fixed Account are
not permitted, and transfers between Subaccounts or from Subaccounts to the
Fixed Account may be limited to once per Policy Year. (See "DISTRIBUTIONS
UNDER THE POLICY--Annuity Payment Options," p. 53.)
Transfers may be made by telephone, subject to the provisions described
below under "Telephone Transactions."
REINSTATEMENTS
Requests are occasionally received by PFL to reinstate funds which had been
transferred to another insurance company pursuant to a Section 1035 exchange
or trustee-to-trustee transfer under the Code. In this situation PFL will
require the Owner to replace the same total amount of money in the applicable
Subaccounts or Fixed Accounts as taken from them to effect the exchange. The
total dollar amount of funds reapplied to the Separate Account will be used to
purchase a number of Accumulation Units available for each Subaccount based on
the Accumulation Unit prices at the date of reinstatement (within two days
after the date the funds are received by PFL). The number of Accumulation
Units available on the reinstatement date may be more or less than the number
of Units surrendered for the exchange. Amounts reapplied to the Fixed Account
will receive the effective
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annual interest rate they would otherwise have received, had they not been
withdrawn. However, an adjustment will be made to the amount reapplied to
compensate PFL for the additional interest credited during the period of time
between the withdrawal and the reapplication of the funds. Owners should
consult a qualified tax adviser concerning the tax consequences of any Section
1035 exchanges or reinstatements.
TELEPHONE TRANSACTIONS
An Owner (or the Owner's designated account executive) may make transfers
and/or change the allocation of subsequent Premium Payments by telephone.
Telephone transfers are only allowed if the "Telephone Transfer/Reallocation
Authorization" box in the Policy application has been checked or telephone
transfers have been subsequently authorized in writing on a form provided by
PFL by the Owner. PFL will not be liable for following instructions
communicated by telephone that it reasonably believes to be genuine. PFL will
employ reasonable procedures, however, to confirm that instructions
communicated by telephone are genuine. If PFL fails to do so, it may be liable
for any losses due to unauthorized or fraudulent instructions. All telephone
requests will be recorded on voice recorder equipment for the protection of
the Owner. The Owner, when making telephone requests, will be required to
provide a social security number or other information for identification
purposes.
Telephone requests must be received at the Administrative and Service Office
no later than 3:00 p.m. Central time in order to assure same day pricing of
the transaction.
At its discretion, PFL may discontinue the telephone transaction privilege
at any time as to some or all Owners, and PFL may require written confirmation
of any transaction request.
DOLLAR COST AVERAGING (DCA)
Under the Dollar Cost Averaging program, prior to the Annuity Commencement
Date, the Owner can instruct PFL to automatically transfer a specified dollar
amount from the Dollar Cost Averaging Fixed Account Option, the TCW Money
Market Subaccount or the Dreyfus U.S. Government Securities Subaccount to any
other Subaccount or Subaccounts of the Mutual Fund Account. The automatic
transfers can occur monthly or quarterly and will occur on the 28th day of the
month. If the Dollar Cost Averaging request is received prior to the 28th day
of any month, the first transfer will occur on the 28th day of that month. If
the Dollar Cost Averaging request is received on or after the 28th day of any
month, the first transfer will occur on the 28th day of the following month.
The amount transferred each time must be at least $500. A minimum of six
monthly or four quarterly transfers are required and a maximum of 24 monthly
or eight quarterly transfers are allowed from the Dollar Cost Averaging Fixed
Account.
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Dollar Cost Averaging results in the purchase of more units when the Unit
Value is low, and fewer units when the Unit Value is high. However, there is
no guarantee that the Dollar Cost Averaging program will result in higher
Policy Values or will otherwise be successful. Dollar Cost Averaging requires
regular investment regardless of fluctuating prices and does not guarantee
profits nor prevent losses in a declining market. Before electing this option,
individuals should consider their financial ability to continue transfers
through periods of both high and low price levels.
The Owner may request Dollar Cost Averaging when purchasing the Policy or at
a later date. The program will terminate when the amount in the Dollar Cost
Averaging Fixed Account, the TCW Money Market Subaccount or the Dreyfus U.S.
Government Securities Subaccount is insufficient for the next transfer, at
which time the entire remaining balance is transferred.
Except for automatic Dollar Cost Averaging transfers from the Dollar Cost
Averaging Fixed Account Option the Owner may increase or decrease the amount
of the transfers by sending PFL a new Dollar Cost Averaging form. The Owner
may discontinue the program at any time by sending a Written Notice to the
Administrative and Service Office. The minimum number of transfers (6 monthly
or 4 quarterly) requirement must be satisfied each time the Dollar Cost
Averaging program is restarted following termination of the program for any
reason. There is no charge for participation in the Dollar Cost Averaging
program.
ASSET REBALANCING
Prior to the Annuity Commencement Date the Owner may instruct PFL to
automatically transfer amounts among the Subaccounts of the Mutual Fund
Account on a regular basis to maintain a desired allocation of the Policy
Value among the various Subaccounts offered. Rebalancing will occur on a
monthly, quarterly, semi-annual, or annual basis, beginning on a date selected
by the Owner. If no date is selected, the account will be rebalanced on the
day of the month the Policy was effective. The Owner must select the
percentage of the Policy Value desired in each of the various Subaccounts
offered (totaling 100%). Any amounts in the Fixed Account are ignored for
purposes of asset rebalancing. Rebalancing may be started, stopped, or changed
at any time, except that rebalancing will not be available when:
(1) Automatic Dollar Cost Averaging transfers are being made; or
(2) any other transfer is requested.
There is no charge for participation in the asset rebalancing program.
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THE POLICY
The Endeavor Variable Annuity Policy is a Flexible Premium Variable Annuity
Policy. The rights and benefits under the Policy are summarized below;
however, the description of the Policy contained in this Prospectus is
qualified in its entirety by reference to the Policy itself, a copy of which
is available upon request from PFL. The Policy may be purchased on a non-tax
qualified basis ("Nonqualified Policy"). The Policy may also be purchased and
used in connection with retirement plans or individual retirement accounts
that qualify for favorable federal income tax treatment ("Qualified Policy").
POLICY APPLICATION AND ISSUANCE OF POLICIES--PREMIUM PAYMENTS
Before it will issue a Policy, PFL must receive a completed Policy
application or transmittal form and a minimum initial Premium Payment of
$5,000 for a Nonqualified Policy, or $1,000 for a Qualified Policy. There is
no minimum initial Premium Payment required for tax deferred 403(b) annuity
purchases, any amount selected by the Owner in such case, up to the maximum
total premium payment allowed by PFL, may be used to start a Policy. The
initial Premium Payment for tax deferred 403(b) purchases must be received
within 90 days following the Policy Date, otherwise the Policy will be
canceled. The initial Premium Payment is the only Premium Payment required to
be paid under a Policy. A Policy ordinarily will be issued only in respect of
Annuitants Age 0 through 80. Acceptance or declination of an application shall
be based on PFL's underwriting standards, and PFL reserves the right to reject
any application or Premium Payment based on those underwriting standards.
If the application or transmittal form can be accepted in the form received,
the initial Premium Payment will be credited to the Policy Value within two
Business Days after the later of receipt of the information needed to issue
the Policy or receipt of the initial Premium Payment. If the initial Premium
Payment cannot be credited because the application or other issuing
requirements are incomplete, the applicant will be contacted within five
Business Days and given an explanation for the delay and the initial Premium
Payment will be returned at that time unless the applicant consents to PFL's
retaining the initial Premium Payment and crediting it as soon as the
necessary requirements are fulfilled.
The date on which the initial Premium Payment is credited to the Policy
Value is the Policy Date. The Policy Date is the date used to determine Policy
Years and Policy Anniversaries.
All checks or drafts for Premium Payments should be made payable to PFL Life
Insurance Company and sent to the Administrative and Service Office. The Death
Benefit will not take effect until the Premium Payment is received and any
check or draft for the Premium Payment is honored.
Additional Premium Payments. While the Annuitant is living and prior to the
Annuity Commencement Date, the Owner may make additional
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Premium Payments at any time, and in any frequency. The minimum additional
Premium Payment under both a Nonqualified Policy and a Qualified Policy is
$50. Additional Premium Payments will be credited to the Policy and added to
the Policy Value as of the Business Day when the premium and required
information are received.
Maximum Total Premium Payments. The maximum total Premium Payments allowed
without prior approval of PFL is $1,000,000.
Allocation of Premium Payments. An Owner must allocate Premium Payments to
one or more of the Investment Options. The Owner must specify the initial
allocation in the Policy application or transmittal form. This allocation will
be used for Subsequent Additional Premium Payments unless the Owner requests a
change of allocation. All allocations must be made in whole percentages and
must total 100%. If Premium Payments are allocated to the Dollar Cost
Averaging Fixed Account, directions regarding the Subaccount(s) to which
transfers are to be made must be specified on the Application or other proper
Written Request. If the Owner fails to specify how Premium Payments are to be
allocated, the Premium Payment(s) cannot be accepted.
The Owner may change the allocation instructions for future subsequent
additional Premium Payments by sending Written Notice, signed by the Owner, to
PFL's Administrative and Service Office, or by telephone (subject to the
provisions described under "Telephone Transactions," p. 44.) The allocation
change will apply to Premium Payments received after the date the Written
Notice or telephone request is received.
Payment Not Honored by Bank. Any payment due under the Policy which is
derived, all or in part, from any amount paid to PFL by check or draft may be
postponed until such time as PFL determines that such instrument has been
honored.
POLICY VALUE
On the Policy Date, the Policy Value equals the initial Premium Payment.
Thereafter, the Policy Value equals the sum of the values in the Mutual Fund
Account and the Fixed Account. The Policy Value will increase by: (1) any
Subsequent Additional Premium Payments received by PFL; (2) any increases in
the Policy Value due to investment results of the selected Subaccount(s); (3)
any positive Excess Interest Adjustments on transfers, and (4) interest
credited in the Fixed Account. The Policy Value will decrease by (1) any
surrenders, including applicable Excess Interest Adjustments and/or Surrender
Charges; (2) any decreases in the Policy Value due to investment results of
the selected Subaccounts; (3) the charges and deductions imposed by PFL; and
(4) any negative Excess Interest Adjustments on transfers.
The Policy Value is expected to change from Valuation Period to Valuation
Period, reflecting the investment experience of the selected Subaccount(s), as
well as the deductions for charges. A Valuation Period is
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the period between successive Business Days. It begins at the close of
business on each Business Day and ends at the close of business on the next
succeeding Business Day. A Business Day is each day that the New York Stock
Exchange is open for business. Holidays are generally not Business Days.
The Mutual Fund Account Value. When a Premium Payment is allocated or an
amount is transferred to a Subaccount of the Mutual Fund Account, it is
credited to the Policy Value in the form of Accumulation Units. Each
Subaccount of the Mutual Fund Account has a distinct Accumulation Unit value
(the "Unit Value"). The number of Accumulation Units credited is determined by
dividing the Premium Payment or amount transferred by the Unit Value of the
Subaccount as of the end of the Valuation Period during which the allocation
is made. When amounts are transferred out of, or surrendered or withdrawn from
a Subaccount, Accumulation Units are canceled or redeemed in a similar manner.
For each Subaccount, the Unit Value for a given Business Day is based on the
net asset value of a share of the corresponding Portfolio of the Underlying
Funds. Therefore, the Unit Values will fluctuate from day to day based on the
investment experience of the corresponding Portfolio. The determination of
Subaccount Unit Values is described in detail in the Statement of Additional
Information.
AMENDMENTS
No change in the Policy is valid unless made in writing by PFL and approved
by one of PFL's officers. No registered representative has authority to change
or waive any provision of the Policy.
PFL reserves the right to amend the Policies to meet the requirements of the
Code, regulations or published rulings. An Owner can refuse such a change by
giving Written Notice, but a refusal may result in adverse tax consequences.
NON-PARTICIPATING POLICY
The Policy does not participate or share in the profits or surplus earnings
of PFL. No dividends are payable on the Policy.
DISTRIBUTIONS UNDER THE POLICY
SURRENDERS
Prior to the Annuity Commencement Date, the Owner may surrender all or a
portion of the Cash Value in exchange for a cash payment from PFL. The Cash
Value is the Policy Value less any applicable Surrender Charge plus or minus
any Excess Interest Adjustments. (See "Annuity Payment Options," p. 53.) The
Policy cannot be surrendered after the Annuity Commencement Date. (See
"Annuity Payments," p. 51.)
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When requesting a partial withdrawal ($500 minimum), the Owner must tell PFL
how the withdrawal is to be allocated from among various Guaranteed Period
Options of the Fixed Account and/or the Subaccount(s) of the Mutual Fund
Account. If the Owner's request for a partial withdrawal from a Guaranteed
Period Option of the Fixed Account is greater than the Cash Value of that
Guaranteed Period Option, PFL will pay the Owner the amount of the Cash Value
of that Guaranteed Period Option. If no allocation instructions are given, the
withdrawal will be deducted from each Investment Option in the same proportion
that the Policy Owner's interest in each Investment Option bears to the
Policy's total Policy Value. PFL reserves the right to defer payment of the
Cash Value from the Fixed Account for up to six months.
Beginning in the second Policy Year, an Owner may request a partial
withdrawal of up to 10% of the Policy Value at the time of withdrawal without
an Excess Interest Adjustment and without a Surrender Charge if no withdrawal
has been made in the current Policy Year ("10% Withdrawals"). Amounts
withdrawn from the Policy in excess of the 10% Withdrawal or withdrawn in the
same Policy Year as a previous 10% Withdrawal (and all surrenders in the first
Policy Year) are subject to the Excess Interest Adjustment and to the
Surrender Charge. Neither a Surrender Charge nor an Excess Interest Adjustment
will be assessed if the withdrawal is necessary to meet the minimum
distribution requirements for that Policy specified by the Code for tax-
qualified plans.
10% Withdrawals will reduce the Policy Value by the amount withdrawn.
Amounts requested in excess of the 10% Withdrawal are Excess Partial
Withdrawals. Excess Partial Withdrawals will reduce the Policy Value by an
amount equal to (X-Y + Z) where:
X = Excess Partial Withdrawal
Y = Excess Interest Adjustment applicable to the Excess Partial Withdrawal
Z = Surrender Charge on X minus Y.
For a discussion of the Surrender Charge, see "CHARGES AND DEDUCTIONS--
Surrender Charge," p. 60. For a discussion of the Excess Interest Adjustment,
see "DISTRIBUTIONS UNDER THE POLICY--Excess Interest Adjustment (EIA)," p. 50,
and Appendix A.
Since the Owner assumes the investment risk with respect to Premium Payments
allocated to the Mutual Fund Account, and because partial withdrawals may be
subject to an Excess Interest Adjustment and to a Surrender Charge, and
possibly income taxes or premium taxes, the total amount paid upon total
surrender of the Cash Value (taking any prior surrenders into account) may be
more or less than the total Premium Payments made. Following a surrender of
the total Cash Value, or at any time the Policy Value is zero, all rights of
the Owner and Annuitant will terminate.
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<PAGE>
In addition to the Excess Interest Adjustment and Surrender Charge and any
applicable premium taxes, surrenders may be subject to income taxes and, if
prior to age 59 1/2, a ten percent Federal penalty tax. (See "CERTAIN FEDERAL
INCOME TAX CONSEQUENCES," p. 63.)
NURSING CARE AND TERMINAL CONDITION WITHDRAWAL OPTION
If the Owner or Owner's spouse (Annuitant or Annuitant's spouse if the Owner
is not a natural person): (1) has been confined in a hospital or nursing
facility for 30 consecutive days, or (2) has been diagnosed as having a
terminal condition as defined in the Policy or endorsement (generally a life
expectancy of 12 months or less), then the Surrender Charge, and Excess
Interest Adjustment, are not imposed on surrenders or partial withdrawals.
(This benefit may not be available in all states or in all Policy forms--see
the Policy or endorsement for details.)
EXCESS INTEREST ADJUSTMENT (EIA)
Surrenders, partial withdrawals, transfers, and amounts applied to a Payment
Option (prior to the end of a Guaranteed Period) from the Fixed Account
Guaranteed Period Options will be subject to an Excess Interest Adjustment
except as provided for under "Surrenders" or "Nursing Care and Terminal
Condition Withdrawal Option" above or "Systematic Payout Option," below. Prior
versions of the Policy or Policies offered in certain states may not be
subject to an Excess Interest Adjustment.
The Excess Interest Adjustment partially compensates PFL for the foregoing
early removal of funds from the Guaranteed Period Options where interest rates
declared by PFL have risen since the date of the guarantee. Conversely, the
Excess Interest Adjustment allows PFL to share the benefit of falling interest
rates with the Owner upon such withdrawals.
Generally, if interest rates declared by PFL have risen since the date of
the guarantee, the application of the Excess Interest Adjustment (a negative
Excess Interest Adjustment in this case) will result in a lower payment upon
surrender. Conversely, if interest rates have fallen since the date of the
guarantee, the application of the Excess Interest Adjustment (a positive
Excess Interest Adjustment in this case) will result in a higher payment upon
surrender.
Excess Interest Adjustments will not reduce the Adjusted Policy Value for a
Guaranteed Period Option below the Premium Payments and transfers to that
Guaranteed Period Option, less any prior partial withdrawals and transfers
from that Guaranteed Period Option, plus interest at the Policy's minimum
guaranteed effective annual interest rate of 3%.
The formula for calculating the Excess Interest Adjustment and examples of
the application of the Excess Interest Adjustments are set forth in Appendix A
to this Prospectus.
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<PAGE>
SYSTEMATIC PAYOUT OPTION
Under the Systematic Payout Option, Policy Owners can instruct PFL to make
automatic payments to them monthly, quarterly, semi-annually or annually from
a specified Subaccount. Monthly and quarterly payments can only be sent by
electronic funds transfer directly to a checking or savings account. The
minimum payment is $50. The maximum payment is 10% of the Policy Value at the
time the Systematic Payout is made divided by the number of payouts made per
year (for example, 12 for monthly). If this requested amount is below the
minimum distribution requirements for that policy specified by the IRS for tax
qualified plans, the maximum payment will be increased to this minimum
required distribution amount. The "Request for Systematic Payout" form must
specify a date for the first payment, which must be at least 30 days but not
more than one year after the form is submitted (i.e., Systematic Payouts will
start at the end of the payment mode selected, but not earlier than 30 days
from the date of request).
The Surrender Charge and Excess Interest Adjustment will be waived for
Policy Owners under age 59 1/2 of Qualified Policies if they take Systematic
Payouts using one of the payout methods described in IRS Notice 89-25, Q&A-12
(the Life Expectancy Recalculation Option, Amortization, or Annuity Factor)
which generally require payments for life or life expectancy. These payments
must be continued until the later of age 59 1/2 or five years from their
commencement. No additional partial withdrawal may be taken during this time.
For Qualified Policies, when the Policy Owner is age 59 1/2 or older, the
Surrender Charge and Excess Interest Adjustment will be waived if payments are
made using the Life Expectancy Recalculation Option.
In addition, for either Qualified or Nonqualified Policies, the Surrender
Charge and Excess Interest Adjustment will not be imposed on Systematic
Payouts.
Qualified Policies are subject to complex rules with respect to restrictions
on and taxation of distributions, including the applicability of penalty
taxes. In addition, the tax treatment of systematic payouts from Nonqualified
Policies has had an unfavorable ruling regarding the ability to avoid the 10%
penalty tax. Therefore, the Policy Owner should consult a qualified tax
adviser before requesting a Systematic Payout. In certain circumstances
withdrawn amounts may be included in the Policy Owner' s gross income. (See
"CERTAIN FEDERAL INCOME TAX CONSEQUENCES," p. 63.)
ANNUITY PAYMENTS
Annuity Commencement Date. Unless the Annuity Commencement Date is changed,
Annuity Payments under a Policy will begin on the Annuity Commencement Date
selected by the Owner at the time the Owner applies for the Policy. The
Annuity Commencement Date may be changed from time to time by the Owner by
Written Notice to PFL, provided that notice of each
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change is received by PFL at its Administrative and Service Office at least
thirty (30) days prior to the then current Annuity Commencement Date. Except
as otherwise permitted by PFL, a new Annuity Commencement Date must be a date
which is: (1) at least thirty (30) days after the date notice of the change is
received by PFL; and (2) not later than the last day of the policy month
starting after the Annuitant attains age 85. In no event will an Annuity
Commencement Date be permitted to be later than the last day of the month
following the month in which the Annuitant attains age 95. The Annuity
Commencement Date may also be changed by the Beneficiary's election of the
Annuity Option after the Annuitant's death.
Election of Payment Option. During the lifetime of the Annuitant and prior
to the Annuity Commencement Date, the Owner may choose an Annuity Payment
Option or change the election, but Written Notice of any election or change of
election must be received by PFL at its Administrative and Service Office at
least thirty (30) days prior to the Annuity Commencement Date. If no election
is made prior to the Annuity Commencement Date, Annuity Payments will be made
under (i) Option 3, life income with level payments for 10 years certain,
using the existing Adjusted Policy Value of the Fixed Account, or (ii) under
Option 3-V, life income with variable payments for 10 years certain using the
existing Adjusted Policy Value of the Mutual Fund Account, or (iii) in a
combination of (i) and (ii) if the Adjusted Policy Value is allocated among
both the Fixed Account and the Mutual Fund Account. If the Adjusted Policy
Value on the Annuity Commencement Date is less than $2000, PFL reserves the
right to pay it in one lump sum in lieu of applying it under an Annuity
Payment Option.
Prior to the Annuity Commencement Date, the Beneficiary may elect to receive
the Death Benefit in a lump sum or under one of the Payment Options, to the
extent allowed by law and subject to the terms of any settlement agreement.
(See "Death Benefit," p. 56.) Subject to the restrictions of certain state
laws, Annuity Payments will be made on either a fixed basis or a variable
basis as selected by the Owner (or the Beneficiary, after the Annuitant's
death).
The person who elects a Payment Option can also name one or more successor
payees to receive any unpaid amount PFL has at the death of a payee. Naming
these payees cancels any prior choice of a successor payee.
A payee who did not elect the Payment Option does not have the right to
advance or assign payments, take the payments in one sum, or make any other
change. However, the payee may be given the right to do one or more of these
things if the person who elects the option tells PFL in writing and PFL
agrees.
Unless the Policy Owner specifies otherwise, the payee shall be the
Annuitant, or, after the Annuitant's death, the Beneficiary. PFL may require
written proof of the age of any person who has an annuity purchased under
Option 3, 3-V, 5 or 5-V.
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<PAGE>
Premium Tax. PFL may be required by state law to pay premium tax on the
amount applied to a Payment Option, upon Surrender, or upon payment of death
proceeds. If so, PFL will deduct the premium tax before applying or paying the
proceeds.
Supplementary Policy. Once proceeds become payable and a Payment Option has
been chosen, PFL will issue a Supplementary Policy in settlement of the option
elected under the Policy setting forth the terms of the option elected. The
Supplementary Policy will name the payees and will describe the payment
schedule.
ANNUITY PAYMENT OPTIONS
The Policy provides five Payment Options which are described below. Three of
these are offered as either "Fixed Payment Options" or "Variable Payment
Options," and two are only available as Fixed Payment Options. The Policy
Owner may elect a Fixed Payment Option, a Variable Payment Option, or a
combination of both. If the Policy Owner elects a combination, he must specify
what part of the Policy proceeds are to be applied to the Fixed and Variable
Options (and he must also specify which Subaccounts for the Variable Options).
NOTE CAREFULLY: Under Payment Options 3(1) and 5 (including 3-V(1) and 5-V),
it would be possible for only one Annuity Payment to be made if the
Annuitant(s) were to die before the due date of the second annuity payment;
only two Annuity Payments if the Annuitant(s) were to die before the due date
of the third annuity payment; and so forth.
On the Annuity Commencement Date, the Policy's Adjusted Policy Value will be
applied to provide for Annuity Payments under the selected Annuity Option as
specified. The Adjusted Policy Value is the Policy Value (for the Valuation
Period which ends immediately preceding the Annuity Commencement Date),
increased or decreased by any applicable Excess Interest Adjustment.
The effect of choosing a Fixed Annuity Option is that the amount of each
payment will be set on the Annuity Commencement Date and will not change. If a
Fixed Annuity Option is selected, the Adjusted Policy Value will be
transferred to the general account of PFL, and the Annuity Payments will be
fixed in amount by the fixed annuity provisions selected and the age and sex
(if consideration of sex is allowed under applicable law) of the Annuitant.
For further information, contact PFL at its Administrative and Service Office.
Guaranteed Values. There are five Fixed Annuity Options. Options 1, 2 and 4
are based on a guaranteed interest rate of 3%. Options 3 and 5 are based on a
guaranteed effective annual interest rate of 3% using the "1983 Table a"
(male, female, and unisex if required by law) mortality table improved to the
year 2000 with projection scale G. ("The 1983 Table a" mortality rates are
adjusted based on improvements in mortality since 1983 to more appropriately
reflect increased longevity. This is accomplished using a set of improvement
factors referred to as projection scale G.)
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Option 1--Interest Payments. The policy proceeds may be left with PFL for
any term as agreed by PFL and the Owner. PFL will pay the interest in equal
payments or it may be left to accumulate. Withdrawal rights will be agreed
upon by the Owner and PFL when the option is elected.
Option 2--Income for a Specified Period. Level payments of the proceeds with
interest are made for the fixed period elected, at which time the funds are
exhausted.
Option 3--Life Income. An election may be made between:
1. "No Period Certain"--Level payments will be made during the
lifetime of the Annuitant.
2. "10 Years Certain"--Level Payments will be made for the longer of
the Annuitant's lifetime or ten years.
3. "Guaranteed Return of Policy Proceeds"--Level payments will be
made for the longer of the Annuitant's lifetime or the number of
payments which, when added together, equals the proceeds applied
to the income option.
Option 4--Income of a Specified Amount. Payments are made for any specified
amount until the proceeds with interest are exhausted.
Option 5--Joint and Survivor Annuity. Payments are made during the joint
lifetime of the payee and a joint payee of the Owner's selection. Payments
will be made as long as either person is living.
Other options may be arranged by agreement with PFL. Certain options may not
be available in some states.
Current immediate annuity rates for the same class of annuities will be used
if higher than the guaranteed amount (guaranteed amounts are based upon the
tables contained in the Policy). Current amounts may be obtained from PFL.
Variable Payment Options. The dollar amount of the first Variable Annuity
Payment will be determined in accordance with the annuity payment rates set
forth in the applicable table contained in the Policy. The tables are based on
a 5% effective annual assumed investment return and the "1983 Table a" (male,
female, and unisex if required by law) mortality table improved to the year
2000 with projection Scale G. ("The 1983 Table a" mortality rates are adjusted
based on improvements in mortality since 1983 to more appropriately reflect
increased longevity. This is accomplished using a set of improvement factors
referred to as projection scale G.) The dollar amount of subsequent Variable
Annuity Payments will vary based on the investment performance of the
Subaccount of the Mutual Fund Account selected by the Annuitant or
Beneficiary. If the actual investment performance exactly matched the Assumed
Investment Return of 5% at all times, the amount of each Variable Annuity
Payment would remain equal. If actual investment performance exceeds the
Assumed Investment Return, the amount of the payments would increase.
Conversely, if actual investment performance is worse than the Assumed
Investment Return, the amount of the payments would decrease.
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Determination of the First Variable Payment. The amount of the first
variable payment depends upon the sex (if consideration of sex is allowed) and
adjusted age of the Annuitant. The adjusted age is the Annuitant's actual age
nearest birthday, at the Annuity Commencement Date, adjusted as follows:
<TABLE>
<CAPTION>
ANNUITY COMMENCEMENT DATE ADJUSTED AGE
------------------------- --------------------
<S> <C>
Before 2001 Actual Age
2001-2010 Actual Age minus 1
2011-2020 Actual Age minus 2
2021-2030 Actual Age minus 3
2031-2040 Actual Age minus 4
After 2040 As determined by PFL
</TABLE>
This adjustment assumes an increase in life expectancy, and therefore it
results in lower payments than without such an adjustment.
The following Variable Payment Options generally are available:
Option 3-V--Life Income. An election may be made between:
1. "No Period Certain"--Payments will be made during the lifetime of
the Annuitant.
2. "10 Years Certain"--Payments will be made for the longer of the
Annuitant's lifetime or ten years.
Option 5-V--Joint and Survivor Annuity. Payments are made as long as either
the Annuitant or the joint Annuitant is living.
Certain options may not be available in some states.
Determination of Subsequent Variable Payments. All Variable Annuity Payments
other than the first are calculated using "Annuity Units" which are credited
to the Policy. The number of Annuity Units to be credited in respect of a
particular Subaccount is determined by dividing that portion of the first
Variable Annuity Payment attributable to that Subaccount by the Annuity Unit
Value of that Subaccount for the Annuity Commencement Date. The number of
Annuity Units of each particular Subaccount credited to the Policy then
remains fixed. The dollar value of variable Annuity Units in the chosen
Subaccount will increase or decrease reflecting the investment experience of
the chosen Subaccount. The dollar amount of each Variable Annuity Payment
after the first may increase, decrease or remain constant, and is equal to the
sum of the amounts determined by multiplying the number of Annuity Units of
each particular Subaccount credited to the Policy by the Annuity Unit Value
for the particular Subaccount on the date the payment is made.
Transfers. A Policy Owner may transfer the value of the Annuity Units from
one Subaccount to another within the Mutual Fund Account or to the Fixed
Account. However, after the Annuity Commencement Date no transfers may be made
from the Fixed Account to the Mutual Fund Account. The minimum amount which
may be transferred is the lesser of $10 of
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monthly income or the entire monthly income of the variable Annuity Units in
the Subaccount from which the transfer is being made. The remaining Annuity
Units in the Subaccount must provide at least $10 of monthly income. If, after
a transfer, the monthly income of the remaining Annuity Units in a Subaccount
would be less than $10, PFL reserves the right to include those Annuity Units
as part of the transfer. PFL reserves the right to limit transfers between
Subaccounts or to the Fixed Account after the Annuity Commencement Date to
once per Policy Year.
Tax Withholding. A portion or the entire amount of the Annuity Payments may
be taxable as ordinary income. If, at the time the Annuity Payments begin, the
Policy Owner has not provided PFL with a written election not to have federal
income taxes withheld, PFL must by law withhold such taxes from the taxable
portion of such annuity payments and remit that amount to the federal
government. Withholding is mandatory for certain Qualified Policies. (See
"CERTAIN FEDERAL INCOME TAX CONSEQUENCES," p. 63.)
Adjustment of Annuity Payments. Payments will be made at 1, 3, 6, or 12
month intervals. If the individual payments provided for would be or become
less than $50, PFL may change, at its discretion, the frequency of payments to
such intervals as will result in payments of at least $50. If the Adjusted
Policy Value on the Annuity Commencement Date is less than $2,000, PFL may pay
such value in one sum in lieu of the payments otherwise provided for.
DEATH BENEFIT
Death of Annuitant Prior to Annuity Commencement Date. A Death Benefit will
be paid to the Beneficiary if the Owner, who is the Annuitant, dies prior to
the Annuity Commencement Date. The amount of the Death Benefit is the greatest
of the Policy Value, Cash Value or the Guaranteed Minimum Death Benefit
selected. Prior versions of the Policy or Policies offered in certain states
may provide for a different definition or calculation of the Death Benefit.
See the Policy or endorsement for details. The Death Benefit is not payable
upon the death of the Annuitant if the Annuitant and the Owner are not the
same person unless the Owner makes a separate election.
There are three Guaranteed Minimum Death Benefit Options available: (A) The
"5% Annually Compounding Death Benefit," (B) the "Annual Step-Up Death
Benefit," and (C) the "Return of Premium Death Benefit."
The "5% Annually Compounding Death Benefit" is the total Premium Payments
less any Adjusted Partial Withdrawals plus interest at an effective annual
rate of 5% from the payment or withdrawal date up to the date of death.
The "Annual Step-Up Guaranteed Minimum Death Benefit" is the highest Policy
Value on any Policy Anniversary prior to the earlier of the date of death or
the Owner's 81st birthday, plus Premium Payments less any Adjusted Partial
Withdrawals since that anniversary. For this purpose, the
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Policy Date will be treated as a Policy Anniversary. Any applicable Excess
Interest Adjustments on transfers from the Fixed Account will affect the value
of this Guaranteed Minimum Death Benefit.
The "Return of Premium Death Benefit" is the total Premium Payments less any
Adjusted Partial Withdrawals (defined below) as of the date of death.
Under all Guaranteed Minimum Death Benefit Options, if the surviving spouse
elects to continue the Policy in lieu of receiving the Death Benefit, an
amount equal to the excess, if any, of the Guaranteed Minimum Death Benefit
over the Policy Value, will then be added to the Policy Value. This amount
will be added only once, at the time of such election.
The 5% Annually Compound Death Benefit is not available if either the
Annuitant or the Owner is age 75 or higher on the Policy Date. The Annual
Step-Up Death Benefit is not available if either the Annuitant or the Owner is
age 81 or higher on the Policy Date. If no choice is made in the Policy
application then the Return of Premium Death Benefit will apply.
After the Policy Date, an election cannot be made and the Guaranteed Minimum
Death Benefit option cannot be changed.
The Death Benefit is based on values determined on the later of when PFL
receives due proof of death and an election of a settlement option.
Adjusted Partial Withdrawal. The Adjusted Partial Withdrawal is the total
amount deducted from the Guaranteed Minimum Death Benefit following a partial
withdrawal of the Policy Value. Each Adjusted Partial Withdrawal is the sum of
(1) and (2), where:
(1) The 10% Withdrawal and,
(2) The amount that an Excess Partial Withdrawal reduces the Policy Value.
(See "DISTRIBUTIONS UNDER THE POLICY--Surrenders," p. 48) times [(a)
divided by (b)] where:
(a) is the Death Benefit less any 10% Withdrawals; and
(b) is the Policy Value less any 10% Withdrawals.
If a partial withdrawal is taken when the Guaranteed Minimum Death Benefit
exceeds the Policy Value, then the amount deducted from the Guaranteed Minimum
Death Benefit as a result of the partial withdrawal (that is, the Adjusted
Partial Withdrawal) will exceed the amount of the partial withdrawal request.
In that case, the total proceeds of a partial withdrawal followed by a Death
Benefit could be less than total Premium Payments.
Due Proof of Death of the Annuitant is proof that the Annuitant who is the
Owner died prior to the commencement of Annuity Payments. Upon receipt of this
proof, an election of a method of settlement and return of the Policy, the
Death Benefit generally will be paid within seven days, or as soon thereafter
as PFL has sufficient information about the Beneficiary to make
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the payment. The Beneficiary may receive the amount payable in a lump sum cash
benefit, or, subject to any limitation under any state or federal law, rule,
or regulation, under one of the Annuity Payment Options described above,
unless a settlement agreement is effective at the death of the Owner
preventing such election.
If the Annuitant was the Policy Owner, and the Beneficiary was not the
Annuitant's spouse, the Death Benefit must (1) be distributed within five
years of the date of the deceased Owner's death, or (2) payments under a
Payment Option must begin within one year of the deceased Owner's death and
must be made for the Beneficiary's lifetime or for a period certain (so long
as any certain period does not exceed the Beneficiary's life expectancy).
Death proceeds which are not paid to or for the benefit of a natural person
must be distributed within five years of the date of the deceased Owner's
death. If the sole Beneficiary is the deceased Owner's surviving spouse, such
spouse may elect to continue the Policy as the new Annuitant and Policy Owner
instead of receiving the Death Benefit. (See "Federal Tax Matters" in the
Statement of Additional Information.)
If the Annuitant is not the Owner, and the Owner dies prior to the Annuity
Commencement Date, a Successor Owner may surrender the Policy at any time for
the Adjusted Policy Value. If the Successor Owner is not the deceased Owner's
surviving spouse, however, this amount must be distributed within five years
after the date of death of the Owner, or payments under a Payment Option must
begin within one year of the deceased Owner's death and must be made for the
Beneficiary's lifetime or for a period certain (so long as any certain period
does not exceed the Beneficiary's life expectancy).
Death On or After Annuity Commencement Date. The death benefit payable on or
after the Annuity Commencement Date depends on the Payment Option selected. If
any Owner dies on or after the Annuity Commencement Date, but before the
entire interest in the Policy is distributed, the remaining portion of such
interest in the Policy will be distributed at least as rapidly as under the
method of distribution being used as of the date of that Owner's death.
Beneficiary. The Beneficiary designation in the application will remain in
effect until changed. The Policy Owner may change the designated Beneficiary
by sending Written Notice to PFL. The Beneficiary's consent to such change is
not required unless the Beneficiary was irrevocably designated or consent is
required by law. (If an irrevocable Beneficiary dies, the Policy Owner may
then designate a new Beneficiary.) The change will take effect as of the date
the Policy Owner signs the Written Notice, whether or not the Policy Owner is
living when the Notice is received by PFL. PFL will not be liable for any
payment made before the Written Notice is received. If more than one
Beneficiary is designated, and the Policy Owner fails to specify their
interests, they will share equally.
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DEATH OF OWNER
Federal tax law requires that if any Policy Owner (including any joint Owner
or any Successor Policy Owner who has become a current Owner) dies before the
Annuity Commencement Date, then the entire value of the Policy must generally
be distributed within five years of the date of death of such Policy Owner.
Certain rules apply where 1) the spouse of the deceased Owner is the sole
beneficiary, 2) the Policy Owner is not a natural person and the primary
Annuitant dies or is changed, or 3) any Policy Owner dies after the Annuity
Commencement Date. See "Federal Tax Matters" in the Statement of Additional
Information for a detailed description of these rules. Other rules may apply
to Qualified Policies. (See also "DISTRIBUTIONS UNDER THE POLICY--Death
Benefit" p. 56.)
RESTRICTIONS UNDER THE TEXAS OPTIONAL RETIREMENT PROGRAM
Section 36.105 of the Texas Educational Code permits participants in the
Texas Optional Retirement Program (ORP) to withdraw their interest in a
variable annuity Policy issued under the ORP only upon: (1) termination of
employment in the Texas public institutions of higher education;
(2) retirement; or (3) death. Accordingly, a participant in the ORP (or the
participant's estate if the participant has died) will be required to obtain a
certificate of termination from the employer or a certificate of death before
the account can be redeemed.
RESTRICTIONS UNDER SECTION 403(B) PLANS
Section 403(b) of the Internal Revenue Code provides for tax-deferred
retirement savings plans for employees of certain non-profit and educational
organizations. In accordance with the requirements of Section 403(b), any
Policy used for a 403(b) plan will prohibit distributions of elective
contributions and earnings on elective contributions except upon death of the
employee, attainment of age 59 1/2, separation from service, disability, or
financial hardship. In addition, income attributable to elective contributions
may not be distributed in the case of hardship.
RESTRICTIONS UNDER QUALIFIED POLICIES
Other restrictions with respect to the election, commencement, or
distribution of benefits may apply under Qualified Policies or under the terms
of the plans in respect of which Qualified Policies are issued.
CHARGES AND DEDUCTIONS
No deductions are made from Premium Payments, so that the full amount of
each Premium Payment is invested in one or more of the Accounts. PFL will make
certain charges and deductions in connection with the Policy in order to
compensate it for incurring expenses in distributing the Policy, bearing
mortality and expense risks under the Policy, and administering the Accounts
and the Policies. Charges may also be made for premium taxes, federal, state
or local taxes, or for certain transfers or other transactions. Charges and
expenses are also deducted from the Underlying Funds.
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SURRENDER CHARGE
PFL will incur expenses relating to the sale of Policies, including
commissions to registered representatives and other promotional expenses. PFL
may deduct a Surrender Charge from any amount surrendered (i.e., withdrawn) in
connection with a partial withdrawal or a surrender in order to cover a
portion of such distribution expenses. A Surrender Charge will not be deducted
from a withdrawal, after the first Policy Year, of up to 10% of the Policy
Value, if there have been no partial withdrawals in the current Policy Year.
(See "DISTRIBUTIONS UNDER THE POLICY--Surrenders," p. 48.)
The Surrender Charge is not imposed upon exercise of the Nursing Care and
Terminal Condition Option. This feature may not be available in all states.
(See "DISTRIBUTIONS UNDER THE POLICY," p. 48.)
The amount of the Surrender Charge is determined by multiplying the amount
of the Premium Payments withdrawn by the applicable Surrender Charge
Percentage. The applicable Surrender Charge Percentage will depend upon the
number of years that have elapsed since the Premium Payment that is being
withdrawn was made. For this purpose, surrenders are allocated to Premium
Payments on a "first-in, first-out" basis, that is, first to the oldest
Premium Payment, then to the next oldest Premium Payment, and so on. Premium
Payments are deemed to be withdrawn before earnings, and after all Premium
Payments have been withdrawn, the remaining Adjusted Policy Value may be
withdrawn without any Surrender Charge. The following is the table of
Surrender Charge Percentages:
<TABLE>
<CAPTION>
APPLICABLE SURRENDER
CHARGE PERCENTAGE
(AS PERCENTAGE OF
NUMBER OF YEARS SINCE PREMIUM PAYMENT
PREMIUM PAYMENT DATE WITHDRAWN)
--------------------- --------------------
<S> <C>
Less than 1........................................... 7%
At least 1 and less than 2............................ 6%
At least 2 and less than 3............................ 5%
At least 3 and less than 4............................ 4%
At least 4 and less than 5............................ 3%
At least 5 and less than 6............................ 2%
At least 6 and less than 7............................ 1%
</TABLE>
PFL anticipates that the Surrender Charge will not generate sufficient funds
to pay the cost of distributing the Policies. If this charge is insufficient
to cover the distribution expenses, the deficiency will be met from PFL's
general funds, which will include amounts derived from the fee for mortality
and expense risks and the Distribution Financing Charge.
MORTALITY AND EXPENSE RISK FEE
PFL imposes a daily charge as compensation for bearing certain mortality and
expense risks in connection with the Policies. For the 5% Annually Compounding
Death Benefit and the Annual Step-Up Death Benefit, this charge is equal to an
effective annual rate of 1.25% of the daily
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net asset value of the Mutual Fund Account. For the Return of Premium Death
Benefit, the corresponding charge is equal to an effective annual rate of
1.10% of the daily net asset value of the Mutual Fund Account. The Mortality
and Expense Risk Fee is reflected in the Accumulation or Annuity Unit Values
for the Policy for each Subaccount.
Policy Values and Annuity Payments are not affected by changes in actual
mortality experience nor by actual expenses incurred by PFL. The mortality
risks assumed by PFL arise from its contractual obligations to make Annuity
Payments (determined in accordance with the Annuity tables and other
provisions contained in the Policy) and to pay Death Benefits prior to the
Annuity Commencement Date. Thus, Owners are assured that neither an
Annuitant's own longevity nor an unanticipated improvement in genera l life
expectancy will adversely affect the monthly Annuity payments that the
Annuitant will receive under the Policy.
PFL also bears substantial risk in connection with the Death Benefit
Guarantee since PFL will pay a Death Benefit equal to the Guaranteed Minimum
Death Benefit if that amount is higher than the Policy Value.
The expense risk assumed by PFL is the risk that PFL's actual expenses in
administering the Policy and the Accounts will exceed the amount recovered
through the Administrative Charges.
If the Mortality and Expense Risk Fee is insufficient to cover PFL's actual
costs, PFL will bear the loss; conversely, if the charge is more than
sufficient to cover costs, the excess will be profit to PFL. PFL expects a
profit from this charge. To the extent that the Surrender Charge is
insufficient to cover the actual cost of Policy distribution, the deficiency
will be met from PFL's general corporate assets, which may include amounts, if
any, derived from the Distribution Financing Charge and, if necessary, the
Mortality and Expense Risk Fee. A Mortality and Expense Risk Fee is assessed
during the accumulation phase and during the annuity phase for all Variable
Annuity Options including those that do not carry a life contingency.
ADMINISTRATIVE CHARGES
Service Charge. In order to cover the costs of administering the Policies,
PFL deducts a Service Charge from the Policy Value of each Policy. The annual
Service Charge is deducted from the Policy Value of each Policy on each Policy
Anniversary prior to the Annuity Commencement Date. PFL also reserves the
right to charge up to $35 at the time of surrender during any Policy Year. The
charge is not deducted after the Annuity Commencement Date. The annual Service
Charge is the lesser of 2% of the Policy Value or $35, and it will not be
increased in the future. This charge is waived if either the Policy Value or
the sum of all Premium Payments less the sum of all partial withdrawals equals
or exceeds $50,000 on a Policy Anniversary (or date of surrender). The Service
Charge will be deducted from the Investment Option(s) in the same proportion
that the Owner's interest in each Investment Option bears to the Owner's total
Policy Value.
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Administrative Charge. PFL also deducts a daily Administrative Charge from
the net assets of the Mutual Fund Account to partially cover expenses incurred
by PFL in connection with the administration of the Account and the Policies.
The effective annual rate of this charge is .15% of the daily net assets value
of the Mutual Fund Account. (See "CHARGES AND DEDUCTIONS--Administrative
Charges," p. 61.)
DISTRIBUTION FINANCING CHARGE
During the first seven Policy Years, PFL deducts a daily Distribution
Financing Charge equal to an effective annual rate of 0.15% of the daily net
asset value of the Mutual Fund Account. The cumulative amount of the charge,
plus the Surrender Charge, will never exceed 8.5% of the cumulative Premium
Payments for a Policy. The Distribution Financing Charge is paid to PFL and is
designed to partially compensate PFL for the cost of distributing the
Policies. The Distribution Financing Charge will be used to support marketing
efforts, training of representatives and reimbursement of expenses incurred by
broker/dealers who sell the Policies. The staff of the SEC deems such charge
to constitute a deferred sales charge.
PREMIUM TAXES
PFL currently makes no deduction from the Premium Payments for any state
premium taxes PFL pays in connection with Premium Payments under the Policies.
However, PFL will, when permitted by state law, deduct the aggregate premium
taxes paid on behalf of a particular Policy on (i) the Annuity Commencement
Date, (ii) the total surrender of a Policy, or (iii) payment of the death
proceeds of a Policy. Premium taxes currently range from 0% to 3.50% of
Premium Payments.
FEDERAL, STATE AND LOCAL TAXES
No charges are currently made for federal, state, or local taxes other than
premium taxes. However, PFL reserves the right to deduct charges in the future
for any taxes or other economic burden resulting from the application of any
tax laws that PFL determines to be attributable to the accounts or the
policies.
TRANSFER CHARGE
There is no charge for the first 12 transfers between Investment Options in
each Policy Year. PFL reserves the right to impose a $10 charge for the
thirteenth and each subsequent transfer request made by the Owner during a
single Policy Year. For the purpose of determining whether a transfer charge
is payable, Premium Payment allocations are not considered transfers. All
transfer requests made simultaneously will be treated as a single request. No
transfer charge will be imposed for any transfer which is not at the Owner's
request.
OTHER EXPENSES INCLUDING INVESTMENT ADVISORY FEES
Each of the Portfolios of the Underlying Funds is responsible for all of its
expenses. In addition, charges will be made against each of the Portfolios
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of the Underlying Funds for investment advisory services provided to the
Portfolio. The net assets of each Portfolio of the Underlying Funds will
reflect deductions in connection with the investment advisory fee and other
expenses.
For more information concerning the investment advisory fee and other
charges against the Portfolios, see the prospectuses for the Underlying Funds,
current copies of which accompany this Prospectus.
EMPLOYEE AND AGENT PURCHASES
The Policy may be acquired by an employee or registered representative of
any broker/dealer authorized to sell the Policy or their spouse or minor
children, or by an officer, director, trustee or bona-fide full-time employee
of PFL or its affiliated companies or their spouse or minor children. In such
case, a bonus of 5% of each premium deposit may be credited to the Policy due
to lower acquisition costs PFL experiences on these purchases. The bonus will
be reported to the Internal Revenue Service as taxable income to the employee
or registered representative. Compensation to the registered representative
and broker/dealer will be reduced by the amount of such bonus.
CERTAIN FEDERAL INCOME TAX CONSEQUENCES
The following summary does not constitute tax advice. It is a general
discussion of certain of the expected federal income tax consequences of
investment in and distributions with respect to a Policy, based on the
Internal Revenue Code of 1986, as amended (the "Code"), proposed and final
Treasury Regulations thereunder, judicial authority, and current
administrative rulings and practice. This summary discusses only certain
federal income tax consequences to "United States Persons," and does not
discuss state, local, or foreign tax consequences. United States Persons means
citizens or residents of the United States, domestic corporations, domestic
partnerships and trusts or estates that are subject to United States federal
income tax regardless of the source of their income.
At the time the initial Premium Payment is paid, a prospective purchaser
must specify whether he or she is purchasing a Nonqualified Policy or a
Qualified Policy. If the initial Premium Payment is derived from an exchange
or surrender of another annuity policy, PFL may require that the prospective
purchaser provide information with regard to the federal income tax status of
the previous annuity policy. PFL will require that persons purchase separate
Policies if they desire to invest monies qualifying for different annuity tax
treatment under the Code. Each such separate Policy would require the minimum
initial Premium Payment stated above. Subsequent Additional Premium Payments
under a Policy must qualify for the same federal income tax treatment as the
initial Premium Payment under the Policy; PFL will not accept a Subsequent
Additional Premium Payment under a Policy if the federal income tax treatment
of such Premium Payment would be different from that of the initial Premium
Payment.
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The Qualified Policies were designed for use by retirement plans and
individual retirement accounts that qualify for special federal income tax
treatment under Sections 401(a), 403(b), or 408(a), or 457 of the Code and
individuals purchasing individual retirement annuities that qualify for
special federal income tax treatment under Section 408(b) of the Code. Certain
requirements must be satisfied in purchasing a Qualified Policy in order for
the plan, account or annuity to retain its special tax treatment. This summary
is not intended to cover such requirements, and assumes that Qualified
Policies are purchased pursuant to retirement plans or individual retirement
accounts, or are individual retirement annuities, that qualify for such
special tax treatment. This summary was prepared by PFL after consultation
with tax counsel, but no opinion of tax counsel has been obtained.
THE DISCUSSION SET FORTH BELOW IS INCLUDED FOR GENERAL PURPOSES ONLY. EACH
POTENTIAL PURCHASER IS URGED TO CONSULT HIS/HER OWN TAX ADVISER AS TO THE
CONSEQUENCES OF INVESTMENT IN A POLICY UNDER FEDERAL AND APPLICABLE STATE,
LOCAL AND FOREIGN TAX LAWS
TAX STATUS OF THE POLICY
The following discussion is based on the assumption that the Policy
qualifies as an annuity contract for federal income tax purposes. The
Statement of Additional Information discusses the tax requirements for
qualifying as an annuity contract.
TAXATION OF ANNUITIES
The discussion below applies only to those Policies owned by natural
persons, and that qualify as annuity contracts for federal income tax
purposes. With respect to Owners who are natural persons, the Policy should be
treated as an annuity contract for federal income tax purposes.
In General. Except as described below with respect to Owners who are not
natural persons, an Owner who holds a Policy satisfying the diversification
and distribution requirements described in the Statement of Additional
Information should not be taxed on increases in the Policy Value until an
amount is received or deemed received, e.g., upon a partial withdrawal or
surrender or as Annuity Payments under the Annuity Option selected. Generally,
any amount received or deemed received under a Nonqualified Annuity Contract
prior to the Annuity Commencement Date is deemed to come first from any
"Income on the Contract" and then from the "Investment in the Contract." The
"Investment in the Contract" generally equals total premium payments less
amounts received which were not includable in gross income. To the extent that
the Policy Value (Cash Value in the event of a surrender) exceeds the
"Investment in the Contract," such excess constitutes the "Income on the
Contract." For these purposes such "Income on the Contract" shall be computed
by reference to the aggregation rules described below, and the amount
includable in gross income will be taxable as ordinary income. If at the time
that any amount is received or
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deemed received there is no "Income on the Contract" (e.g., because the gross
Policy Value does not exceed the "Investment in the Contract" and no
aggregation rule applies), then such amount received or deemed received will
not be includable in gross income, and will simply reduce the "Investment in
the Contract."
For this purpose, the assignment, pledge or agreement to assign or pledge
any portion of the Policy Value (including assignment of Owner's right to
receive Annuity Payments prior to the Annuity Commencement Date) generally
will be treated as a distribution in the amount of such portion of the Policy
Value. Additionally, if an Owner designates a new Owner prior to the Annuity
Commencement Date without receiving full and adequate consideration, the old
Owner generally will be treated as receiving a distribution under the Policy
in an amount equal to the Policy Value. A transfer of ownership or an
assignment of a Policy, or designation of an Annuitant or Beneficiary who is
not also the Owner, as well as the selection of certain Annuity Commencement
Dates, may result in certain tax consequences to the Owner that are not
discussed herein. An Owner contemplating any such transfer, designation,
selection or assignment of a Policy should contact a competent tax adviser
with respect to the potential tax effects of such a transaction.
Aggregation Rules. Generally all nonqualified deferred annuity contracts
issued by the same company (or an affiliated company) to the same owner during
any calendar year shall be treated as one annuity contract, and "aggregated"
for purposes of determining the amount includable in gross income. In
addition, for such purposes all individual retirement annuities and accounts
under Section 408 of the Code for an individual are aggregated, and generally
all distributions therefrom during a calendar year are treated as one
distribution made as of the end of such year.
Surrenders or Partial Withdrawals. In the case of a partial withdrawal
(including systematic partial withdrawals) under a Nonqualified Policy, the
amount received generally will be includable in gross income to the extent
that it does not exceed the "Income on the Contract," which is generally equal
to the excess of the Policy Value immediately before the partial withdrawal
over the "Investment in the Contract" at that time. However, for these
purposes the Policy Value immediately before a partial withdrawal may have to
be increased by any positive Excess Interest Adjustment which results from
such a partial withdrawal or which could result from a simultaneous surrender,
and may need further adjustments if the aggregation rules apply. There is,
however, no definitive guidance on the proper tax treatment of Excess Interest
Adjustments, and the Owner should contact a competent tax adviser with respect
to the potential tax consequences of an Excess Interest Adjustment that may
apply in the case of a Non-Qualified Policy or a Qualified Policy. In the case
of a partial withdrawal (including systematic partial withdrawals) under a
Qualified Policy (other than one qualified under Section 457 of the Code), a
ratable portion of the amount received is generally excludable from gross
income,
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based on the ratio of the "Investment in the Contract" to the individual's
total Policy Value or accrued benefit under the retirement plan at the time of
each such payment. For a Qualified Policy, the "Investment in the Contract"
can be zero. Special tax rules may be available for certain distributions from
a Qualified Policy. In the case of a surrender under a Nonqualified Policy or
a Qualified Policy, the amount received generally will be taxable only to the
extent it exceeds the "Investment in the Contract", unless the aggregation
rules apply.
Annuity Payments. Although the tax consequences may vary depending on the
Annuity Payment Option elected under the Policy, in general only a portion of
the Annuity Payments received after the Annuity Commencement Date will be
includable in the gross income of the recipient.
For Fixed Annuity Payments, in general the excludable portion of each
payment is determined by dividing the "Investment in the Contract" on the
Annuity Commencement Date by the total expected return resulting from the
Annuity Payments for the term of the payments. The remainder of each Annuity
Payment is includable in gross income. Once the "Investment in the Contract"
has been fully recovered, the full amount of any additional Annuity Payments
received is includable in gross income.
For Variable Annuity Payments, the includable portion is generally
determined by an equation that establishes a specific dollar amount of each
payment that is excludable from gross income. This dollar amount is determined
by dividing the "Investment in the Contract" on the Annuity Commencement Date
by the total number of expected periodic payments. The remainder of each
Annuity Payment is includable in gross income. Once the "Investment in the
Contract" has been fully recovered, the full amount of any additional Annuity
Payments is includable in gross income.
Where an Owner allocates a portion of the Adjusted Policy Value on the
Annuity Commencement Date to more than one annuity payment option (fixed or
variable), special rules govern the allocation of the Policy's entire
"Investment in the Contract" on such date to each such option, for purposes of
determining the excludable amount of each payment received under that option.
PFL makes no attempt to describe these allocation rules, because they would
prescribe a complex variety of results, depending on how the allocations were
made among the various types of annuity payment options. Instead, any Owner is
advised to consult a competent tax adviser as to the potential tax effects of
allocating any amount of Adjusted Policy Value to any particular annuity
payment option.
If, after the Annuity Commencement Date, Annuity Payments cease by reason of
the death of the Annuitant, the excess (if any) of the "Investment in the
Contract" as of the Annuity Commencement Date over the aggregate amount of
Annuity Payments received on or after the Annuity Commencement Date that was
excluded from gross income is allowable as a deduction for the last taxable
year of the Annuitant.
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Taxation of Death Benefit Proceeds. Amounts may be distributed from the
Policy because of the death of an Owner or the Annuitant. Generally, such
amounts are includable in the income of the recipient as follows: (1) if
distributed in a lump sum, they are taxed in the same manner as a surrender,
as described above, or (2) if distributed under an Annuity Payment Option,
they are taxed in the same manner as Annuity Payments, as described above. For
these purposes, the "Investment in the Contract" is not affected by the
Owner's or Annuitant's death. That is, the "Investment in the Contract"
remains generally the total premium payments less amounts received which were
not includable in gross income.
Penalty Taxes. In the case of any amount received or deemed received from
the Policy, e.g., upon a surrender of a Policy (including systematic
withdrawals) or a deemed distribution under a Policy resulting from a pledge,
assignment or agreement to pledge or assign or an Annuity Payment with respect
to a Policy, there may be imposed on the recipient a federal penalty tax equal
to 10% of the amount includable in gross income. The penalty tax generally
will not apply to any distribution: (i) made on or after the date on which the
taxpayer attains age 59 1/2; (ii) made as a result of the death of the holder
(generally the Owner); (iii) attributable to the disability of the taxpayer;
or (iv) which is part of a series of substantially equal periodic payments
made (not less frequently than annually) for the life (or life expectancy) of
the taxpayer or the joint lives (or joint life expectancies) of such taxpayer
and the taxpayer's beneficiary. Other rules may apply to Qualified Policies.
Withholding. The portion of any distribution under a Policy that is
includable in gross income will be subject to federal income tax withholding
unless the recipient of such distribution elects not to have federal income
tax withheld. Election forms will be provided at the time distributions are
requested or made. For certain Qualified Policies, certain distributions are
subject to mandatory withholding.
Qualified Policies. The Qualified Policy is designed for use with several
types of tax-qualified retirement plans. The tax rules applicable to
participants and beneficiaries in tax-qualified retirement plans vary
according to the type of plan and the terms and conditions of the plan.
Special favorable tax treatment may be available for certain types of
contributions and distributions. Adverse tax consequences may result from
contributions in excess of specified limits; distributions prior to age 59 1/2
(subject to certain exceptions); distributions that do not conform to
specified commencement and minimum distribution rules; aggregate distributions
in excess of a specified annual amount; and in other specified circumstances.
Some retirement plans are subject to distribution and other requirements that
are not incorporated into our Policy administration procedures. Owners,
participants and beneficiaries are responsible for determining that
contributions, distributions and other transactions with respect to the
Policies comply with applicable law.
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PFL makes no attempt to provide more than general information about use of
the Policy with the various types of retirement plans. Purchasers of Policies
for use with any retirement plan should consult their legal counsel and tax
adviser regarding the suitability of the Policy.
Individual Retirement Annuities. In order to qualify as an individual
retirement annuity under Section 408(b) of the Code, a Policy must contain
certain provisions: (i) the Owner must be the Annuitant; (ii) the Policy
generally is not transferable by the Owner, e.g., the Owner may not designate
a new Owner, designate a Contingent Owner or assign the Policy as collateral
security; (iii) the total Premium Payments for any calendar year may not
exceed $2,000, except in case of a rollover amount or contribution under
Sections 402(c), 403(a)(4), 403(b)(8) or 408(d)(3) of the Code; (iv) Annuity
Payments or partial withdrawals must begin no later than April 1 of the
calendar year following the calendar year in which the Annuitant attains age
70 1/2; (v) an Annuity Payment Option with a Period Certain that will
guarantee Annuity Payments beyond the life expectancy of the Annuitant and the
Beneficiary may not be selected; and (vi) certain payments of Death Benefits
must be made in the event the Annuitant dies prior to the distribution of the
Policy Value. Policies intended to qualify as individual retirement annuities
under Section 408(b) of the Code contain such provisions.
Section 408 of the Code also indicates that no part of the funds for an
individual retirement account or annuity ("IRA") should be invested in a life
insurance contract, but the regulations thereunder allow such funds to be
invested in an annuity contract that provides a death benefit that equals the
greater of the premiums paid or the cash value for the contract. The Policy
provides an enhanced death benefit that could exceed the amount of such a
permissible death benefit, but it is unclear to what extent such an enhanced
death benefit could disqualify the Policy under Section 408 of the Code. The
Internal Revenue Service has not reviewed the Policy for qualification as an
IRA, and has not addressed in a ruling of general applicability whether an
enhanced death benefit provision, such as the provision in the Policy,
comports with IRA qualification requirements.
Section 403(b) Plans. Under Section 403(b) of the Code, payments made by
public school systems and certain tax exempt organizations to purchase
Policies for their employees are excludable from the gross income of the
employee, subject to certain limitations. However, such payments may be
subject to FICA (Social Security) taxes. Additionally, in accordance with the
requirements of the Code, Section 403(b) annuities generally may not permit
distribution of (i) elective contributions made in years beginning after
December 31, 1988, and (ii) earnings on those contributions and (iii) earnings
on amounts attributed to elective contributions held as of the end of the last
year beginning before January 1, 1989. Distributions of such amounts will be
allowed only upon the death of the employee, on or after attainment of age 59
1/2, separation from service, disability, or financial hardship, except that
income attributable to elective contributions may not be distributed in the
case of hardship.
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Corporate Pension and Profit-Sharing Plans and H.R. 10 Plans. Sections
401(a) and 403(a) of the Code permit corporate employers to establish various
types of retirement plans for employees and self-employed individuals to
establish qualified plans for themselves and their employees. Such retirement
plans may permit the purchase of the Policies to accumulate retirement
savings. Adverse tax consequences to the plan, the participant or both may
result if the Policy is assigned or transferred to any individual as a means
to provide benefit payments.
Deferred Compensation Plans. Section 457 of the Code, while not actually
providing for a qualified plan as that term is normally used, provides for
certain deferred compensation plans with respect to service for state
governments, local governments, political sub-divisions, agencies,
instrumentalities and certain affiliates of such entities and tax exempt
organizations which enjoy special treatment. The Policies can be used with
such plans. Under such plans a participant may specify the form of investment
in which his or her participation will be made. All such investments, however,
are owned by, and are subject to, the claims of the general creditors of the
sponsoring employer. Depending on the terms of the particular plan, the
employer may be entitled to draw on deferred amounts for purposes unrelated to
its Section 457 plan obligations. In general, all amounts received under a
Section 457 plan are taxable and are subject to federal income tax withholding
as wages.
Non-natural Persons. Pursuant to Section 72(u) of the Code, an annuity
contract held by a taxpayer other than a natural person generally will not be
treated as an annuity contract under the Code; accordingly, an Owner who is
not a natural person will recognize as ordinary income for a taxable year the
excess of (i) the sum of the Annuity Purchase Value as of the close of the
taxable year and all previous distributions under the Policy over (ii) the sum
of the Premium Payments paid for the taxable year and any prior taxable year
and the amounts includable in gross income for any prior taxable year with
respect to the Policy. For these purposes, the Policy Value at year end may
have to be increased by any positive Excess Interest Adjustment which could
result from a surrender at such time. There is, however, no definitive
guidance on the proper tax treatment of Excess Interest Adjustments, and the
Owner should contact a competent tax adviser with respect to the potential tax
consequences of an Excess Interest Adjustment. Notwithstanding the preceding
sentences in this paragraph, Section 72(u) of the Code does not apply to (i) a
Policy the nominal Owner of which is not a natural person but the beneficial
Owner of which is a natural person, (ii) a Policy acquired by the estate of a
decedent by reason of such decedent's death, (iii) a Qualified Policy (other
than one qualified under Section 457) or (iv) a single-payment annuity the
Annuity Commencement Date for which is no later than one year from the date of
the single Premium Payment; instead, such Policies are taxed as described
above under the heading "Taxation of Annuities."
Possible Changes in Taxation. In past years, legislation has been proposed
in the U.S. Congress that would have adversely modified the
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federal taxation of certain annuities. For example, one such proposal would
have changed the tax treatment of non-qualified annuities that did not have
"substantial life contingencies" by taxing income as it is credited to the
annuity. Although as of the date of this Prospectus Congress was not actively
considering any legislation regarding the taxation of annuities, there is
always the possibility that the tax treatment of annuities could change by
legislation or other means (such as IRS regulations, revenue rulings, judicial
decisions, etc.). Moreover, it is also possible that any change could be
retroactive (that is, effective prior to the date of the change).
DISTRIBUTOR OF THE POLICIES
AEGON USA Securities, Inc., an affiliate of PFL, is the principal
underwriter of the Policies. AEGON USA Securities, Inc. has entered or will
enter into one or more agreements with various broker-dealers for the
distribution of the Policies. Commissions on Policy sales are paid to
broker/dealers. Commissions payable to broker/dealers will be up to 6% of
Premium Payments, or 5% plus an annual continuing fee based on Policy Values.
In addition, certain broker/dealers may receive additional commissions,
expense allowances, and additional annual continuing fees based upon sales
volume, agent or service training responsibilities, and other factors. The
Distribution Financing Charge will be used by PFL to support these activities
and reimbursements. These commissions are not deducted from Premium Payments,
they are paid by PFL.
VOTING RIGHTS
To the extent required by law, PFL will vote the Underlying Funds shares
held by the Mutual Fund Account at regular and special shareholder meetings of
the Underlying Funds in accordance with instructions received from persons
having voting interests in the portfolios (although the Underlying Funds do
not hold regular annual shareholders' meetings). If, however, the 1940 Act or
any regulation thereunder should be amended or if the present interpretation
thereof should change, and as a result PFL determines that it is permitted to
vote the Underlying Funds' shares in its own right, it may elect to do so.
Before the Annuity Commencement Date, the Policy Owner holds the voting
interest in the selected Portfolios. The number of votes that an Owner has the
right to instruct will be calculated separately for each Subaccount. The
number of votes that an Owner has the right to instruct for a particular
Subaccount will be determined by dividing the Owner's Policy Value in the
Subaccount by the net asset value per share of the corresponding Portfolio in
which the Subaccount invests. Fractional shares will be counted.
After the Annuity Commencement Date, the person receiving Annuity Payments
has the voting interest, and the number of votes decreases as Annuity Payments
are made and as the reserves for the Policy decrease. The
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<PAGE>
person's number of votes will be determined by dividing the reserve for the
Policy allocated to the applicable Subaccount by the net asset value per share
of the corresponding Portfolio. Fractional shares will be counted.
The number of votes that the Owner or person receiving income payments has
the right to instruct will be determined as of the date established by the
Underlying Funds for determining shareholders eligible to vote at the meeting
of the Underlying Funds. PFL will solicit voting instructions by sending
Owners or other persons entitled to vote written requests for instructions
prior to that meeting in accordance with procedures established by the
Underlying Funds. Portfolio shares as to which no timely instructions are
received and shares held by PFL in which Owners or other persons entitled to
vote have no beneficial interest will be voted in proportion to the voting
instructions that are received with respect to all Policies participating in
the same Subaccount.
Each person having a voting interest in a Subaccount will receive proxy
material, reports, and other materials relating to the appropriate Portfolio.
LEGAL PROCEEDINGS
There are no legal proceedings to which the Mutual Fund Account is a party
or to which the assets of the Account are subject. PFL is not involved in any
litigation that is of material importance in relation to its total assets or
that relates to he Mutual Fund Account.
STATEMENT OF ADDITIONAL INFORMATION
A Statement of Additional Information is available (at no cost) which
contains more details concerning the subjects discussed in this Prospectus.
The following is the Table of Contents for that Statement:
- 71 -
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
The Policy--General Provisions............................................. 3
Owner.................................................................... 3
Entire Policy............................................................ 3
Delay of Payment and Transfers........................................... 3
Misstatement of Age or Sex............................................... 4
Reallocation of Policy Values After the Annuity Commencement Date........ 4
Assignment............................................................... 4
Evidence of Survival..................................................... 4
Non-Participating........................................................ 5
Amendments............................................................... 5
Federal Tax Matters........................................................ 5
Tax Status of the Policy................................................. 5
Taxation of PFL.......................................................... 6
Investment Experience...................................................... 6
State Regulation of PFL.................................................... 11
Administration............................................................. 11
Records and Reports........................................................ 11
Distribution of the Policies............................................... 11
Custody of Assets.......................................................... 11
Historical Performance Data................................................ 12
Money Market Yields...................................................... 12
Other Subaccount Yields.................................................. 13
Total Returns............................................................ 13
Other Performance Data................................................... 14
Hypothetical Performance Data............................................ 14
Legal Matters.............................................................. 15
Independent Auditors....................................................... 15
Other Information.......................................................... 15
Financial Statements....................................................... 15
</TABLE>
- 72 -
<PAGE>
APPENDIX A
EXCESS INTEREST ADJUSTMENT(1)
The formula which will be used to determine the Excess Interest Adjustment
(EIA) is:
S* (G - C)* (M/12)
S= Gross amount being withdrawn that is subject to the EIA
G= Guaranteed Interest Rate in effect for the policy
C= Current Guaranteed Interest Rate then being offered on new premiums for
the next longer option period than "M". If this policy form or such an
option period is no longer offered, "C" will be the U.S. Treasury rate for
the next longer maturity (in whole years) than "M" on the 25th day of the
previous calendar month, plus up to 2%.
M= Number of months remaining in the current option period, rounded up to the
next higher whole number of months.
EXAMPLE 1 (SURRENDER, RATES INCREASE BY 3%):
Single Premium: $50,000
Guarantee Period: 5 Years
Guarantee Rate: 5.50% per annum
Surrender: Middle of Contract Year 3
Policy Value at middle of Contract
Year 3 = 50,000* (1.055) (caret) 2.5 =
57,161.18
Penalty Free Amount at middle of
Contract Year 3 = 57,161.18* .10 = 5,716.12
Amount Subject to EIA = 57,161.18 - 5,716.12 = 51,445.06
EIA Floor = 50,000* (1.03) (caret) 2.5 =
53,834.80
Excess Interest Adjustment
G= .055
C= .085
M = 30
Excess Interest Adjustment = S* (G - C)* (M/12)
= 51,445.06* (.055 - .085)* (30/12)
= -3,858.38, but Excess Interest
Adjustment cannot cause the Adjusted
Policy Value to fall below the
floor, so the adjustment is limited
to 53,834.80 - 57,161.18 = -3,326.38
Adjusted Policy Value ("APV") = APV + EIA = 57,161.18 + (-3,326.38)
= 53,834.80
- ----------------------------------
(1) * represents multiplication;
(caret) represents exponentiation.
A-1
<PAGE>
Surrender Charges = (50,000 - 5,716.12)* .05
= 2,214.19
Net Surrender Value at middle of
Contract Year 3 = 53,834.80 - 2,214.19
= 51,620.61
EXAMPLE 2 (SURRENDER, RATES DECREASE BY 1%):
Single Premium: $50,000
Guarantee Period: 5 Years
Guarantee Rate: 5.50% per annum
Surrender: Middle of Contract Year 3
Policy Value at middle of Contract
Year 3 = 50,000* (1.055) (caret) 2.5 =
57,161.18
Penalty Free Amount at middle of
Contract Year 3 = 57,161.18* .10 = 5,716.12
Amount Subject to EIA = 57,161.18 - 5,716.12 = 51,445.06
EIA Floor = 50,000* (1.03) (caret) 2.5 = 53,834.80
Excess Interest Adjustment
G = .055
C = .045
M = 30
Excess Interest Adjustment = S* (G - C)* (M/12)
= 51,445.06* (.055 - .045)* (30/12)
= 1,286.13
Adjusted APV = 57,161.18 + 1,286.13 = 58,447.31
Surrender Charges = (50,000 - 5,716.12)* .05
= 2,214.19
Net Surrender Value at middle of
Contract Year 3 = 58,447.31 - 2,214.19
= 56,233.12
A-2
<PAGE>
On a partial withdrawal, PFL will pay the policy holder the full amount of
withdrawal requested (as long as the Policy Value is sufficient). Surrender
Charge free/adjustment free partial withdrawals will reduce the APV by the
amount withdrawn. Amounts withdrawn in excess of the Surrender Charge
free/adjustment free portion will reduce the APV by an amount equal to:
X - Y+Z
X= Excess Partial Withdrawal
Y= Excess Interest Adjustment = (X)* (G - C)* (M/12) where G, C, and M are
defined above.
Z= Surrender Charge on X - Y.
EXAMPLE 3 (PARTIAL WITHDRAWAL, RATES INCREASE BY 1%):
Single Premium: $50,000
Guarantee Period: 5 Years
Guarantee Rate: 5.50% per annum
Partial Withdrawal: $20,000; Middle of Contract Year 3
Policy Value at middle of Contract
Year 3
= 50,000* (1.055) (caret) 2.5 =
57,161.18
Penalty Free Amount at middle of
Contract Year 3 = 57,161.18* .10 = 5,716.12
Excess Interest/Surrender Charge (SC) Adjustment
X= 20,000 - 5,716.12 = 14,283.88
G= .055
C= .065
M= 30
Y= 14,283.88* (.055 - .065)* (30/12) = (357.10)
Z= .05* (20,000 - 5,716.12 - (-357.10)) = 732.05
Reduction to APV for Excess
Withdrawal: = X - Y + Z
= 14,283.88 - (-357.10) + 732.05
= 15,373.03
Remaining Policy Value at middle of Contract Year 3
= 57,161.18 - 5,716.12 - 15,373.03
= 36,072.03
A-3
<PAGE>
EXAMPLE 4 (PARTIAL WITHDRAWAL, RATES DECREASE BY 1%):
Single Premium: $50,000
Guarantee Period: 5 Years
Guarantee Rate: 5.50% per annum
Partial Withdrawal: $20,000; Middle of Contract Year 3
Policy Value at middle of
Contract Year 3 = 50,000* (1,055) (caret) 2.5 =
57,161.18
Penalty Free Amount at middle of
Contract Year 3 = 57,161.18* .10 = 5,716.12
Excess Interest/Surrender Charge Adjustment
X= 20,000 - 5,716.12 = 14,283.88
G= .055
C= .045
M= 30
Y= 14.283.88* (.055 - .045)* (30/12) = 357.10
Z= .05* (20,000 - 5,716.12 - 357.10) = 696.34
Reduction to APV for Excess Withdrawal:
= X-Y + Z
= 14,283.88 - 357.10 + 696.34
= 14,623.12
Remaining Policy Value at
middle of Contract Year 3 = 57,161.18 - 5,716.12 - 14,623.12
= 32,821.94
A-4
<PAGE>
PROSPECTUS
ENDEAVOR SERIES TRUST
Endeavor Series Trust (the "Fund") is a diversified, open-end management
investment company, that offers a selection of managed investment portfolios,
each with its own investment objective designed to meet different investment
goals. There can be no assurance that these investment objectives will be
achieved.
This Prospectus describes the following ten portfolios currently offered by
the Fund (the "Portfolios").
. TCW Money Market Portfolio
. TCW Managed Asset Allocation Portfolio
. T. Rowe Price International Stock Portfolio
. Value Equity Portfolio
. Dreyfus Small Cap Value Portfolio
. Dreyfus U.S. Government Securities Portfolio
. T. Rowe Price Equity Income Portfolio
. T. Rowe Price Growth Stock Portfolio
. Opportunity Value Portfolio
. Enhanced Index Portfolio
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY
OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
This Prospectus sets forth concisely the information about the Fund and the
Portfolios that a prospective investor should know before investing. Please
read the Prospectus and retain it for future reference. Additional information
contained in a Statement of Additional Information also dated May 1, 1997, has
been filed with the Securities and Exchange Commission and is available upon
request without charge by writing or calling the Fund at the address or
telephone number set forth on the back cover of this Prospectus. The Statement
of Additional Information is incorporated by reference into this Prospectus.
The date of this Prospectus is May 1, 1997.
<PAGE>
THE FUND
Endeavor Series Trust is a diversified, open-end management investment
company that offers a selection of managed investment portfolios. Each
portfolio constitutes a separate mutual fund with its own investment objective
and policies. The Fund currently issues shares of ten portfolios. The Trustees
of the Fund may establish additional portfolios at any time.
Shares of the Portfolios are issued and redeemed at their net asset value
without a sales load and currently are offered only to various separate
accounts of PFL Life Insurance Company and certain of its affiliates ("PFL") to
fund various insurance contracts, including variable life insurance policies
(whether scheduled premium, flexible premium or single premium policies) or
variable annuity contracts. These insurance contracts are hereinafter referred
to as the "Contracts." The rights of PFL as the record holder for a separate
account of shares of the Portfolios are different from the rights of the owner
of a Contract. The terms "shareholder" or "shareholders" in this Prospectus
refer to PFL and not to any Contract owner.
The structure of the Fund permits Contract owners, within the limitations
described in the appropriate Contract, to allocate the amounts held by PFL
under the Contracts for investment in the various portfolios of the Fund. See
the prospectus and other material accompanying this Prospectus for a
description of the Contracts, which portfolios of the Fund are available to
Contract owners, and the relationship between increases or decreases in the net
asset value of shares of the portfolios (and any dividends and distributions on
such shares) and the benefits provided under the Contracts.
It is conceivable that in the future it may be disadvantageous for scheduled
premium variable life insurance separate accounts, flexible and single premium
variable life insurance separate accounts, and variable annuity separate
accounts to invest simultaneously in the Fund due to tax or other
considerations. The Trustees of the Fund intend to monitor events for the
existence of any irreconcilable material conflict between or among such
accounts, and PFL will take whatever remedial action may be necessary.
INVESTMENT OBJECTIVES
The Investment objectives of the Portfolios are as follows:
TCW Money Market Portfolio (formerly, Money Market Portfolio)--seeks current
income, preservation of capital and maintenance of liquidity through investment
in short-term money market securities. The Portfolio's shares are neither
insured by nor guaranteed by the U.S. government. The Portfolio seeks to
maintain a constant net asset value of $1.00 per share although no assurances
can be given that such constant net asset value will be maintained.
- 2 -
<PAGE>
TCW Managed Asset Allocation Portfolio (formerly, Managed Asset Allocation
Portfolio)--seeks high total return through a managed asset allocation
portfolio of equity, fixed income and money market securities.
T. Rowe Price International Stock Portfolio--seeks long-term growth of
capital through investments primarily in common stocks of established non-U.S.
companies.
Value Equity Portfolio (formerly, Quest for Value Equity Portfolio)-- seeks
long term capital appreciation through investment in a diversified portfolio of
equity securities selected on the basis of a value oriented approach to
investing.
Dreyfus Small Cap Value Portfolio (formerly known as the Value Small Cap
Portfolio and prior to that the Quest for Value Small Cap Portfolio)--seeks
capital appreciation through investment in a diversified portfolio of equity
securities of companies with a median market capitalization of approximately
$750 million, provided that under normal market conditions at least 75% of the
Portfolio's investments will be in equity securities of companies with
capitalizations at the time of purchase between $150 million and $1.5 billion.
Dreyfus U.S. Government Securities Portfolio (formerly, U.S. Goverment
Securities Portfolio)--seeks as high a level of total return as is consistent
with prudent investment strategies by investing under normal conditions at
least 65% of its assets in U.S. government debt obligations and mortgage-backed
securities issued or guaranteed by the U.S. government, its agencies or
instrumentalities.
T. Rowe Price Equity Income Portfolio--seeks to provide substantial dividend
income and also capital appreciation by investing primarily in dividend-paying
common stocks of established companies.
T. Rowe Price Growth Stock Portfolio--seeks long-term growth of capital and
to increase dividend income through investment primarily in common stocks of
well-established growth companies.
Opportunity Value Portfolio--seeks growth of capital over time through
investment in a portfolio consisting of common stocks, bonds and cash
equivalents, the percentages of which will vary based upon the Portfolio
Adviser's assessment of relative values.
Enhanced Index Portfolio--seeks to earn a total return modestly in excess of
the total return performance of the S&P 500 Composite Stock Price Index (the
"S&P 500 Index") while maintaining a volatility of return similar to the S&P
500 Index.
- 3 -
<PAGE>
FINANCIAL HIGHLIGHTS
The following tables are based on a Portfolio share outstanding throughout
each period and should be read in conjunction with the financial statements
and related notes that also appear in the Fund's Annual Report dated December
31, 1996 which is incorporated by reference into the Statement of Additional
Information. The financial statements contained in the Fund's Annual Report
have been audited by Ernst & Young LLP, independent auditors, whose report
appears in the Annual Report. Additional information concerning the
performance of the Fund is included in the Annual Report which may be obtained
without charge by writing the Fund at the address on the back cover of this
Prospectus.
TCW MONEY MARKET PORTFOLIO*
<TABLE>
<CAPTION>
YEAR YEAR YEAR YEAR YEAR PERIOD
ENDED ENDED ENDED ENDED ENDED ENDED
12/31/96 12/31/95 12/31/94 12/31/93 12/31/92 12/31/91*
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Operating Performance:
Net asset value,
beginning of period... $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
------- -------- -------- -------- -------- --------
Net investment income#. 0.0479 0.0540 0.0337 0.0218 0.0287 0.0377
------- -------- -------- -------- -------- --------
Distributions:
Dividends from net
investment income..... (0.0479) (0.0540) (0.0336) (0.0218) (0.0287) (0.0377)
Distributions from net
realized capital
gains................. -- -- (0.0001) -- -- --
------- -------- -------- -------- -------- --------
Total distributions.... (0.0479) (0.0540) (0.0337) (0.0218) (0.0287) (0.0377)
------- -------- -------- -------- -------- --------
Net asset value, end of
period................ $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
======= ======== ======== ======== ======== ========
Total return++......... 4.91% 5.54% 3.41% 2.19% 2.90% 3.84%
======= ======== ======== ======== ======== ========
Ratios to average net
assets/
supplemental data:
Net assets, end of
period
(in 000's)............ $41,545 $ 27,551 $ 20,766 $ 12,836 $ 4,527 $ 1,907
Ratio of net investment
income to average net
assets................ 4.81%+ 5.37% 3.58% 2.19% 2.84% 5.02%+
Ratio of operating
expenses to average
net assets**.......... 0.60%+ 0.60% 0.85% 0.99% 0.91% 0.00%+
</TABLE>
- ----------
* Effective May 1, 1996, the name of the Money Market Portfolio was changed
to TCW Money Market Portfolio. The Portfolio commenced operations on April
8, 1991.
** Annualized operating expense ratios before waiver of fees and/or
reimbursement of expenses by investment manager for the years ended
December 31, 1993, December 31, 1992 and the period ended December 31,
1991 were 1.23%, 2.37% and 8.48%, respectively.
+ Annualized.
++ Total return represents the aggregate total return for the periods
indicated. The total return of the Portfolio does not reflect the charges
against the separate accounts of PFL or the Contracts.
# Net investment income/(loss) before fees waived and/or reimbursement of
expenses by investment manager for the years ended December 31, 1993,
December 31, 1992 and the period ended December 31, 1991 were $0.0195,
$0.0140 and $(0.0259), respectively.
- 4 -
<PAGE>
TCW MANAGED ASSET ALLOCATION PORTFOLIO*
<TABLE>
<CAPTION>
YEAR YEAR YEAR YEAR YEAR PERIOD
ENDED ENDED ENDED ENDED ENDED ENDED
12/31/96 12/31/95 12/31/94+++ 12/31/93+++ 12/31/92+++ 12/31/91*
-------- -------- ----------- ----------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
Operating Performance:
Net asset value,
beginning of period.. $ 16.28 $ 13.48 $ 14.30 $ 12.31 $ 11.37 $10.00
-------- -------- -------- ------- ------- ------
Net investment
income#.............. 0.27 0.33 0.28 0.23 0.24 0.10
Net realized and
unrealized
gain/(loss) on
investments.......... 2.61 2.72 (1.03) 1.84 0.77 1.27
-------- -------- -------- ------- ------- ------
Net
increase/(decrease)
in net assets
resulting from
investment
operations........... 2.88 3.05 (0.75) 2.07 1.01 1.37
Distributions:
Dividends from net
investment income.... (0.32) (0.25) (0.07) (0.08) (0.07) --
-------- -------- -------- ------- ------- ------
Net asset value, end
of period............ $ 18.84 $ 16.28 $ 13.48 $ 14.30 $ 12.31 $11.37
======== ======== ======== ======= ======= ======
Total return++........ 17.82% 22.91% (5.28)% 16.79% 9.01% 13.70%
======== ======== ======== ======= ======= ======
Ratios to average net
assets/supplemental
data:
Net assets, end of
period (in 000's).... $240,210 $198,876 $172,449 $96,657 $14,055 $4,247
Ratio of net
investment income to
average net assets... 1.59%+ 2.12% 2.03% 1.71% 2.11% 4.54%+
Ratio of operating
expenses to average
net assets**......... 0.85%+ 0.84% 0.90% 1.12% 1.18% 0.00%+
Portfolio turnover
rate................. 58% 93% 67% 67% 50% 61%
Average commission
rate (per share of
security)(a)......... $ 0.0041 -- -- -- -- --
</TABLE>
- ----------
* Effective May 1, 1996, the name of the Managed Asset Allocation Portfolio
was changed to TCW Managed Asset Allocation Portfolio. The Portfolio
commenced operations on April 8, 1991.
** Annualized operating expense ratios before waiver of fees and/or
reimbursement of expense by investment manager for the year ended December
31, 1992 and the period ended December 31, 1991 were 1.73% and 5.18%,
respectively.
+ Annualized.
++ Total return represents aggregate total return for the periods indicated.
The total return of the Portfolio does not reflect the charges against the
separate accounts of PFL or the Contracts.
+++ Per share amounts have been calculated using the monthly average share
method, which more appropriately presents the per share data for this
period since use of the undistributed method does not accord with results
of operations.
# Net investment income/(loss) before fees waived and/or reimbursement of
expenses by investment manager for the year ended December 31, 1992 and the
period ended December 31, 1991 were $0.18 and $(0.01), respectively.
(a) Average commission rate paid per share of securities purchased and sold by
the Portfolio.
- 5 -
<PAGE>
T. ROWE PRICE INTERNATIONAL STOCK PORTFOLIO*
<TABLE>
<CAPTION>
YEAR YEAR PERIOD
YEAR ENDED ENDED ENDED YEAR ENDED YEAR ENDED ENDED
12/31/96+++ 12/31/95## 12/31/94 12/31/93+++ 12/31/92+++ 12/31/91*
----------- ---------- -------- ----------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
Operating Performance:
Net asset value,
beginning of period.. $ 12.19 $ 11.31 $ 11.99 $ 10.12 $10.52 $10.00
-------- ------- ------- ------- ------ ------
Net investment
income/(loss)#....... 0.09 0.09 (0.02) (0.04) 0.00*** 0.06
Net realized and
unrealized
gain/(loss) on
investments.......... 1.76 1.06 (0.66) 1.91 (0.38) 0.46
-------- ------- ------- ------- ------ ------
Net
increase/(decrease)
in net assets
resulting from
investment
operations........... 1.85 1.15 (0.68) 1.87 (0.38) 0.52
-------- ------- ------- ------- ------ ------
Distributions:
Dividends from net
investment income.... (0.09) -- -- -- (0.02) --
Distributions from net
realized gains....... 0.00*** (0.27) -- -- -- --
-------- ------- ------- ------- ------ ------
Total distributions... (0.09) (0.27) -- -- (0.02) --
-------- ------- ------- ------- ------ ------
Net asset value, end
of period............ $ 13.95 $ 12.19 $ 11.31 $ 11.99 $10.12 $10.52
======== ======= ======= ======= ====== ======
Total return++........ 15.23% 10.37% (5.67)% 18.48% (3.61)% 5.20%
======== ======= ======= ======= ====== ======
Ratios to average net
assets/supplemental
data:
Net assets, end of
period (in 000's).... $134,435 $92,352 $84,102 $52,777 $6,305 $3,200
Ratio of net
investment
income/(loss) to
average net assets... 0.73%+ 0.81% (0.16)% (0.31)% 0.01% 3.18%+
Ratio of operating
expenses to average
net assets**......... 1.18%+ 1.15% 1.16% 1.52% 1.43% 0.00%+
Portfolio turnover
rate................. 11% 111% 88% 37% 34% 0%
Average commission
rate (per share of
security)(a)......... $ 0.0024 -- -- -- -- --
</TABLE>
- ----------
* Effective March 24, 1995, the name of the Global Growth Portfolio was
changed to T. Rowe Price International Stock Portfolio and the investment
objective was changed from investment on a global basis to investment on
an international basis (i.e., in non-U.S. companies). The Portfolio
commenced operations on April 8, 1991.
** Annualized operating expense ratios before waiver of fees and/or
reimbursement of expenses by investment manager for the year ended
December 31, 1992 and the period ended December 31, 1991 were 2.10% and
6.83%, respectively.
*** Amount represents less than $0.01 per share.
+ Annualized.
++ Total return represents aggregate total return for the periods indicated.
The total return of the Portfolio does not reflect the charges against the
separate accounts of PFL or the Contracts.
+++ Per share amounts have been calculated using the monthly average share
method, which more appropriately presents the per share data for this
period since use of the undistributed method does not accord with results
of operations.
# Net investment loss before fees waived and/or reimbursement of expenses by
investment manager for the year ended December 31, 1992 and the period
ended December 31, 1991 were $(0.07) and $(0.07), respectively.
## Rowe Price-Fleming International, Inc. became the Portfolio's Adviser
effective January 3, 1995.
(a) Average commission rate paid per share of securities purchased and sold by
the Portfolio.
- 6 -
<PAGE>
VALUE EQUITY PORTFOLIO*
<TABLE>
<CAPTION>
YEAR YEAR PERIOD
YEAR ENDED ENDED ENDED ENDED
12/31/96+++ 12/31/95 12/31/94 12/31/93*+++
----------- -------- -------- ------------
<S> <C> <C> <C> <C>
Operating Performance:
Net asset value, beginning of
period.......................... $ 14.23 $ 10.69 $ 10.28 $ 10.00
-------- ------- ------- -------
Net investment income#............ 0.20 0.15 0.09 0.05
Net realized and unrealized gain
on investments.................. 3.15 3.52 0.33 0.23
-------- ------- ------- -------
Net increase in net assets
resulting from investment
operations...................... 3.35 3.67 0.42 0.28
-------- ------- ------- -------
Distributions:
Dividends from net investment in-
come............................ (0.13) (0.09) (0.01) --
Distributions from net realized
gains........................... (0.24) (0.04) -- --
-------- ------- ------- -------
Total distributions............... (0.37) (0.13) (0.01) --
-------- ------- ------- -------
Net asset value, end of period.... $ 17.21 $ 14.23 $ 10.69 $ 10.28
======== ======= ======= =======
Total return++.................... 23.84% 34.59% 4.09% 2.80%
======== ======= ======= =======
Ratios to average net
assets/supplemental data:
Net assets, end of period (in
000's).......................... $127,927 $68,630 $32,776 $11,178
Ratio of net investment income to
average net assets.............. 1.29%+ 1.56% 1.31% 0.84%+
Ratio of operating expenses to av-
erage net assets**.............. 0.91%+ 0.86% 1.02% 1.30%+
Portfolio turnover rate........... 27% 28% 56% 1%
Average commission rate (per share
of security)(a) ................ $ 0.0569 -- -- --
</TABLE>
- -----------
* Effective May 1, 1996, the name of the Quest for Value Equity Portfolio was
changed to Value Equity Portfolio. The Portfolio commenced operations on
May 27, 1993.
** Annualized expense ratio before waiver of fees by investment manager for
the period ended December 31, 1993 was 2.10%.
+ Annualized.
++ Total return represents aggregate total return for the periods indicated.
The total return of the Portfolio does not reflect the charges against the
separate accounts of PFL or the Contracts.
+++ Per share amounts have been calculated using the monthly average share
method which more appropriately presents the per share data for this period
since use of the undistributed method did not accord with results of
operations.
# Net investment income before fees waived by investment manager for the
period ended December 31, 1993 was $0.00.
(a) Average commission rate paid per share of securities purchased and sold by
the Portfolio.
- 7 -
<PAGE>
DREYFUS SMALL CAP VALUE PORTFOLIO*
<TABLE>
<CAPTION>
YEAR YEAR PERIOD
YEAR ENDED ENDED ENDED ENDED
12/31/96+++## 12/31/95 12/31/94+++ 12/31/93*+++
------------- -------- ----------- ------------
<S> <C> <C> <C> <C>
Operating Performance:
Net asset value, beginning of
period..................... $ 12.22 $ 10.98 $ 11.18 $ 10.00
------- ------- ------- -------
Net investment income#....... 0.12 0.15 0.10 0.22
Net realized and unrealized
gain/(loss) on investments. 2.95 1.36 (0.30) 0.96
------- ------- ------- -------
Net increase/(decrease) in
net assets resulting from
investment operations...... 3.07 1.51 (0.20) 1.18
------- ------- ------- -------
Distributions:
Dividends from net investment
income..................... (0.14) (0.10) -- --
Distributions from net
realized gains............. (0.46) (0.17) -- --
------- ------- ------- -------
Total distributions.......... (0.60) (0.27) -- --
------- ------- ------- -------
Net asset value, end of
period..................... $ 14.69 $ 12.22 $ 10.98 $ 11.18
======= ======= ======= =======
Total return++............... 25.63% 14.05% (1.79)% 11.80%
======= ======= ======= =======
Ratios to average net
assets/supplemental data:
Net assets, end of period (in
000's)..................... $85,803 $52,597 $35,966 $12,699
Ratio of net investment
income to average net
assets..................... 0.95%+ 1.56% 0.89% 3.98%+
Ratio of operating expenses
to average net assets**.... 0.92%+ 0.87% 1.03% 1.30%+
Portfolio turnover rate...... 171% 75% 77% 41%
Average commission rate (per
share of security)(a)...... $0.0539 -- -- --
</TABLE>
- -----------
* Effective October 29, 1996, the name of the Value Small Cap Portfolio was
changed to Dreyfus Small Cap Value Portfolio. On May 1, 1996, the name of
the Quest for Value Small Cap Portfolio was changed to Value Small Cap
Portfolio. The Portfolio commenced operations on May 4, 1993.
** Annualized operating expense ratio before waiver of fees by investment
manager for the period ended December 31, 1993 was 2.10%.
+ Annualized.
++ Total return represents aggregate total return for the periods indicated.
The total return of the Portfolio does not reflect the charges against the
separate accounts of PFL or the Contracts.
+++ Per share amounts have been calculated using the monthly average share
method which more appropriately presents the per share data for this
period since use of the undistributed method did not accord with results
of operations.
# Net investment income before fees waived by investment manager for the
period ended December 31, 1993 was $0.18.
## The Dreyfus Corporation became the Portfolio's Adviser effective September
16, 1996.
(a) Average commission rate paid per share of securities purchased and sold by
the Portfolio.
- 8 -
<PAGE>
DREYFUS U.S. GOVERNMENT SECURITIES PORTFOLIO*
<TABLE>
<CAPTION>
YEAR YEAR PERIOD
ENDED ENDED ENDED
12/31/96 +++ 12/31/95 12/31/94*+++
------------ -------- ------------
<S> <C> <C> <C>
Operating Performance:
Net asset value, beginning of period...... $ 11.39 $ 9.96 $10.00
------- ------- ------
Net investment income#.................... 0.62 0.30 0.24
Net realized and unrealized gain/(loss) on
investments............................. (0.44) 1.25 (0.28)
------- ------- ------
Net increase/(decrease) in net assets
resulting from investment operations.... 0.18 1.55 (0.04)
------- ------- ------
Distributions:
Dividends from net investment income...... (0.22) (0.12) --
Distributions from net realized gains..... (0.12) -- --
------- ------- ------
Total distributions....................... (0.34) (0.12) --
------- ------- ------
Net asset value, end of period............ $ 11.23 $ 11.39 $ 9.96
======= ======= ======
Total return++............................ 1.81% 15.64% (0.40)%
======= ======= ======
Ratios to average net assets/supplemental
data:
Net assets, end of period (in 000's)...... $24,727 $12,718 $3,505
Ratio of net investment income to average
net assets.............................. 5.68%+ 5.58% 4.14%+
Ratio of operating expenses to average net
assets**................................ 0.82%+ 0.84% 0.78%+
Portfolio turnover rate................... 222% 161% 100%
</TABLE>
- -----------
* Effective May 1, 1996, the name of the U.S. Government Securities Portfolio
was changed to Dreyfus U.S. Government Securities Portfolio. The Portfolio
commenced operations on May 13, 1994.
** Annualized operating expense ratio before waiver of fees and reimbursement
of expenses by investment manager for the period ended December 31, 1994
was 1.83%.
+ Annualized.
++ Total return represents aggregate total return for the periods indicated.
The total return of the Portfolio does not reflect the charges against the
separate accounts of PFL or the Contracts.
+++ Per share amounts have been calculated using the monthly average share
method, which more appropriately presents the per share data for this
period since use of the undistributed method did not accord with results of
operations.
# Net investment income before fees waived and reimbursement of expenses by
investment manager for the period ended December 31, 1994 was $0.18.
- 9 -
<PAGE>
T. ROWE PRICE EQUITY INCOME PORTFOLIO
<TABLE>
<CAPTION>
YEAR YEAR
ENDED ENDED
12/31/96 +++ 12/31/95*+++
------------ ------------
<S> <C> <C>
Operating performance:
Net asset value, beginning of year................. $ 13.05 $ 10.00
------- -------
Net investment income.............................. 0.41 0.34
Net realized and unrealized gain on investments.... 2.17 2.71
------- -------
Net increase in net assets resulting from
investment operations............................ 2.58 3.05
------- -------
Distributions:
Dividends from net investment income............... (0.10) --
Distribution from net realized gains............... (0.04) --
------- -------
Total distributions................................ (0.14) --
------- -------
Net asset value, end of year....................... $ 15.49 $ 13.05
======= =======
Total return++..................................... 19.88% 30.50%
======= =======
Ratios to average net assets/supplemental data:
Net assets, end of year (in 000's)................. $78,251 $21,910
Ratio of net investment income to average net
assets........................................... 2.89%+ 3.24%+
Ratio of operating expenses to average net assets.. 0.96%+ 1.15%+
Portfolio turnover rate............................ 19% 16%
Average commission rate (per share of security)(a). $0.0396 --
</TABLE>
- -----------
* The Portfolio commenced operations on January 3, 1995.
+ Annualized.
++ Total return represents aggregate total return for the periods indicated.
The total return of the Portfolio does not reflect the charges against the
separate accounts of PFL or the Contracts.
+++ Per share amounts have been calculated using the monthly average share
method which more appropriately presents the per share data for the period
since use of the undistributed method did not accord with results of
operations.
(a) Average commission rate paid per share of securities purchased and sold by
the Portfolio.
- 10 -
<PAGE>
T. ROWE PRICE GROWTH STOCK PORTFOLIO
<TABLE>
<CAPTION>
YEAR YEAR
ENDED ENDED
12/31/96+++ 12/31/95*+++
----------- ------------
<S> <C> <C>
Operating performance:
Net asset value, beginning of year.................. $ 13.72 $ 10.00
------- -------
Net investment income............................... 0.11 0.08
Net realized and unrealized gain on investments..... 2.71 3.64
------- -------
Net increase in net assets resulting from investment
operations........................................ 2.82 3.72
------- -------
Distributions:
Dividends from net investment income................ (0.01) --
Distributions from net realized gains............... (0.24) --
------- -------
Total distributions................................. (0.25) --
------- -------
Net asset value, end of year........................ $ 16.29 $ 13.72
======= =======
Total return++...................................... 20.77% 37.20%
======= =======
Ratios to average net assets/supplemental data:
Net assets, end of year (in 000's).................. $59,732 $21,651
Ratio of net investment income to average net
assets............................................ 0.75%+ 0.69%+
Ratio of operating expenses to average net assets... 1.01%+ 1.26%+
Portfolio turnover rate............................. 44% 64%
Average commission rate (per share of security)(a).. $0.0385 --
</TABLE>
- -----------
* The Portfolio commenced operations on January 3, 1995.
+ Annualized.
++ Total return represents aggregate total return for the periods indicated.
The total return of the Portfolio does not reflect the charges against the
separate accounts of PFL or the Contracts.
+++ Per share amounts have been calculated using the monthly average share
method which more appropriately presents the per share data for the period
since use of the undistributed method did not accord with results of
operations.
(a) Average commission rate paid per share of securities purchased and sold by
the Portfolio.
- 11 -
<PAGE>
OPPORTUNITY VALUE PORTFOLIO
<TABLE>
<CAPTION>
THREE MONTHS
ENDED PERIOD
3/31/97 ENDED
(UNAUDITED)+++ 12/31/96*
-------------- ---------
<S> <C> <C>
Operating performance:
Net asset value, beginning of period.............. $ 10.06 $ 10.00
------- -------
Net investment income (loss)#..................... 0.05 0.00##
Net realized and unrealized gain on investments... (0.09) 0.06
------- -------
Net increase (decrease) in net assets resulting
from investment operations...................... (0.04) 0.06
------- -------
Net asset value, end of period.................... $ 10.02 $ 10.06
======= =======
Total return++.................................... (0.04)% 0.60%
======= =======
Ratios to average net assets/supplemental data:
Net assets, end of period (in 000's).............. $ 5,167 $ 701
Ratio of net investment income (loss) to average
net assets...................................... 1.97% (1.09)%+
Ratio of operating expenses to average net
assets**........................................ 1.30%+ 1.30%+
Portfolio turnover rate........................... 4% 0%
Average commission rate (per share of
security)(a).................................... $0.0564 $0.0600
</TABLE>
- -----------
* The Portfolio commenced operations on November 18, 1996.
** Annualized operating expense ratio before waiver/reimbursement by
investment manager for the period ended December 31, 1996 was 12.69%.
+ Annualized.
++ Total return represents aggregate total return for the periods indicated.
The total return of the Portfolio does not reflect the charges against the
separate accounts of PFL or the Contracts.
+++ Per share amounts have been calculated using the monthly average share
method which more appropriately presents the per share data for the period
since use of the undistributed method did not accord with the results of
operations.
# Net investment loss before waiver/reimbursement of expenses by investment
manager for the period ended December 31, 1996 was ($0.04).
## Amount represents less than $(0.01) per share.
(a) Average commission rate paid per share of securities purchased and sold by
the Portfolio.
----------------------
Endeavor Investment Advisers (the "Manager") has agreed, until terminated by
the Manager, to assume expenses of the Portfolios that exceed the rates stated
below. This has the effect of lowering each Portfolio's expense ratio and of
increasing returns otherwise available to investors at the time such amounts
are assumed. While this arrangement
- 12 -
<PAGE>
is in effect, the Manager pays all expenses of the Portfolios to the extent
they exceed the following percentages of a Portfolio's average net assets: TCW
Money Market--.99%, TCW Managed Asset Allocation--1.25%, T. Rowe Price
International Stock--1.53%, Value Equity--1.30%, Dreyfus Small Cap Value--
1.30%, Dreyfus U.S. Government Securities--1.00%, T. Rowe Price Equity Income--
1.30%, T. Rowe Price Growth Stock--1.30%, Opportunity Value--1.30% and Enhanced
Index--1.30%.
The offering of shares of the Enhanced Index Portfolio is expected to
commence on or about the date of the Prospectus. Accordingly, no financial
highlight data is available for shares of this Portfolio.
INVESTMENT OBJECTIVES AND POLICIES
The following is a brief description of the investment objectives and
policies of the Portfolios. The investment objective and the policies of each
Portfolio other than those listed under the caption "Investment Restrictions"
in the Statement of Additional Information are not fundamental policies and may
be changed by the Trustees of the Fund without the approval of shareholders.
Certain portfolio investments and techniques discussed below are described in
greater detail in the Statement of Additional Information. Due to the
uncertainty inherent in all investments, there can be no assurance that the
Portfolios will be able to achieve their respective investment objectives.
TCW MONEY MARKET PORTFOLIO
The investment objective of the TCW Money Market Portfolio is to provide
current income, preservation of capital and liquidity through investment in
short-term money market securities.
The Portfolio seeks to maintain a constant net asset value of $1.00 per
share. If the Trustees believe that the extent of any deviation from a $1.00
price per share may result in material dilution or other unfair results to
shareholders, they will take such steps as they consider appropriate to
eliminate or reduce these consequences to the extent reasonably practicable.
This may include selling portfolio securities prior to maturity, shortening the
average maturity of the Portfolio, withholding or reducing dividends, redeeming
shares in kind, reducing the number of the Portfolio's outstanding shares
without monetary consideration, or utilizing a net asset value per share
determined by using available market quotations.
The Portfolio expects to invest in the following types of money market
securities:
. securities issued or guaranteed as to principal and interest by the U.S.
government or by its agencies or instrumentalities ("U.S. government
securities");
. certificates of deposit, bankers' acceptances and other obligations
issued or guaranteed by bank holding companies in the United States and
their subsidiaries;
- 13 -
<PAGE>
. U.S. dollar denominated obligations ("Eurodollar obligations") of bank
holding companies in the United States, their subsidiaries and their
foreign branches or of the International Bank for Reconstruction and
Development (also known as the World Bank);
. commercial paper and other short-term obligations of, and variable
amount master demand notes and variable rate notes issued by U.S. and
foreign corporations; and
. repurchase agreements (see "Investment Strategies").
Investment Criteria. With respect to investments in money market securities,
in accordance with applicable regulations of the Securities and Exchange
Commission, the Portfolio will:
. invest only in high quality money market instruments that present
minimal credit risks;
. invest only in money market instruments with remaining or implied
maturities of thirteen months or less; and
. maintain an average dollar weighted maturity of the Portfolio's
investments of 90 days or less.
The Portfolio will invest only in high quality money market instruments,
i.e., securities which have been assigned the highest quality ratings by
nationally recognized statistical rating organizations ("NRSROs") such as "A-1"
by Standard & Poor's Ratings Service, a division of McGraw-Hill Companies, Inc.
("Standard & Poor's") or "Prime-1" by Moody's Investors Service, Inc.
("Moody's"), or if not rated, determined to be of comparable quality by the
Portfolio's Adviser (as hereinafter defined); provided, that up to 5% of the
Portfolio's total assets may be invested in instruments assigned the second
highest quality ratings such as "A-2" or "Prime-2", or if not rated, determined
to be of comparable quality by the Portfolio's Adviser. For a description of
the NRSROs and their ratings, see the Appendix attached to the Statement of
Additional Information.
The Portfolio may not invest in the securities of any one issuer if,
immediately after such investment, more than 5% of the total assets of the
Portfolio (taken at current value) would be invested in the securities of such
issuer; provided, that this limitation does not apply to U.S. government
securities or to repurchase agreements secured by such securities and that with
respect to 25% of the Portfolio's total assets more than 5% may be invested in
securities of any one issuer for three business days after the purchase thereof
if the securities have been assigned the highest quality ratings by NRSROs, or
if not rated, have been determined to be of comparable quality by the
Portfolio's Adviser. With respect to U.S. government securities, the Portfolio
will not invest more than 55% of its assets in securities issued or guaranteed
by the U.S. Treasury or any single U.S. government agency or instrumentality.
See "Investment Restrictions" in the Statement of Additional Information for a
further description of the Portfolio's investment criteria.
- 14 -
<PAGE>
U.S. Government Securities. Securities issued or guaranteed as to principal
and interest by the U.S. government or its agencies and instrumentalities
include U.S. Treasury obligations, consisting of bills, notes and bonds, which
principally differ in their interest rates, maturities and times of issuance,
and obligations issued or guaranteed by agencies and instrumentalities which
are supported by (i) the full faith and credit of the U.S. Treasury (such as
securities of the Small Business Administration), (ii) the limited authority of
the issuer to borrow from the U.S. Treasury (such as securities of the Student
Loan Marketing Association) or (iii) the authority of the U.S. government to
purchase certain obligations of the issuer (such as securities of the Federal
National Mortgage Association). No assurance can be given that the U.S.
government will provide financial support to U.S. government agencies or
instrumentalities as described in clauses (ii) or (iii) above in the future,
other than as set forth above, since it is not obligated to do so by law.
Other Money Market Securities. Other money market securities in which the
Portfolio may invest include U.S. dollar denominated instruments (such as
bankers' acceptances, commercial paper, certificates of deposit and Eurodollar
obligations) issued or guaranteed by bank holding companies in the United
States, their subsidiaries and their foreign branches. These bank obligations
may be general obligations of the parent bank holding company or may be limited
to the issuing entity by the terms of the specific obligation or by government
regulation.
Obligations of the International Bank for Reconstruction and Development
(also known as the World Bank) are supported by subscribed but unpaid
commitments of its member countries. There can be no assurance that these
commitments will be undertaken or complied with in the future.
The other money market securities in which the Portfolio may invest also
include certain variable and floating rate instruments and participations in
corporate loans to corporations in whose commercial paper or other short-term
obligations the Portfolio may invest. Because the bank issuing the
participations does not guarantee them in any way, they are subject to the
credit risks generally associated with the underlying corporate borrower. To
the extent that the Portfolio may be regarded as a creditor of the issuing bank
(rather than of the underlying corporate borrower under the terms of the loan
participation), the Portfolio may also be subject to credit risks associated
with the issuing bank. The secondary market, if any, for these loan
participations is extremely limited and any such participations purchased by
the Portfolio will be regarded as illiquid.
Other money market securities in which the Portfolio may invest also include
bonds and notes with remaining maturities of thirteen months or less, variable
rate notes and variable amount master demand notes. A variable amount master
demand note differs from ordinary commercial paper in that it is issued
pursuant to a written agreement
- 15 -
<PAGE>
between the issuer and the holder, its amount may be increased from time to
time by the holder (subject to an agreed maximum) or decreased by the holder or
the issuer, it is payable on demand, the rate of interest payable on it varies
with an agreed formula and it is typically not rated by a rating agency.
Transfer of such notes is usually restricted by the issuer, and there is no
secondary trading market for them. Any variable amount master demand note
purchased by the Portfolio will be regarded as an illiquid security. See
"Investment Restrictions" in the Statement of Additional Information.
Foreign Securities. The Portfolio may invest up to 10% of its total assets in
the securities (payable in U.S. dollars) of foreign issuers in developed
countries and in the securities of foreign branches of U.S. banks such as
negotiable certificates of deposit (Eurodollars). Because the Portfolio may
invest in foreign securities, investment in the Portfolio involves investment
risks that are different in some respects from an investment in a fund which
invests only in debt obligations of U.S. domestic issuers. Such risks may
include adverse future political and economic developments, the possible
imposition of foreign withholding taxes on interest income payable on the
securities held in the Portfolio, possible seizure or nationalization of
foreign deposits, the possible establishment of exchange controls, or the
adoption of other foreign governmental restrictions which might adversely
affect the payment of principal and interest on securities in the Portfolio.
There may also be less publicly available information about a foreign issuer
than about a domestic issuer and foreign issuers are not generally subject to
uniform accounting, auditing and financial reporting standards, practices and
requirements comparable to those applicable to domestic issuers.
The Portfolio may employ certain investment strategies which are described
under the caption "Investment Strategies" below and in the Statement of
Additional Information.
TCW MANAGED ASSET ALLOCATION PORTFOLIO
The investment objective of the TCW Managed Asset Allocation Portfolio is to
provide high total return through a managed asset allocation portfolio of
equity, fixed income and money market securities. The Portfolio seeks to
achieve its objective by investing primarily in securities issued by United
States companies.
The composition of the Portfolio's investments will be based on the
determination by the Portfolio's Adviser of the appropriate weighting for each
asset class and will be adjusted periodically. In making adjustments to the
asset allocation, the Portfolio's Adviser will use its asset allocation model
and will integrate its view of the expected returns for each asset class,
conditions in the stock, bond and money markets, interest rate and corporate
earnings growth trends, and economic conditions.
The asset class weightings may theoretically range from 0% to 100%, although
the Portfolio's Adviser expects these extremes to be
- 16 -
<PAGE>
reached rarely, if at all, for any class. The Portfolio will be "rebalanced" or
checked for possible reallocation monthly or more often if market conditions
demand.
The equity portion of the Portfolio will be invested in a diversified
selection of equity securities of established companies in sound financial
condition. The equity securities in which the Portfolio will be invested may
include common stocks, preferred stocks, securities convertible into or
exchangeable for common stocks and warrants. The Portfolio's Adviser will
strive to achieve total returns from dividends and capital gains in excess of
those from broadly-based stock market indices, but will not incur excessive
risk of loss to do so.
The fixed income portion of the Portfolio will be invested in taxable
securities including securities issued or guaranteed by the U.S. government and
its agencies or instrumentalities, collateralized mortgage obligations that are
issued or guaranteed by the U.S. government or instrumentalities or that are
collateralized by a portfolio of mortgages or mortgage-related securities
guaranteed by such an agency or instrumentality and high grade corporate and
mortgage-backed bonds with maturities typically ranging from 2 to 30 years. The
weighted average maturity of such investments will generally range from 3 to 10
years and securities will, at time of purchase, have ratings within the four
highest rating categories established by Moody's, Standard & Poor's, or a
similar NRSRO or if not rated, be of comparable quality as determined by the
Portfolio's Adviser. The NRSROs' descriptions of these bond ratings are set
forth in the Appendix to the Statement of Additional Information. Securities
rated in the fourth highest category may have speculative characteristics;
changes in economic or business conditions are more likely to lead to a
weakened capacity to make principal and interest payments than in the case of
higher grade bonds. Like the three highest grades, however, these securities
are considered investment grade.
Mortgage-backed bonds have yield and maturity characteristics corresponding
to the underlying mortgage loans. Thus, for example, unlike other bonds, which
pay a fixed rate of interest until maturity when the entire principal amount
comes due, payments on mortgage-backed bonds include both interest and a
partial repayment of principal. Fluctuating prepayments of principal may result
from the refinancing or foreclosure of the underlying mortgage loans. Although
maturities of the underlying mortgage loans range up to 30 years, such
prepayments may shorten the effective maturities. Because of the prepayment
feature, mortgage-backed bonds may be less effective than other types of
securities as a means of "locking in" attractive long-term interest rates. This
is caused by the need to reinvest repayments of principal generally and the
possibility of significant unscheduled prepayments resulting from declines in
mortgage interest rates. As a result, mortgage-backed bonds may have less
potential for capital appreciation during periods of declining interest rates
than other investments of comparable
- 17 -
<PAGE>
maturities, while having a comparable risk of decline during periods of rising
interest rates.
Foreign Securities. The Portfolio may invest up to 10% of its total assets in
equity securities (payable in U.S. dollars) of foreign issuers in developed
countries. Because the Portfolio may invest in foreign securities, investment
in the Portfolio involves investment risks that are different in some respects
from an investment in a fund which invests only in securities of U.S. domestic
issuers. Such risks may include adverse future political and economic
developments, the possible imposition of foreign withholding taxes on interest
income payable on the securities held in the Portfolio, possible seizure or
nationalization of foreign deposits, the possible establishment of exchange
controls, or the adoption of other foreign governmental restrictions which
might adversely affect the payment of principal and interest on securities in
the Portfolio. There may also be less publicly available information about a
foreign issuer than about a domestic issuer and foreign issuers are not
generally subject to uniform accounting, auditing and financial reporting
standards, practices and requirements comparable to those applicable to
domestic issuers.
The cash portion of the Portfolio will be invested in the same portfolio
securities that are eligible for investment by the TCW Money Market Portfolio
described above. The Portfolio may employ certain investment strategies which
are discussed under the caption "Investment Strategies" below and in the
Statement of Additional Information.
T. ROWE PRICE INTERNATIONAL STOCK PORTFOLIO
The T. Rowe Price International Stock Portfolio was formerly known as the
Global Growth Portfolio. Effective March 24, 1995, the name of the Global
Growth Portfolio was changed to T. Rowe Price International Stock Portfolio and
the Portfolio's investment objective was changed from seeking long-term capital
appreciation through a policy of investing in small capitalization common
stocks and their convertible equivalents on a global basis to the investment
objective and policies set forth below.
The investment objective of the T. Rowe Price International Stock Portfolio
is to seek long-term growth of capital through investments primarily in common
stocks of established non-U.S. companies.
Over the last 30 years, many foreign economies have grown faster than the
United States' economy, and the return from equity investments in these
countries has often exceeded the return on similar investments in the United
States. Moreover, there has normally been a wide and largely unrelated
variation in performance between international equity markets over this period.
Although there can be no assurance that these conditions will continue, the
Portfolio's Adviser, within the framework of diversification, seeks to identify
and invest in companies participating in the faster growing foreign economies
and
- 18 -
<PAGE>
markets. The Adviser believes that investment in foreign securities offers
significant potential for long-term capital appreciation and an opportunity to
achieve investment diversification.
The Adviser intends to invest substantially all of the Portfolio's assets
outside the United States and diversify investments broadly among countries
throughout the world--developed, newly industrialized and emerging--by having
at least five different countries represented in the Portfolio. The Portfolio
may invest in countries of the Far East and Europe as well as South Africa,
Australia, Canada, and other areas (including developing countries). Further,
not more than 20% of the Portfolio's net asset value will be invested in
securities of issuers located in any one country with the exception of issuers
located in Australia, Canada, France, Japan, the United Kingdom or Germany
(where the investment limitation is 35%). In addition, the Adviser will
consider factors applicable to United States investors in making investment
decisions for the Portfolio.
In seeking its objective, the Portfolio invests primarily in common stocks of
established foreign companies which have, in the Adviser's opinion, the
potential for growth of capital. However, the Portfolio may also invest in a
variety of other equity related securities such as preferred stocks, warrants
and convertible securities, as well as corporate and governmental debt
securities, when considered consistent with the Portfolio's investment
objective and program. The Portfolio may also invest in investment funds which
have been authorized by the governments of certain countries specifically to
permit foreign investment in securities of companies listed and traded on the
stock exchanges in these respective countries. The Portfolio's investment in
these funds is subject to the provisions of the Investment Company Act of 1940
(the "1940 Act"). If the Portfolio invests in such investment funds, the
Portfolio's shareholders will bear not only their proportionate share of the
expenses of the Portfolio (including operating expenses and the fees of the
investment manager), but also will bear indirectly similar expenses of the
underlying investment funds. In addition, the securities of these investment
funds may trade at a premium of their net asset value. Under normal conditions,
the Portfolio's investments in securities other than common stocks is limited
to no more than 35% of its total assets.
In determining the appropriate distribution of investments among various
countries and geographic regions, the Portfolio's Adviser ordinarily considers
the following factors: prospects for relative economic growth between foreign
countries; expected levels of inflation; government policies influencing
business conditions; the outlook for currency relationships; and the range of
individual investment opportunities available to international investors.
In analyzing companies for investment, the Adviser ordinarily looks for one
or more of the following characteristics: an above-average earnings growth per
share; high return on invested capital; healthy
- 19 -
<PAGE>
balance sheet; sound financial and accounting policies and overall financial
strength; strong competitive advantages; effective research and product
development and marketing; efficient service; pricing flexibility; strength of
management; and general operating characteristics which will enable the
companies to compete successfully in their market place. While current dividend
income is not a prerequisite in the selection of portfolio companies, the
companies in which the Portfolio invests normally will have a record of paying
dividends, and will generally be expected to increase the amounts of such
dividends in future years as earnings increase. It is expected that the
Portfolio's investments will ordinarily be traded on exchanges located at least
in the respective countries in which the various issuers of such securities are
principally based.
In the event that future economic or financial conditions abroad adversely
affect equity securities, or stocks are considered overvalued, or the
Portfolio's Adviser believes that investing for defensive purposes is
appropriate, or in order to meet anticipated redemption requests, the Portfolio
may invest part or all of its assets in U.S. government securities, investment-
grade debt obligations of U.S. companies and high quality (within the two
highest rating categories assigned by a NRSRO) short-term debt securities (with
remaining maturities of one year or less) including certificates of deposit,
bankers' acceptances, commercial paper, short-term corporate securities and
repurchase agreements.
The international objectives of the Portfolio allow investors an opportunity
to achieve potentially higher returns, reflecting participation in countries
and economies with higher growth rates than those available domestically.
However, foreign investments involve certain risks that are not present in
domestic securities. Because the Portfolio intends to purchase securities
denominated in foreign currencies, a change in the value of any such currency
against the U.S. dollar will result in a change in the U.S. dollar value of the
Portfolio's assets and the Portfolio's income. In addition, although a portion
of the Portfolio's investment income may be received or realized in such
currencies, the Portfolio will be required to compute and distribute its income
in U.S. dollars. Therefore, if the exchange rate for any such currency declines
after the Portfolio's income has been earned and computed in U.S. dollars but
before conversion and payment, the Portfolio could be required to liquidate
portfolio securities to make such distributions.
The values of foreign investments and the investment income derived from them
may also be affected unfavorably by changes in currency exchange control
regulations. Although the Portfolio will invest only in securities denominated
in foreign currencies that are fully exchangeable into U.S. dollars without
legal restriction at the time of investment, there can be no assurance that
currency controls will not be imposed subsequently. In addition, the values of
foreign fixed income investments will fluctuate in response to changes in U.S.
and foreign interest rates.
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There may be less information publicly available about a foreign issuer than
about a U.S. issuer, and foreign issuers are not generally subject to
accounting, auditing and financial reporting standards and practices comparable
to those in the United States. Foreign stock markets are generally not as
developed or efficient as, and may be more volatile than, those in the United
States. While growing in volume, they usually have substantially less volume
than U.S. markets and the Portfolio's investment securities may be less liquid
and subject to more rapid and erratic price movements than securities of
comparable U.S. companies. Equity securities may trade at price/earnings
multiples higher than comparable United States securities and such levels may
not be sustainable. There is generally less government supervision and
regulation of foreign stock exchanges, brokers and listed companies than in the
United States. Moreover, settlement practices for transactions in foreign
markets may differ from those in United States markets. Such differences may
include delays beyond periods customary in the United States and practices,
such as delivery of securities prior to receipt of payment, which increase the
likelihood of a "failed settlement." Failed settlements can result in losses to
the Portfolio. In less liquid and well developed stock markets, such as those
in some Asian and Latin American countries, volatility may be heightened by
actions of a few major investors. For example, substantial increases or
decreases in cash flows of mutual funds investing in these markets could
significantly affect stock prices and, therefore, share prices.
Foreign brokerage commissions, custodial expenses and other fees are also
generally higher than for securities traded in the United States. Consequently,
the overall expense ratios of international funds are usually somewhat higher
than those of typical domestic stock funds.
In addition, the economies, markets and political structures of a number of
the countries in which the Portfolio can invest do not compare favorably with
the United States and other mature economies in terms of wealth and stability.
Therefore, investments in these countries may be riskier, and will be subject
to erratic and abrupt price movements. Some economies are less well developed
and less diverse (for example, Latin America, Eastern Europe and certain Asian
countries), and more vulnerable to the ebb and flow of international trade,
trade barriers and other protectionist or retaliatory measures (for example,
Japan, southeast Asia and Latin America). Some countries, particularly in Latin
America, are grappling with severe inflation and high levels of national debt.
Investments in countries that have recently begun moving away from central
planning and state-owned industries toward free markets, such as the Eastern
European or Chinese economies, should be regarded as speculative.
Certain portfolio countries have histories of instability and upheaval (Latin
America) and internal politics that could cause their governments to act in a
detrimental or hostile manner toward private enterprise or foreign investment.
Any such actions, for example, nationalizing an
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industry or company, could have a severe and adverse effect on security prices
and impair the Portfolio's ability to repatriate capital or income. The
Portfolio's Adviser will not invest the Portfolio's assets in countries where
it believes such events are likely to occur.
Income received by the Portfolio from sources within foreign countries may be
reduced by withholding and other taxes imposed by such countries. Tax
conventions between certain countries and the United States may reduce or
eliminate such taxes. The Portfolio's Adviser will attempt to minimize such
taxes by timing of transactions and other strategies, but there can be no
assurance that such efforts will be successful. Any such taxes paid by the
Portfolio will reduce its net income available for distribution to
shareholders.
The Portfolio may employ certain investment strategies which are discussed
under the caption "Investment Strategies" below and in the Statement of
Additional Information.
VALUE EQUITY PORTFOLIO
The investment objective of the Value Equity Portfolio is long term capital
appreciation through investment in securities (primarily equity securities) of
companies that are believed by the Portfolio's Adviser to be undervalued in the
marketplace in relation to factors such as the companies' assets or earnings.
It is the Portfolio Adviser's intention to invest in securities which in its
opinion possess one or more of the following characteristics: undervalued
assets, valuable consumer or commercial franchises, securities valuation below
peer companies, substantial and growing cash flow and/or a favorable price to
book value relationship.
Investment policies aimed at achieving the Portfolio's objective are set in a
flexible framework of securities selection which primarily includes equity
securities, such as common stocks, preferred stocks, convertible securities,
rights and warrants in proportions which vary from time to time. Under normal
circumstances at least 65% of the Portfolio's assets will be invested in common
stocks or securities convertible into common stocks. The Portfolio will invest
primarily in stocks listed on the New York Stock Exchange. In addition, it may
also purchase securities listed on other domestic securities exchanges or
traded in the domestic over-the-counter market and foreign securities that are
listed on a domestic or foreign securities exchange, traded in the domestic or
foreign over-the-counter markets or represented by American Depositary
Receipts.
In the event that future economic or financial conditions adversely affect
equity securities, or stocks are considered overvalued, or the Portfolio's
Adviser believes that investing for defensive purposes is appropriate, or in
order to meet anticipated redemption requests, the Portfolio may invest part or
all of its assets in U.S. government securities
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and high quality short-term debt securities (with remaining maturities of one
year or less) including certificates of deposit, bankers' acceptances,
commercial paper, short-term corporate securities and repurchase agreements.
The Portfolio may invest in certain foreign securities which may represent a
greater degree of risk than investing in domestic securities. These risks are
discussed in the above section of this Prospectus describing the T. Rowe Price
International Stock Portfolio.
It is the present intention of the Portfolio's Adviser to invest no more than
5% of the Portfolio's net assets in bonds rated below Baa3 by Moody's or BBB by
Standard & Poor's (commonly known as "junk bonds"). In the event that the
Portfolio's Adviser intends in the future to invest more than 5% of the
Portfolio's net assets in junk bonds, appropriate disclosures will be made to
existing and prospective shareholders. For information about the possible risks
of investing in junk bonds see "Investment Objective and Policies--Lower Rated
Bonds" in the Statement of Additional Information.
The Portfolio may employ certain investment strategies which are discussed
under the caption "Investment Strategies" below and in the Statement of
Additional Information.
DREYFUS SMALL CAP VALUE PORTFOLIO
The investment objective of the Dreyfus Small Cap Value Portfolio is to seek
capital appreciation through investments in a diversified portfolio of equity
securities of companies with a median market capitalization of approximately
$750 million, provided that under normal market conditions at least 75% of the
Portfolio's investments will be in equity securities of companies with
capitalizations at the time of purchase between $150 million and $1.5 billion.
Small-capitalization companies are often under-priced for the following
reasons: (i) institutional investors, which currently represent a majority of
the trading volume in the shares of publicly-traded companies, are often less
interested in such companies because in order to acquire an equity position
that is large enough to be meaningful to an institutional investor, such an
investor may be required to buy a large percentage of the company's outstanding
equity securities and (ii) such companies may not be regularly researched by
stock analysts, thereby resulting in greater discrepancies in valuation.
The Portfolio will invest in equity securities of domestic and foreign (up to
5% of its total assets) issuers which would be characterized as "value"
companies according to criteria established by the Portfolio's Adviser. To
manage the Portfolio, the Portfolio's Adviser classifies issuers as "growth" or
"value" companies. In general, the Portfolio's Adviser believes that companies
with relatively low price to book ratios, low price to earnings ratios or
higher than average dividend payments
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in relation to price should be classified as value companies. Alternatively,
companies which have above average earnings or sales growth and retention of
earnings and command higher price to earnings ratios fit the more classic
growth description.
While seeking desirable equity investments, the Portfolio may invest in money
market instruments consisting of U.S. government securities, certificates of
deposit, time deposits, bankers' acceptances, short-term investment grade
corporate bonds and other short-term debt instruments, and repurchase
agreements. Under normal market conditions, the Portfolio does not expect to
have a substantial portion of its assets invested in money market instruments.
However, when the Portfolio's Adviser determines that adverse market conditions
exist, the Portfolio may adopt a temporary defensive posture and invest all of
its assets in money market instruments.
Equity securities consist of common stocks, preferred stocks and securities
convertible into common stocks. Securities purchased by the Portfolio will be
traded on the New York Stock Exchange, the American Stock Exchange or in the
over-the-counter market, and will also include options, warrants, bonds, notes
and debentures which are convertible into or exchangeable for, or which grant a
right to purchase or sell, such securities. In addition, the Portfolio may
purchase securities issued by closed-end investment companies and foreign
securities that are listed on a domestic or foreign securities exchange, traded
in domestic or foreign over-the-counter markets or represented by American
Depositary Receipts.
The Portfolio is expected to have greater risk exposure and reward potential
than a fund which invests primarily in larger-capitalization companies. The
trading volumes of securities of smaller-capitalization companies are normally
less than those of larger-capitalization companies. This often translates into
greater price swings, both upward and downward. Since trading volumes are
lower, new demand for the securities of such companies could result in
disproportionately large increases in the price of such securities. The waiting
period for the achievement of an investor's objectives might be longer since
these securities are not closely monitored by research analysts and, thus, it
takes more time for investors to become aware of fundamental changes or other
factors which have motivated the Portfolio's purchase. Small-capitalization
companies often achieve higher growth rates and experience higher failure rates
than do larger-capitalization companies.
The Portfolio may invest in certain foreign securities which may represent a
greater degree of risk than investing in domestic securities. These risks are
discussed in the above section of this Prospectus describing the T. Rowe Price
International Stock Portfolio.
The Portfolio may employ certain investment strategies which are discussed
under the caption "Investment Strategies" below and in the Statement of
Additional Information.
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DREYFUS U.S. GOVERNMENT SECURITIES PORTFOLIO
The investment objective of the Dreyfus U.S. Government Securities Portfolio
is to seek as high a level of total return as is consistent with prudent
investment strategies by investing under normal conditions at least 65% of its
assets in U.S. government debt obligations and mortgage-backed securities
issued or guaranteed by the U.S. government, its agencies or instrumentalities
("U.S. Government Securities").
The Portfolio expects to invest in the following types of U.S. Government
Securities:
. U.S. Treasury obligations;
. obligations issued or guaranteed by agencies or instrumentalities of the
U.S. government which are backed by their own credit and may not be
backed by the full faith and credit of the U.S. government;
. mortgage-backed securities guaranteed by the Government National
Mortgage Association that are supported by the full faith and credit of
the U.S. government and which are the "modified pass-through" type of
mortgage-backed security ("GNMA Certificates"). Such securities entitle
the holder to receive all interest and principal payments due whether or
not payments are actually made on the underlying mortgages;
. mortgage-backed securities guaranteed by agencies or instrumentalities
of the U.S. government which are supported by their own credit but not
the full faith and credit of the U.S. government, such as the Federal
Home Loan Mortgage Corporation and the Federal National Mortgage
Association; and
. collateralized mortgage obligations issued by private issuers for which
the underlying mortgage-backed securities serving as collateral are
backed (i) by the credit alone of the U.S. government agency or
instrumentality which issues or guarantees the mortgage-backed
securities, or (ii) by the full faith and credit of the U.S. government.
Mortgage-Backed Securities. The mortgage-backed securities in which the
Portfolio invests represent participation interests in pools of mortgage loans
which are guaranteed by agencies or instrumentalities of the U.S. government.
However, the guarantee of these types of securities runs only to the principal
and interest payments and not to the market value of such securities. In
addition, the guarantee only runs to the portfolio securities held by the
Portfolio and not the purchase of shares of the Portfolio.
Mortgage-backed securities are issued by lenders such as mortgage bankers,
commercial banks, and savings and loan associations. Such securities differ
from conventional debt securities which provide for periodic payment of
interest in fixed amounts (usually semiannually) with principal payments at
maturity or specified call dates. Mortgage-backed
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securities provide for monthly payments which are, in effect, a "pass-through"
of the monthly interest and principal payments (including any prepayments)
made by the individual borrowers on the pooled mortgage loans. Principal
prepayments result from the sale of the underlying property or the refinancing
or foreclosure of underlying mortgages.
The yield of mortgage-backed securities is based on the average life of the
underlying pool of mortgage loans, which is computed on the basis of the
maturities of the underlying instruments. The actual life of any particular
pool may be shortened by unscheduled or early payments of principal and
interest. The occurrence of prepayments is affected by a wide range of
economic, demographic and social factors and, accordingly, it is not possible
to accurately predict the average life of a particular pool. For pools of
fixed rate 30-year mortgages, it has been common practice to assume that
prepayments will result in a 12-year average life. The actual prepayment
experience of a pool of mortgage loans may cause the yield realized by the
Portfolio to differ from the yield calculated on the basis of the average life
of the pool. In addition, if any of these mortgage-backed securities are
purchased at a premium, the premium may be lost in the event of early
prepayment which may result in a loss to the Portfolio.
Prepayments tend to increase during periods of falling interest rates, while
during periods of rising interest rates prepayments will most likely decline.
Reinvestment by the Portfolio of scheduled principal payments and unscheduled
prepayments may occur at higher or lower rates than the original investment,
thus affecting the yield of the Portfolio. Monthly interest payments received
by the Portfolio have a compounding effect which will increase the yield to
shareholders as compared to debt obligations that pay interest semiannually.
Because of the reinvestment of prepayments of principal at current rates,
mortgage-backed securities may be less effective than Treasury bonds of
similar maturity at maintaining yields during periods of declining interest
rates. Also, although the value of debt securities may increase as interest
rates decline, the value of these pass-through type of securities may not
increase as much due to the prepayment feature.
Collateralized Mortgage Obligations. Collateralized mortgage obligations
("CMOs"), which are debt obligations collateralized by mortgage loans or
mortgage pass-through securities, provide the holder with a specified interest
in the cash flow of a pool of underlying mortgages or other mortgage-backed
securities. Issuers of CMOs frequently elect to be taxed as a pass-through
entity known as real estate mortgage investment conduits. CMOs are issued in
multiple classes, each with a specified fixed or floating interest rate and a
final distribution date. The relative payment rights of the various CMO
classes may be structured in many ways. In most cases, however, payments of
principal are applied to the CMO classes in the order of their respective
stated maturities, so that no principal payments will be made on a CMO class
until all other classes having an earlier stated maturity date are paid in
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full. The classes may include accrual certificates (also known as "Z-Bonds"),
which only accrue interest at a specified rate until other specified classes
have been retired and are converted thereafter to interest-paying securities.
They may also include planned amortization classes which generally require,
within certain limits, that specified amounts of principal be applied on each
payment date, and generally exhibit less yield and market volatility than other
classes.
Stripped Mortgage-Backed Securities. The Portfolio may also invest a portion
of its assets in stripped mortgage-backed securities ("SMBS"), which are
derivative multi-class mortgage securities. SMBS are usually structured with
two classes that receive different proportions of the interest and principal
distributions from a pool of mortgage assets. The Portfolio will only invest in
SMBS whose mortgage assets are U.S. Government Securities.
A common type of SMBS will be structured so that one class receives some of
the interest and most of the principal from the mortgage assets, while the
other class receives most of the interest and the remainder of the principal.
In the most extreme case, one class will receive all of the interest (the
interest-only or "IO" class) while the other class will receive all of the
principal (the principal-only or "PO" class). The yield to maturity on an IO
class is extremely sensitive to the rate of principal payments (including
prepayments) on the related underlying mortgage assets, and a rapid rate of
principal payments may have a material adverse effect on the Portfolio's yield
to maturity from these securities. If the underlying mortgage assets experience
greater than anticipated prepayments of principal, the Portfolio may fail to
fully recoup its initial investment in these securities even if the security is
in one of the highest rating categories. The Portfolio may invest not more than
5% of its total assets in CMOs deemed by its Adviser to be complex, such as
floating rate and inverse floating rate tranches and SMBS.
Non-Mortgage Asset Backed Securities. The Portfolio may invest in non-
mortgage backed securities including interests in pools of receivables, such as
motor vehicle installment purchase obligations and credit card receivables.
Such securities are generally issued as pass-through certificates, which
represent undivided fractional ownership interests in the underlying pools of
assets.
Non-mortgage backed securities are not issued or guaranteed by the U.S.
government or its agencies or instrumentalities; however, the payment of
principal and interest on such obligations may be guaranteed up to certain
amounts and for a certain time period by a letter of credit issued by a
financial institution (such as a bank or insurance company) unaffiliated with
the issuers of such securities. In addition, such securities generally will
have remaining estimated lives at the time of purchase of five years or less.
The purchase of non-mortgage backed securities raises considerations peculiar
to the financing of the instruments underlying
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such securities. For example, most organizations that issue asset backed
securities relating to motor vehicle installment purchase obligations perfect
their interests in their respective obligations only by filing a financing
statement and by having the servicer of the obligations, which is usually the
originator, take custody thereof. In such circumstances, if the servicer were
to sell the same obligations to another party, in violation of its duty not to
do so, there is a risk that such party could acquire an interest in the
obligations superior to that of holders of the asset backed securities. Also,
although most such obligations grant a security interest in the motor vehicle
being financed, in most states the security interest in a motor vehicle must be
noted on the certificate of title to perfect such security interest against
competing claims of other parties. Due to the large number of vehicles
involved, however, the certificate of title to each vehicle financed, pursuant
to the obligations underlying the asset backed securities, usually is not
amended to reflect the assignment of the seller's security interest for the
benefit of the holders of the asset backed securities. Therefore, there is the
possibility that recoveries on repossessed collateral may not, in some cases,
be available to support payments on those securities. In addition, various
state and federal laws give the motor vehicle owner the right to assert against
the holder of the owner's obligation certain defenses such owner would have
against the seller of the motor vehicle. The assertion of such defenses could
reduce payments on the related asset backed securities. Insofar as credit card
receivables are concerned, credit card holders are entitled to the protection
of a number of state and federal consumer credit laws, many of which give such
holders the right to set off certain amounts against balances owed on the
credit card, thereby reducing the amounts paid on such receivables. In
addition, unlike most other asset backed securities, credit card receivables
are unsecured obligations of the card holder.
U.S. Treasury Obligations. U.S. Treasury obligations consist of bills, notes
and bonds which principally differ in their interest rates, maturities and
times of issuance. Obligations issued or guaranteed by agencies or
instrumentalities of the U.S. government are supported by (i) the full faith
and credit of the U.S. Treasury (such as securities of the Small Business
Administration), (ii) the limited authority of the issuer to borrow from the
U.S. Treasury (such as securities of the Student Loan Marketing Association) or
(iii) the authority of the U.S. government to purchase certain obligations of
the issuer (such as securities of the Federal National Mortgage Association).
No assurance can be given that the U.S. government will provide financial
support to U.S. government agencies or instrumentalities as described in
clauses (ii) or (iii) above in the future, other than as set forth above, since
it is not obligated to do so by law. The Portfolio will not invest more than
55% of the value of its assets in GNMA Certificates or in securities issued or
guaranteed by any other single U.S. government agency or instrumentality.
Corporate and Other Obligations. In seeking to obtain its investment
objective, the Portfolio may also invest in a broad range of
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debt securities, other than U.S. Government Securities, with varying maturities
such as corporate convertible and non-convertible debt obligations such as
fixed and variable rate bonds. The weighted average maturity of such
investments will generally range from 2 to 10 years. Debt securities may also
include money market securities, including bank certificates of deposit and
time deposits, bankers' acceptances, prime commercial paper, high-grade, short-
term corporate obligations, and repurchase agreements with respect to these
instruments.
Investment-grade debt securities are securities rated Baa or higher by
Moody's or BBB or higher by Standard & Poor's, and unrated securities that are
of equivalent quality in the opinion of the Portfolio's Adviser. The NRSROs'
descriptions of these bond ratings are set forth in the Appendix to the
Statement of Additional Information. Securities rated in the fourth highest
category may have speculative characteristics; changes in economic conditions
are more likely to lead to a weakened capacity to make principal and interest
payments than in the case of higher grade bonds. Like the three highest grades,
however, these securities are considered investment grade.
Lower-Rated Securities. The Portfolio may also invest a portion of its
assets, not to exceed 25%, in securities rated below Baa by Moody's or BBB by
Standard & Poor's (commonly known as "junk bonds"), so long as they are
consistent with the Portfolio's objective of seeking as high a level of total
return as is consistent with prudent investment strategies. Such securities may
include bonds rated as low as C by Moody's and by Standard & Poor's. See the
Appendix to the Statement of Additional Information. The Portfolio's Adviser
anticipates that a substantial portion of the Portfolio's lower-rated
securities will be in the higher end of these ratings.
Lower-rated and comparable unrated securities (collectively referred to in
this discussion as "lower-rated securities") will likely have some quality and
protective characteristics that, in the judgment of the rating organization,
are out-weighed by large uncertainties or major risk exposures to adverse
conditions; and are predominantly speculative with respect to the issuer's
capacity to pay interest and repay principal in accordance with the terms of
the obligation.
While the market values of lower-rated securities tend to react less to
fluctuations in interest rate levels than the market values of higher-rated
securities, the market values of certain lower-rated securities also tend to be
more sensitive to individual corporate developments and changes in economic
conditions than higher-rated securities. In addition, lower-rated securities
generally present a higher degree of credit risk. Issuers of lower-rated
securities are often highly leveraged and may not have more traditional methods
of financing available to them so that their ability to service their debt
obligations during an economic downturn or during sustained periods of rising
interest rates may be impaired. The risk of loss due to default by such issuers
is significantly
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greater because lower-rated securities generally are unsecured and frequently
are subordinated to the prior payment of senior indebtedness. The Portfolio may
incur additional expenses to the extent that it is required to seek recovery
upon a default in the payment of principal or interest on its portfolio
holdings. The existence of limited markets for lower-rated securities may
diminish the Portfolio's ability to obtain accurate market quotations for
purposes of valuing such securities and calculating its net asset value. For
additional information about the possible risks of investing in junk bonds, see
"Investment Objectives and Policies--Lower-Rated Bonds" in the Statement of
Additional Information.
Foreign Securities. The Portfolio may invest up to 15% of its total assets in
debt securities, including securities denominated in foreign currencies of
foreign issuers (including foreign governments) in developed countries and
emerging markets. Because the Portfolio may invest in foreign securities,
investment in the Portfolio involves investment risks that are different in
some respects from an investment in a fund which invests only in securities of
U.S. domestic issuers. Such risks may include adverse future political and
economic developments, the possible imposition of foreign withholding taxes on
interest income payable on the securities held in the Portfolio, possible
seizure or nationalization of foreign deposits, the possible establishment of
exchange controls, or the adoption of other foreign governmental restrictions
which might adversely affect the payment of principal and interest on
securities in the Portfolio. There may also be less publicly available
information about a foreign issuer than about a domestic issuer and foreign
issuers are not generally subject to uniform accounting, auditing and financial
reporting standards, practices and requirements comparable to those applicable
to domestic issuers.
The considerations described above generally are more of a concern in
developing countries inasmuch as their economic systems are generally smaller
and less diverse and mature and their political systems less stable than those
in developed countries. The Portfolio seeks to mitigate the risks associated
with these considerations through diversification and active portfolio
management.
The Portfolio may invest up to 35% of its assets in U.S. dollar-denominated
obligations issued by foreign branches of domestic banks ("Eurodollar"
obligations) and domestic branches of foreign banks ("Yankee dollar"
obligations).
The Portfolio may employ certain investment strategies which are discussed
under the caption "Investment Strategies" below and in the Statement of
Additional Information.
T. ROWE PRICE EQUITY INCOME PORTFOLIO
The investment objective of the T. Rowe Price Equity Income Portfolio is to
seek to provide substantial dividend income and also
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capital appreciation by investing primarily in dividend-paying common stocks of
established companies. In pursuing its objective, the Portfolio emphasizes
companies with favorable prospects for increasing dividend income, and
secondarily, capital appreciation. Over time, the income component (dividends
and interest earned) of the Portfolio's investments is expected to be a
significant contributor to the Portfolio's total return. The Portfolio's yield
is expected to be significantly above that of the S&P 500 Index. Total return
will consist primarily of dividend income and secondarily of capital
appreciation (or depreciation).
The investment program of the Portfolio is based on several premises. First,
the Portfolio's Adviser believes that, over time, dividend income can account
for a significant component of the total return from equity investments.
Second, dividends are normally a more stable and predictable source of return
than capital appreciation. While the price of a company's stock generally
increases or decreases in response to short-term earnings and market
fluctuations, its dividends are generally less volatile. Finally, the
Portfolio's Adviser believes that stocks which distribute a high level of
current income tend to have less price volatility than those which pay below
average dividends.
To achieve its objective, the Portfolio, under normal circumstances, will
invest at least 65% of its total assets in income-producing common stocks,
whose prospects for dividend growth and capital appreciation are considered
favorable by its Adviser. To enhance capital appreciation potential, the
Portfolio also uses a "value" approach and invests in stocks and other
securities its Adviser believes are temporarily undervalued by various
measures, such as price/earnings ratios. The Portfolio's investments will
generally be made in companies which share some of the following
characteristics:
. established operating histories;
. above-average current dividend yields relative to the S&P 500 Index;
. low price/earnings ratios relative to the S&P 500 Index;
. sound balance sheets and other financial characteristics; and
. low stock price relative to company's underlying value as measured by
assets, earnings, cash flow or business franchises.
Although the Portfolio will invest primarily in U.S. common stocks, it may
also purchase other types of securities, for example, foreign securities,
preferred stocks, convertible securities and warrants, when considered
consistent with the Portfolio's investment objective and program.
In the event that future economic or financial conditions adversely affect
equity securities, or stocks are considered overvalued, or the Portfolio's
Adviser believes that investing for defensive purposes is appropriate, or in
order to meet anticipated redemption requests, the Portfolio may invest part or
all of its assets in U.S. government securities
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and high quality (within the two highest rating categories assigned by a NRSRO)
U.S. and foreign dollar-denominated money market securities including
certificates of deposit, bankers' acceptances, commercial paper, short-term
corporate securities and repurchase agreements.
The Portfolio may invest up to 25% of its total assets in foreign securities.
These include non-dollar denominated securities traded outside the U.S. and
dollar denominated securities traded in the U.S. (such as American Depositary
Receipts). Such investments increase a portfolio's diversification and may
enhance return, but they may represent a greater degree of risk than investing
in domestic securities. These risks are discussed in the above section of this
Prospectus describing the T. Rowe Price International Stock Portfolio.
The Portfolio may invest in debt securities of any type including municipal
securities, without regard to quality or rating. Such securities would be
purchased in companies which meet the investment criteria for the Portfolio.
The price of a bond fluctuates with changes in interest rates, rising when
interest rates fall and falling when interest rates rise. The Portfolio,
however, will not invest more than 10% of its total assets in securities rated
below Baa by Moody's or BBB by Standard & Poor's (commonly known as "junk
bonds"). Such securities may include bonds rated as low as C by Moody's and by
Standard & Poor's. See the Appendix to the Statement of Additional Information.
Investments in non-investment grade securities entail certain risks which are
discussed in the above section of this Prospectus describing the Dreyfus U.S.
Government Securities Portfolio under the heading "Lower-Rated Securities."
The Portfolio may employ certain investment strategies which are discussed
under the caption "Investment Strategies" below and in the Statement of
Additional Information.
T. ROWE PRICE GROWTH STOCK PORTFOLIO
The investment objectives of the T. Rowe Price Growth Stock Portfolio are to
seek long-term growth of capital and to increase dividend income through
investment primarily in common stocks of well-established growth companies. A
growth company is defined by the Portfolio's Adviser as one which: (1) has
demonstrated historical growth of earnings faster than the growth of inflation
and the economy in general; and (2) has indications of being able to continue
this growth pattern in the future. Total return will consist primarily of
capital appreciation or depreciation and secondarily of dividend income.
More than fifty years ago, Thomas Rowe Price pioneered the Growth Stock
Theory of Investing. It is based on the premise that inflation represents a
more serious, long-term threat to an investor's portfolio than stock market
fluctuations or recessions. Mr. Price believed that when a company's earnings
grow faster than both inflation and the economy in general, the market will
eventually reward its long-term
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earnings growth with a higher stock price. In addition, the company should be
able to raise its dividend in line with its growth in earnings.
Although corporate earnings can be expected to be lower during periods of
recession, it is the Portfolio Adviser's opinion that, over the long term, the
earnings of well-established growth companies will not be affected adversely by
unfavorable economic conditions to the same extent as the earnings of more
cyclical companies. However, investors should be aware that the Portfolio's
share value may not always reflect the long-term earnings trend of growth
companies.
The Portfolio will invest primarily in the common stocks of a diversified
group of well-established growth companies. While current dividend income is
not a prerequisite in the selection of a growth company, the companies in which
the Portfolio will invest normally have a record of paying dividends and are
generally expected to increase the amounts of such dividends in future years as
earnings increase.
Although the Portfolio will invest primarily in U.S. common stocks, it may
also purchase other types of securities, for example, foreign securities,
preferred stocks, convertible securities and warrants, when considered
consistent with the Portfolio's investment objectives and program.
In the event that future economic or financial conditions adversely affect
equity securities, or stocks are considered overvalued, or the Portfolio's
Adviser believes that investing for defensive purposes is appropriate, or in
order to meet anticipated redemption requests, the Portfolio may invest part or
all of its assets in U.S. government securities and high quality (within the
two highest rating categories assigned by a NRSRO) U.S. and foreign dollar-
denominated money market securities including certificates of deposit, bankers'
acceptances, commercial paper, short-term corporate securities and repurchase
agreements.
The Portfolio may invest up to 30% of its total assets in foreign securities.
These include non-dollar denominated securities traded outside the U.S. and
dollar denominated securities traded in the U.S. (such as American Depositary
Receipts). Such investments increase a portfolio's diversification and may
enhance return, but they may represent a greater degree of risk than investing
in domestic securities. These risks are discussed in the above section of this
Prospectus describing the T. Rowe Price International Stock Portfolio.
The Portfolio may employ certain investment strategies which are discussed
under the caption "Investment Strategies" below and in the Statement of
Additional Information.
OPPORTUNITY VALUE PORTFOLIO
The investment objective of the Opportunity Value Portfolio is to achieve
growth of capital over time through investment in a portfolio
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consisting of common stocks, bonds and cash equivalents, the percentages of
which will vary based on the Portfolio Adviser's assessments of the relative
outlook for such investments. In seeking to achieve its investment objective,
the types of equity securities in which the Portfolio may invest will be
securities of companies that are believed by the Portfolio's Adviser to be
undervalued in the marketplace in relation to factors such as the companies'
assets or earnings. It is the Adviser's intention to invest in securities of
companies which in its opinion possess one or more of the following
characteristics: undervalued assets, valuable consumer or commercial
franchises, securities valuation below peer companies, substantial and growing
cash flow and/or a favorable price to book value relationship. Investment
policies aimed at achieving the Portfolio's objective are set in a flexible
framework of securities selection which primarily includes equity securities,
such as common stocks, preferred stocks, convertible securities, rights and
warrants in proportions which vary from time to time. The Portfolio will invest
primarily in stocks listed on the New York Stock Exchange. In addition, it may
also purchase securities of companies, including companies with small market
capitalizations, listed on other domestic securities exchanges, securities
traded in the domestic over-the-counter market and foreign securities provided
that they are listed on a domestic or foreign securities exchange or
represented by American Depositary Receipts listed on a domestic securities
exchange or traded in domestic or foreign over-the-counter markets.
Investing in foreign securities may present a greater degree of risk than
investing in domestic securities. These risks are discussed in the above
section of this Prospectus describing the T. Rowe Price International Stock
Portfolio. Investing in the securities of small capitalization companies
involves greater risk exposure and reward potential than investments in larger
capitalization companies. These risks are discussed in the above section of
this Prospectus describing the Dreyfus Small Cap Value Portfolio.
Debt securities are expected to be predominantly investment grade
intermediate to long-term U.S. government and corporate debt, although the
Portfolio will also invest in high quality short-term money market and cash
equivalent securities and may invest almost all of its assets in such
securities when the Portfolio's Adviser deems it advisable in order to preserve
capital. The Portfolio's debt securities may also include mortgage-backed
securities issued by the U.S. government, its agencies or instrumentalities and
collateralized mortgage obligations that are issued or guaranteed by the U.S.
government or its agencies or instrumentalities or that are collateralized by a
portfolio of mortgages or mortgage-related securities guaranteed by such an
agency or instrumentality.
The effective maturity of a mortgage-backed security may be shortened by
unscheduled or early payment of principal and interest on the underlying
mortgages, which may affect the effective yield of such
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securities. The principal that is returned may be invested in instruments
having a higher or lower yield than the prepaid instruments depending on then-
current market conditions.
Investment grade securities will, at the time of purchase, have ratings
within the four highest rating categories established by Moody's, Standard &
Poor's, or a similar NRSRO or, if not rated, be of comparable quality as
determined by the Portfolio's Adviser. The NRSROs' descriptions of these bond
ratings are set forth in the Appendix to the Statement of Additional
Information. Securities rated in the fourth highest category may have
speculative characteristics; changes in economic or business conditions are
more likely to lead to a weakened capacity to make principal and interest
payments than in the case of higher grade bonds. Like the three highest grades,
however, these securities are considered investment grade.
It is the present intention of the Portfolio's Adviser to invest no more than
5% of the Portfolio's net assets in bonds rated below Baa3 by Moody's or BBB by
Standard & Poor's (commonly knows as "junk bonds"). In the event that the
Portfolio's Adviser intends in the future to invest more than 5% of the
Portfolio's net assets in junk bonds, appropriate disclosures will be made to
existing and prospective shareholders. For information about the possible risks
of investing in junk bonds see "Investment Objectives and Policies--Lower Rated
Bonds" in the Statement of Additional Information.
The allocation of the Portfolio's assets among the different types of
permitted investments will vary from time to time based upon the Portfolio
Adviser's evaluation of economic and market trends and its perception of the
relative values available from such types of securities at any given time.
There is neither a minimum nor a maximum percentage of the Portfolio's assets
that may, at any given time, be invested in any of the types of investments
identified above. Consequently, while the Portfolio will earn income to the
extent it is invested in bonds or cash equivalents, the Portfolio does not have
any specific income objective. Although there is neither a minimum nor maximum
percentage of the Portfolio's assets that may, at any given time, be invested
in any of the types of investments identified above, it is anticipated that
most of the time the substantial majority of the Portfolio's assets will be
invested in common stocks.
The Portfolio may employ certain investment strategies which are discussed
under the caption "Investment Strategies" below and in the Statement of
Additional Information.
ENHANCED INDEX PORTFOLIO
The investment objective of the Enhanced Index Portfolio is to earn a total
return modestly in excess of the total return performance of the S&P 500 Index
(including the reinvestment of dividends) while maintaining a volatility of
return similar to the S&P 500 Index. The
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Portfolio is appropriate for investors who seek a modestly enhanced total
return relative to that of large and medium sized U.S. companies typically
represented in the S&P 500 Index. The Portfolio intends to invest in securities
of approximately 300 issuers, which securities are rated by the Portfolio's
Adviser to have above average expected returns.
The Portfolio seeks to achieve its investment objective through fundamental
analysis, systematic stock valuation and disciplined portfolio construction.
. Fundamental research: The Portfolio Adviser's approximately 25 domestic
equity analysts, each an industry specialist with an average of
approximately 12 years experience, follow over 900 predominantly large
and medium sized U.S. companies--approximately 525 of which form the
universe for the Portfolio's investments. A substantial majority of
these companies are issuers of securities which are included in the S&P
500 Index. The analysts' research goal is to forecast normalized, longer
term earnings and dividends for the companies that they cover.
. Systematic valuation: The analysts' forecasts are converted into
comparable expected returns by a dividend discount model, which
calculates those expected returns by solving for the rate of return that
equates the company's current stock price to the present value of its
estimated long-term earnings power. Within each sector, companies are
ranked by their expected return and grouped into quintiles; those with
the highest expected returns (Quintile 1) are deemed the most
undervalued relative to their long-term earnings power, while those with
the lowest expected returns (Quintile 5) are deemed the most overvalued.
. Disciplined portfolio construction: A diversified portfolio is
constructed using disciplined buy and sell rules. Portfolio sector
weightings will generally approximate those of the S&P 500 Index. The
Portfolio will normally be principally comprised, based on the dividend
discount model, of stocks in the first three Quintiles. Finally, the
Portfolio holds a large number of stocks to enhance its diversification.
Under normal market circumstances, the Portfolio's Adviser will invest at
least 65% of its net assets in equity securities consisting of common stocks
and other securities with equity characteristics such as trust interests,
limited partnership interests, preferred stocks, warrants, rights and
securities convertible into common stock. The Portfolio's primary equity
investments will be the common stock of large and medium sized U.S. companies
with market capitalizations above $1 billion. Such securities will be listed on
a national securities exchange or traded in the over-the-counter market. The
Portfolio may invest in similar securities of foreign corporations, provided
that the securities of such corporations are included in the S&P 500 Index.
The Portfolio intends to manage its portfolio actively in pursuit of its
investment objective. Since the Portfolio has a long-term investment
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perspective, it does not intend to respond to short-term market fluctuations
or to acquire securities for the purpose of short-term trading; however, it
may take advantage of short-term trading opportunities that are consistent
with its objective.
During ordinary market conditions, the Portfolio's Adviser will keep the
Portfolio as fully invested as practicable in the equity securities described
above. In the event that future economic or financial conditions adversely
affect equity securities, or stocks are considered overvalued, or the
Portfolio's Adviser believes that investing for defensive purposes is
appropriate, or in order to meet anticipated redemption requests, the
Portfolio may invest part or all of its assets in U.S. government securities
and high quality (within the two highest rating categories assigned by a
NRSRO) U.S. dollar-denominated money market securities including certificates
of deposit, bankers' acceptances, commercial paper, short-term debt securities
and repurchase agreements.
Convertible bonds and other fixed income securities (other than money market
instruments) in which the Portfolio may invest will, at the time of
investment, have ratings within the four highest rating categories established
by Moody's, Standard & Poor's, or a similar NRSRO or, if not rated, be of
comparable quality as determined by the Portfolio's Adviser. The NRSROs'
descriptions of these bond ratings are set forth in the Appendix to the
Statement of Additional Information. Securities rated in the fourth highest
category may have speculative characteristics; changes in economic or business
conditions are more likely to lead to a weakened capacity to make principal
and interest payments than in the case of higher grade bonds. Like the three
highest grades, however, these securities are considered investment grade.
The Portfolio may invest in certain foreign securities which may represent a
greater degree of risk than investing in domestic securities. These risks are
discussed in the above section of this Prospectus describing the T. Rowe Price
International Stock Portfolio.
The Portfolio may employ certain investment strategies which are discussed
under the caption "Investment Strategies" below and in the Statement of
Additional Information.
INVESTMENT STRATEGIES
In addition to making investments directly in securities, the Portfolios
(other than the TCW Money Market Portfolio) may write covered call and put
options and hedge their investments by purchasing options and engaging in
transactions in futures contracts and related options. The Adviser to the TCW
Managed Asset Allocation Portfolio does not presently intend to utilize
futures contracts and related options but may do so in the future. The
Advisers to the Dreyfus Small Cap Value Portfolio and the Opportunity Growth
Portfolio do not currently intend to write covered call and put options or
engage in transactions in futures contracts and related options, but may do so
in the future. The
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T. Rowe Price International Stock, Dreyfus U.S. Government Securities, T. Rowe
Price Equity Income, T. Rowe Price Growth Stock, Opportunity Value and
Enhanced Index Portfolios may engage in foreign currency exchange transactions
to protect against changes in future exchange rates. All Portfolios except the
TCW Money Market Portfolio may invest in American Depositary Receipts and
European Depositary Receipts. All Portfolios may enter into repurchase
agreements, may make forward commitments to purchase securities, lend their
portfolio securities and borrow funds under certain limited circumstances. The
T. Rowe Price Equity Income, T. Rowe Price Growth Stock, T. Rowe Price
International Stock and Dreyfus U.S. Government Securities Portfolios may
invest in hybrid instruments. The investment strategies referred to above and
the risks related to them are summarized below and certain of these strategies
are described in more detail in the Statement of Additional Information.
Options and Futures Transactions. A Portfolio (other than the TCW Money
Market Portfolio) may seek to increase the current return on its investments
by writing covered call or covered put options. The Advisers to the Dreyfus
Small Cap Value Portfolio and the Opportunity Value Portfolio have no present
intention to engage in this strategy, but may do so in the future.
In addition, a Portfolio (other than the TCW Money Market Portfolio) may at
times seek to hedge against either a decline in the value of its portfolio
securities or an increase in the price of securities which its Adviser plans
to purchase through the writing and purchase of options on securities and any
index of securities in which the Portfolio may invest and the purchase and
sale of futures contracts and related options. The Advisers to the TCW Managed
Asset Allocation, Dreyfus Small Cap Value and Opportunity Value Portfolios
have no present intention to use this strategy, but may do so in the future.
The Adviser to the Dreyfus U.S. Government Securities Portfolio does not
presently intend to purchase or sell call or put options but may enter into
interest rate futures contracts and write and purchase put and call options on
such futures contracts. The Portfolio may purchase and sell interest rate
futures contracts as a hedge against changes in interest rates. A futures
contract is an agreement between two parties to buy and sell a security for a
set price on a future date. Futures contracts are traded on designated
"contracts markets" which, through their clearing corporations, guarantee
performance of the contracts. Currently, there are futures contracts based on
securities such as long-term U.S. Treasury bonds, U.S. Treasury notes, GNMA
Certificates and three-month U.S. Treasury bills.
Generally, if market interest rates increase, the value of outstanding debt
securities declines (and vice versa). Entering into a futures contract for the
sale of securities has an effect similar to the actual sale of securities,
although the sale of the futures contracts might be accomplished more easily
and quickly. For example, if the Portfolio holds
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long-term U.S. Government Securities and the Adviser anticipates a rise in
long-term interest rates, it could, in lieu of disposing of its portfolio
securities, enter into futures contracts for the sale of similar long-term
securities. If interest rates increased and the value of the Portfolio's
securities declined, the value of the Portfolio's futures contracts would
increase, thereby protecting the Portfolio by preventing the net asset value
from declining as much as it otherwise would have. Similarly, entering into
futures contracts for the purchase of securities has an effect similar to the
actual purchase of the underlying securities, but permits the continued holding
of securities other than the underlying securities. For example, if the Adviser
expects long-term interest rates to decline, the Portfolio might enter into
futures contracts for the purchase of long-term securities, so that it could
gain rapid market exposure that may offset anticipated increases in the cost of
securities it intends to purchase, while continuing to hold higher-yielding
short-term securities or waiting for the long-term market to stabilize.
A Portfolio (other than the TCW Money Market Portfolio) also may purchase and
sell listed put and call options on futures contracts. An option on a futures
contract gives the purchaser the right, in return for the premium paid, to
assume a position in a futures contract (a long position if the option is a
call and a short position if the option is a put), at a specified exercise
price at any time during the option period. When an option on a futures
contract is exercised, delivery of the futures position is accompanied by cash
representing the difference between the current market price of the futures
contract and the exercise price of the option.
The Dreyfus U.S. Government Securities Portfolio may purchase put options on
interest rate futures contracts in lieu of, and for the same purpose as, sale
of a futures contract. It also may purchase such put options in order to hedge
a long position in the underlying futures contract in the same manner as it
purchases "protective puts" on securities. The purchase of call options on
interest rate futures contracts is intended to serve the same purpose as the
actual purchase of the futures contract, and the Portfolio will set aside cash
or cash equivalents sufficient to purchase the amount of portfolio securities
represented by the underlying futures contracts.
A Portfolio may not purchase futures contracts or related options if,
immediately thereafter, more than 33 1/3% (25% for the T. Rowe Price Equity
Income Portfolio, the T. Rowe Price Growth Stock Portfolio and the T. Rowe
Price International Stock Portfolio) of the Portfolio's total assets would be
so invested.
The Portfolios' Advisers generally expect that options and futures
transactions for the Portfolios will be conducted on securities and other
exchanges. In certain instances, however, a Portfolio may purchase and sell
options in the over-the-counter market. The staff of the Securities and
Exchange Commission considers over-the-counter options to be illiquid. A
Portfolio's ability to terminate option positions established in
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the over-the-counter market may be more limited than in the case of exchange
traded options and may also involve the risk that securities dealers
participating in such transactions would fail to meet their obligations to the
Portfolio. There can be no assurance that a Portfolio will be able to effect
closing transactions at any particular time or at an acceptable price. The use
of options and futures involves the risk of imperfect correlation between
movements in options and futures prices and movements in the prices of the
securities that are being hedged. Expenses and losses incurred as a result of
these hedging strategies will reduce the Portfolio's current return. In many
foreign countries, futures and options markets do not exist or are not
sufficiently developed to be effectively used by a Portfolio.
Foreign Currency Transactions. The Dreyfus U.S. Government Securities, T.
Rowe Price Equity Income, T. Rowe Price Growth Stock, T. Rowe Price
International Stock, Opportunity Value and Enhanced Index Portfolios may
purchase foreign currency on a spot (or cash) basis, enter into contracts to
purchase or sell foreign currencies at a future date ("forward contracts"),
purchase and sell foreign currency futures contracts, and purchase exchange
traded and over-the-counter call and put options on foreign currency futures
contracts and on foreign currencies. The Adviser to a Portfolio may engage in
these transactions to protect against uncertainty in the level of future
exchange rates in connection with the purchase and sale of portfolio securities
("transaction hedging") and to protect the value of specific portfolio
positions ("position hedging").
Hedging transactions involve costs and may result in losses. The Dreyfus U.S.
Government Securities, T. Rowe Price Equity Income, T. Rowe Price Growth Stock,
T. Rowe Price International Stock, Opportunity Value and Enhanced Index
Portfolios may write covered call options on foreign currencies to offset some
of the costs of hedging those currencies. A Portfolio will engage in over-the-
counter transactions only when appropriate exchange traded transactions are
unavailable and when, in the opinion of the Portfolio's Adviser, the pricing
mechanism and liquidity are satisfactory and the participants are responsible
parties likely to meet their contractual obligations. A Portfolio's ability to
engage in hedging and related option transactions may be limited by tax
considerations.
Transaction and position hedging do not eliminate fluctuations in the
underlying prices of the securities which the Portfolio owns or intends to
purchase or sell. They simply establish a rate of exchange which one can
achieve at some future point in time. Additionally, although these techniques
tend to minimize the risk of loss due to a decline in the value of the hedged
currency, they tend to limit any potential gain which might result from the
increase in the value of such currency.
Interest Rate Transactions. In order to attempt to protect the value of its
portfolio from interest rate fluctuations, the Dreyfus U.S.
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Government Securities Portfolio may enter into various hedging transactions,
such as interest rate swaps and the purchase or sale of interest rate caps and
floors. Interest rate swaps involve the exchange by the Portfolio with another
party of their respective commitments to pay or receive interest, e.g., an
exchange of floating rate payments for fixed rate payments. The purchase of an
interest rate cap entitles the purchaser, to the extent that a specified index
exceeds a predetermined interest rate, to receive payments of interest on a
notional principal amount from the party selling such interest rate cap. The
purchase of an interest rate floor entitles the purchaser, to the extent that a
specified index falls below a predetermined interest rate, to receive payments
of interest on a notional principal amount from the party selling such interest
rate floor. The Adviser to the Portfolio expects to enter into these
transactions on behalf of the Portfolio primarily to preserve a return or
spread on a particular investment or portion of its portfolio or to protect
against any increase in the price of securities the Portfolio anticipates
purchasing at a later date. The Portfolio intends to use these transactions as
a hedge and not as a speculative investment. The Portfolio will not sell
interest rate caps or floors that it does not own.
The Portfolio may enter into interest rate swaps, caps and floors on either
an asset-based or liability-based basis, depending on whether it is hedging its
assets or its liabilities, and will usually enter into interest rate swaps on a
net basis, i.e., the two payment streams are netted out, with the Portfolio
receiving or paying, as the case may be, only the net amount of the two
payments. Inasmuch as these hedging transactions are entered into for good
faith hedging purposes, the Adviser to the Portfolio and the Fund believe such
obligations do not constitute senior securities and accordingly, will not treat
them as being subject to the Portfolio's borrowing restrictions. The net amount
of the excess, if any, of the Portfolio's obligations over its entitlement with
respect to each interest rate swap will be accrued on a daily basis and an
amount of cash or liquid securities having an aggregate net asset value at
least equal to the accrued excess will be maintained in a segregated account by
the Portfolio's custodian. The Portfolio will not enter into any interest rate
swap, cap or floor transactions unless the unsecured senior debt or the claims-
paying ability of the other party thereto is rated in the highest category of
at least one NRSRO at the time of entering into such transaction. If there is a
default by the other party to such a securities transaction, the Portfolio will
have contractual remedies pursuant to the agreements related to the
transactions. The swap market has grown substantially in recent years with a
large number of banks and investment banking firms acting both as principals
and as agents utilizing standardized swap documentation. As a result, the swap
market has become relatively liquid. Caps and floors are more recent
innovations for which standardized documentation has not yet been developed
and, accordingly, they are less liquid than swaps.
Dollar Roll Transactions. The Dreyfus U.S. Government Securities Portfolio
may enter into dollar roll transactions with selected banks and
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broker-dealers. Dollar roll transactions are comprised of the sale by the
Portfolio of mortgage-based securities, together with a commitment to purchase
similar, but not identical, securities at a future date. In addition, the
Portfolio is paid a fee as consideration for entering into the commitment to
purchase. Dollar rolls may be renewed after cash settlement and initially may
involve only a firm commitment agreement by the Portfolio to buy a security. If
the broker-dealer to whom the Portfolio sells the security becomes insolvent,
the Portfolio's right to purchase or repurchase the security may be restricted;
the value of the security may change adversely over the term of the dollar
roll; the security that the Portfolio is required to repurchase may be worth
less than the security that the Portfolio originally held, and the return
earned by the Portfolio with the proceeds of a dollar roll may not exceed
transaction costs. Dollar roll transactions are treated as borrowings for
purposes of the 1940 Act, and the aggregate of such transactions and all other
borrowings of the Portfolio (including reverse repurchase agreements) will be
subject to the requirement that the Portfolio maintain asset coverage of 300%
for all borrowings.
Reverse Repurchase Agreements. Each Portfolio is permitted to enter into
reverse repurchase agreements. In a reverse repurchase agreement, the Portfolio
sells a security and agrees to repurchase it at a mutually agreed upon date and
price, reflecting the interest rate effective for the term of the agreement.
For the purposes of the 1940 Act it is considered a form of borrowing by the
Portfolio and, therefore, is a form of leverage. Leverage may cause any gains
or losses of the Portfolio to be magnified.
Borrowings. A Portfolio other than the Dreyfus U.S. Government Securities, T.
Rowe Price Equity Income, T. Rowe Price Growth Stock, T. Rowe Price
International Stock, Opportunity Value and Enhanced Index Portfolios may borrow
money for temporary purposes in amounts up to 5% of its total assets. The
Dreyfus U.S. Government Securities Portfolio may borrow from banks and enter
into reverse repurchase agreements or dollar rolls transactions in an amount
equal to up to 33 1/3% of the value of its net assets (computed at the time the
loan is made) to take advantage of investment opportunities and for temporary,
extraordinary or emergency purposes. The Dreyfus U.S. Government Securities
Portfolio may pledge up to 33 1/3% of its total assets to secure these
borrowings. If the Portfolio's asset coverage for borrowings falls below 300%,
the Portfolio will take prompt action to reduce its borrowings.
The T. Rowe Price Equity Income, T. Rowe Price Growth Stock and T. Rowe Price
International Stock Portfolios may borrow money as a temporary measure for
emergency purposes, to facilitate redemption requests, or for other purposes
consistent with the Portfolio's investment objective and program in an amount
up to 33 1/3% of the Portfolio's net assets. Each Portfolio may pledge up to 33
1/3% of its total assets to secure these borrowings. These Portfolios may not
purchase additional securities when borrowings exceed 5% of total assets.
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The Opportunity Value and Enhanced Index Portfolios may borrow money from
banks as a temporary measure for extraordinary or emergency purposes in amounts
up to 10% of its total assets. Neither Portfolio may purchase additional
securities when borrowings exceed 5% of total assets.
As a matter of operating policy, each of the Dreyfus U.S. Government
Securities, T. Rowe Price Equity Income, T. Rowe Price Growth Stock and T. Rowe
Price International Stock Portfolios will limit all borrowings to no more than
25% of such Portfolio's net assets.
American and European Depositary Receipts. All Portfolios except the TCW
Money Market Portfolio may purchase foreign securities in the form of American
Depositary Receipts ("ADRs"), European Depositary Receipts ("EDRs") or other
securities convertible into securities of corporations in which the Portfolios
are permitted to invest pursuant to their respective investment objectives and
policies. These securities may not necessarily be denominated in the same
currency into which they may be converted. ADRs are receipts typically issued
by a United States bank or trust company which evidence ownership of underlying
securities issued by a foreign corporation. EDRs are receipts issued in Europe
by banks or depositories which evidence a similar ownership arrangement.
Generally, ADRs, in registered form, are designed for use in United States
securities markets and EDRs, in bearer form, are designed for use in European
securities markets.
Repurchase Agreements. All Portfolios may enter into repurchase agreements
with a bank, broker-dealer or other financial institution as a means of earning
a fixed rate of return on its cash reserves for periods as short as overnight.
A repurchase agreement is a contract pursuant to which a Portfolio, against
receipt of securities of at least equal value including accrued interest,
agrees to advance a specified sum to the financial institution which agrees to
reacquire the securities at a mutually agreed upon time (usually one day) and
price. Each repurchase agreement entered into by a Portfolio will provide that
the value of the collateral underlying the repurchase agreement will always be
at least equal to the repurchase price, including any accrued interest. The
Portfolio's right to liquidate such securities in the event of a default by the
seller could involve certain costs, losses or delays and, to the extent that
proceeds from any sale upon a default of the obligation to repurchase are less
than the repurchase price, the Portfolio could suffer a loss.
Forward Commitments. Each Portfolio may make contracts to purchase securities
for a fixed price at a future date beyond customary settlement time ("forward
commitments") if it holds, and maintains until the settlement date in a
segregated account, cash or high-grade debt obligations in an amount sufficient
to meet the purchase price, or if it enters into offsetting contracts for the
forward sale of other securities it owns. Forward commitments may be considered
securities in themselves and involve a risk of loss if the value of the
security to be purchased
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declines prior to the settlement date, which risk is in addition to the risk of
decline in value of the Portfolio's other assets. Where such purchases are made
through dealers, the Portfolio relies on the dealer to consummate the sale. The
dealer's failure to do so may result in the loss to the Portfolio of an
advantageous yield or price.
Securities Loans. Each Portfolio may seek to obtain additional income by
making secured loans of its portfolio securities with a value up to 33 1/3% of
its total assets. All securities loans will be made pursuant to agreements
requiring the loans to be continuously secured by collateral in cash or high-
grade debt obligations at least equal at all times to the market value of the
loaned securities. The borrower pays to the Portfolio an amount equal to any
dividends or interest received on loaned securities. The Portfolio retains all
or a portion of the interest received on investment of cash collateral or
receives a fee from the borrower. Lending portfolio securities involves risks
of delay in recovery of the loaned securities or in some cases loss of rights
in the collateral should the borrower fail financially.
Hybrid Instruments. The T. Rowe Price Equity Income, T. Rowe Price Growth
Stock and T. Rowe Price International Stock Portfolios may invest up to 10% of
their total assets, and the Dreyfus U.S. Government Securities Portfolio may
invest up to 5% of its total assets, in hybrid instruments. Hybrid instruments
have recently been developed and combine the elements of futures contacts or
options with those of debt, preferred equity or a depository instrument. Often
these hybrid instruments are indexed to the price of a commodity, particular
currency, or a domestic or foreign debt or equity securities index. Hybrid
instruments may take a variety of forms, including, but not limited to, debt
instruments with interest or principal payments or redemption terms determined
by reference to the value of a currency or commodity or securities index at a
future point in time, preferred stock with dividend rates determined by
reference to the value of a currency, or convertible securities with the
conversion terms related to a particular commodity. Hybrid instruments may bear
interest or pay dividends at below market (or even relatively nominal) rates.
Under certain conditions, the redemption value of such an instrument could be
zero. Hybrid instruments can have volatile prices and limited liquidity and
their use by a Portfolio may not be successful.
Fixed-Income Securities--Downgrades. If any security invested in by any of
the Portfolios loses its rating or has its rating reduced after the Portfolio
has purchased it, unless required by law, the Portfolio is not required to sell
or otherwise dispose of the security, but may consider doing so.
Illiquid Securities. Each Portfolio may invest up to 10% (15% with respect to
T. Rowe Price International Stock Portfolio, T. Rowe Price Equity Income
Portfolio, T. Rowe Price Growth Stock Portfolio, Dreyfus Small Cap Value
Portfolio, Opportunity Value Portfolio, Enhanced Index Portfolio and, if
approved by shareholders at an upcoming shareholders meeting, the Value Equity
Portfolio) of its net assets in illiquid securities
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and other securities which are not readily marketable, including non-negotiable
time deposits, certain restricted securities not deemed by the Fund's Trustees
to be liquid and repurchase agreements with maturities longer than seven days.
Securities eligible for resale pursuant to Rule 144A under the Securities Act
of 1933, which have been determined to be liquid, will not be considered by the
Portfolios' Advisers to be illiquid or not readily marketable and, therefore,
are not subject to the aforementioned 10% or 15% limits. The inability of a
Portfolio to dispose of illiquid or not readily marketable investments readily
or at a reasonable price could impair the Portfolio's ability to raise cash for
redemptions or other purposes. The liquidity of securities purchased by a
Portfolio which are eligible for resale pursuant to Rule 144A will be monitored
by the Portfolios' Advisers on an ongoing basis, subject to the oversight of
the Trustees. In the event that such a security is deemed to be no longer
liquid, a Portfolio's holdings will be reviewed to determine what action, if
any, is required to ensure that the retention of such security does not result
in a Portfolio having more than 10% or 15%, as applicable, of its assets
invested in illiquid or not readily marketable securities.
MANAGEMENT OF THE FUND
The Trustees and officers of the Fund provide broad supervision over the
business and affairs of the Portfolios and the Fund.
THE MANAGER
The Fund is managed by Endeavor Investment Advisers ("the Manager") which,
subject to the supervision and direction of the Trustees of the Fund, has
overall responsibility for the general management and administration of the
Fund. The Manager is a general partnership of which Endeavor Management Co. is
the managing partner. Endeavor Management Co., by whose employees all
management services performed under the management agreement are rendered to
the Fund, holds a 50.01% interest in the Manager and AUSA Financial Markets,
Inc., an affiliate of PFL, holds the remaining 49.99% interest therein. Vincent
J. McGuinness, a Trustee of the Fund, together with his family members and
trusts for the benefit of his family members, own all of Endeavor Management
Co.'s outstanding common stock. Mr. McGuinness is Chairman, Chief Executive
Officer and President of Endeavor Management Co.
The Manager is responsible for providing investment management and
administrative services to the Fund and in the exercise of such responsibility
selects the investment advisers for the Fund's Portfolios (the "Advisers") and
monitors the Advisers' investment programs and results, reviews brokerage
matters, oversees compliance by the Fund with various federal and state
statutes, and carries out the directives of the Trustees. The Manager is
responsible for providing the Fund with office space, office equipment, and
personnel necessary to operate and administer the Fund's business, and also
supervises the provision of
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services by third parties such as the Fund's custodian and transfer agent.
Pursuant to an administration agreement, First Data Investor Services Group,
Inc. ("FDISG") assists the Manager in the performance of its administrative
responsibilities to the Fund.
As compensation for these services the Fund pays the Manager a monthly fee at
the following annual rates of each Portfolio's average daily net assets: TCW
Money Market Portfolio--.50%; TCW Managed Asset Allocation Portfolio--.75%; T.
Rowe Price International Stock Portfolio--.90%; Value Equity Portfolio--.80%;
Dreyfus Small Cap Value Portfolio--.80%; Dreyfus U. S. Government Securities
Portfolio--.65%; T. Rowe Price Equity Income Portfolio--.80%; T. Rowe Price
Growth Stock Portfolio--.80%; Opportunity Value Portfolio--.80%; Enhanced Index
Portfolio--.75%. The management fees paid by the Portfolios (other than the TCW
Money Market Portfolio and Dreyfus U.S. Government Securities Portfolio),
although higher than the fees paid by most other investment companies in
general, are comparable to management fees paid for similar services by many
investment companies with similar investment objectives and policies. From the
management fees, the Manager pays the expenses of providing investment advisory
services to the Portfolios, including the fees of the Adviser of each Portfolio
and the fees and expenses of FDISG pursuant to the administration agreement.
In addition to the management fees, the Fund pays all expenses not assumed by
the Manager, including, without limitation, expenses for legal, accounting and
auditing services, interest, taxes, costs of printing and distributing reports
to shareholders, proxy materials and prospectuses, charges of its custodian,
transfer agent and dividend disbursing agent, registration fees, fees and
expenses of the Trustees who are not interested persons of the Fund, insurance,
brokerage costs, litigation, and other extraordinary or nonrecurring expenses.
All general Fund expenses are allocated among and charged to the assets of the
Portfolios of the Fund on a basis that the Trustees deem fair and equitable,
which may be on the basis of relative net assets of each Portfolio or the
nature of the services performed and relative applicability to each Portfolio.
THE ADVISERS
Pursuant to an investment advisory agreement with the Manager, the Adviser to
a Portfolio furnishes continuously an investment program for the Portfolio,
makes investment decisions on behalf of the Portfolio, places all orders for
the purchase and sale of investments for the Portfolio's account with brokers
or dealers selected by such Adviser and may perform certain limited related
administrative functions in connection therewith. For its services, the Manager
pays the Adviser a fee based on a percentage of the average daily net assets of
the Portfolio. An Adviser may place portfolio securities transactions with
broker-dealers who furnish it with certain services of value in advising the
Portfolio and other clients. In so doing, an Adviser may cause a Portfolio
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to pay greater brokerage commissions than it might otherwise pay. In seeking
the most favorable price and execution available, an Adviser may, if permitted
by law, consider sales of the Contracts as a factor in the selection of broker-
dealers. OpCap Advisors may select, under certain circumstances, Oppenheimer &
Co., Inc., one of its affiliates, to execute transactions for the Value Equity
and Opportunity Value Portfolios. T. Rowe Price Associates, Inc. and Rowe
Price-Fleming International, Inc. may utilize certain brokers indirectly
related to them in the capacity as broker in connection with the execution of
transactions for the T. Rowe Price Equity Income, T. Rowe Price Growth Stock
and T. Rowe Price International Stock Portfolios. J.P. Morgan Investment
Management Inc. may utilize certain brokers affiliated with it in connection
with the execution of transactions for the Enhanced Index Portfolio. See the
Statement of Additional Information for a further discussion of Portfolio
trading.
The Board of Trustees of the Fund has authorized the Manager and the Advisers
to enter into arrangements with brokers who execute brokerage transactions for
the Portfolios whereby a portion of the commissions earned by such brokers will
be shared with a broker-dealer affiliate of the Manager. The affiliated broker
will act an "introducing broker" in the transaction. Subject to the
requirements of applicable law including seeking best price and execution of
orders, commissions paid to executing brokers will not exceed ordinary and
customary brokerage commissions.
The Board of Trustees has determined that the Fund's brokerage commissions
should be utilized for the Fund's benefit to the extent possible. After
reviewing various alternatives, the Board concluded that commissions received
by the broker-dealer affiliate of the Manager can be used to promote the
distribution of the Fund's shares including payments to broker-dealers who sell
the Contracts, the costs of training and educating such broker-dealers with
respect to the Contracts and other bona-fide distribution costs payable to
unaffiliated persons. Other than incidental costs related to establishing the
broker-dealer affiliate as an "introducing broker", no portion of the
commissions received by the broker-dealer affiliate of the Manager will be
retained for its or any affiliate's benefit. On a quarterly basis, the Manager
will report to the Board of Trustees the aggregate commissions received by its
broker-dealer affiliate and the distribution expenses paid from such
commissions. The Board of Trustees will periodically review the extent to which
the foregoing arrangement reduces distribution expenses currently being
incurred by the Manager or its affiliates on behalf of the Fund. The Board of
Trustees may determine from time to time other appropriate uses for the Fund
from the commissions it pays to executing brokers.
The Manager will not implement this program until any required exemptive or
no action relief is obtained from the Securities and Exchange Commission.
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TCW Funds Management, Inc. ("TCW") is the Adviser to the TCW Money Market
Portfolio and the TCW Managed Asset Allocation Portfolio. As compensation for
its services as investment adviser, the Manager pays TCW a monthly fee at the
annual rate of .25% of the average daily net assets of the TCW Money Market
Portfolio and .375% of the average daily net assets of the TCW Managed Asset
Allocation Portfolio. TCW is a wholly owned subsidiary of The TCW Group, Inc.,
whose subsidiaries, including Trust Company of the West and TCW Asset
Management Company, provide a variety of trust, investment management and
investment advisory services. TCW and its affiliates, which as of December 31,
1996 had over $50 billion under management or committed for management, provide
investment advisory services to a number of open-end and closed-end investment
companies.
James M. Goldberg, a Managing Director and Chairman of the Fixed Income
Policy Committee of TCW, is the portfolio manager for the TCW Money Market
Portfolio. Mr. Goldberg has been with TCW since 1984. Investment decisions for
the equity portion of the TCW Managed Asset Allocation Portfolio are made by
Norman Ridley in consultation with Stefan D. Abrams. Mr. Ridley is a Senior
Vice President of TCW and has been with the firm since 1985. Since 1992 Mr.
Abrams has been a Managing Director of TCW and is Director of Equity Strategy
and Asset Allocation. Investment decisions for the fixed income portion of the
TCW Managed Asset Allocation Portfolio are made by Mr. Goldberg.
OpCap Advisors ("OpCap") (formerly known as Quest for Value Advisors) is the
Adviser to the Value Equity Portfolio and the Opportunity Value Portfolio. As
compensation for its services as investment adviser, the Manager pays OpCap a
monthly fee at the annual rate of .40% of the average daily net assets of each
of the Value Equity and Opportunity Value Portfolios, subject to reduction with
respect to the Opportunity Value Portfolio in certain circumstances.
OpCap is a majority-owned subsidiary of Oppenheimer Capital, a general
partnership which is registered as an investment adviser under the Investment
Advisers Act of 1940. The employees of Oppenheimer Capital render all
investment management services performed under the investment advisory
agreements to the Portfolios. Oppenheimer Financial Corp. holds a 33% interest
in Oppenheimer Capital. Oppenheimer Capital, L.P., a Delaware limited
partnership of which Oppenheimer Financial Corp. is the sole general partner,
owns the remaining 67% interest of Oppenheimer Capital. The units of
Oppenheimer Capital, L.P. are traded on the New York Stock Exchange. OpCap and
its affiliates have operated as investment advisers to both mutual funds and
other clients since 1968, and had approximately $48.2 billion under management
as of December 31, 1996.
On February 13, 1997, PIMCO Advisors L.P. ("PIMCO Advisors"), a registered
investment adviser with approximately $110 billion in assets under management
through various subsidiaries, signed an Agreement and Plan of Merger with
Oppenheimer Group, Inc. ("OGI") and its
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subsidiary Oppenheimer Financial Corp. ("Opfin") pursuant to which PIMCO
Advisors and its affiliate, Thomson Advisory Group Inc. ("TAG"), will acquire
the one-third managing general partner interest in Oppenheimer Capital, its
1.0% general partnership interest in OpCap, and its 1.0% general partner
interest in Oppenheimer Capital L.P. (the "Transaction") and OGI will be
merged with and into TAG. The Transaction is subject to certain conditions
being satisfied prior to closing, including consents from certain lenders,
approvals from regulatory authorities, including a favorable tax ruling from
the Internal Revenue Service, and consents of certain clients, which are
expected to take up six months to obtain. If the Transaction is consummated,
it will involve a change in control of Oppenheimer Capital and its subsidiary
OpCap which will constitute an assignment and termination of the investment
advisory agreements between the Manager and OpCap. At a meeting held on April
8, 1997, the Fund's Board of Trustees, including all of the "disinterested
Trustees" as defined in the 1940 Act, approved and determined to submit to
shareholders for approval, new investment advisory agreements with OpCap,
substantially upon the same terms and conditions as the existing investment
advisory agreements. Proxy material will be sent to shareholders of the Value
Equity and Opportunity Value Portfolios concerning approval of the new
investment advisory agreements.
Eileen Rominger, Managing Director of Oppenheimer Capital, is the portfolio
manager for the Value Equity Portfolio. Ms. Rominger has been with Oppenheimer
Capital since 1981. Richard J. Glasebrook II, Managing Director of Oppenheimer
Capital, is the portfolio manager for the Opportunity Value Portfolio. Mr.
Glasebrook has been with Oppenheimer Capital since 1990. Mr. Glasebrook was
named by Morningstar, Inc. (an independent service that monitors the
performance of registered investment companies) as its 1995 Variable Fund
Manager of the Year.
The Dreyfus Corporation ("Dreyfus") is the Adviser to the Dreyfus U.S.
Government Securities Portfolio and the Dreyfus Small Cap Value Portfolio.
Dreyfus, which was formed in 1947, is a wholly-owned subsidiary of Mellon
Bank, N.A., which is a wholly-owned subsidiary of Mellon Bank Corporation
("Mellon"). As of December 31, 1996, Dreyfus managed or administered
approximately $82 billion in assets for more than 1.7 million investor
accounts nationwide. As compensation for its services as investment adviser,
the Manager pays Dreyfus a monthly fee at the annual rate of .15% of the
average daily net assets of the Dreyfus U.S. Government Securities Portfolio
and .375% of the average daily net assets of the Dreyfus Small Cap Value
Portfolio.
Prior to September 16, 1996, OpCap was the Adviser to the Dreyfus Small Cap
Value Portfolio (formerly known as the Value Small Cap Portfolio and prior to
that the Quest for Value Small Cap Portfolio). As compensation for its
services as investment adviser, the Manager paid OpCap a monthly fee at the
annual rate of .40% of the Portfolio's average daily net assets.
Mellon is a publicly-owned multibank holding company incorporated under
Pennsylvania law in 1971 and registered under the Federal Bank
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Holding Company Act of 1956, as amended. Mellon provides a comprehensive range
of financial products and services in domestic and selected international
markets. Mellon is among the twenty-five largest bank holding companies in the
United States based on total assets. Mellon's principal wholly-owned
subsidiaries are Mellon Bank, N.A., Mellon Bank (DE) National Association,
Mellon Bank (MD), The Boston Company, Inc., AFCO Credit Corporation and a
number of companies known as Mellon Financial Services Corporations. Through
its subsidiaries, including Dreyfus, Mellon managed more than $233 billion in
assets as of December 31, 1996, including approximately $81 billion in mutual
fund assets. As of December 31, 1996, Mellon, through various subsidiaries,
provided non-investment services, such as custodial or administrative services,
for more than $1,046 billion in assets, including approximately $57 billion in
mutual fund assets.
Prior to May 1, 1996, The Boston Company Asset Management, Inc. ("Boston
Company"), an affiliate of Dreyfus, was the Dreyfus U.S. Government Securities
Portfolio's Adviser. Boston Company is a wholly-owned subsidiary of The Boston
Company, Inc., which is an indirect wholly-owned subsidiary of Mellon.
Andrew S. Windmueller, who has been employed by Dreyfus since October 1994
and by The Boston Company, Inc. since 1986, is the portfolio manager for the
Dreyfus U.S. Government Securities Portfolio. Mr. Windmueller is co-member of
the Fixed Income Strategy Committee and the Head of Credit Research of The
Boston Company, Inc. and Vice President of Boston Company.
The portfolio managers for the Dreyfus Small Cap Value Portfolio are David L.
Diamond and Peter I. Higgins. Mr. Diamond has been employed by Boston Company
since June, 1991 and by Dreyfus since October, 1994. Mr. Higgins has been
employed by The Boston Company, Inc. since August, 1988, by Boston Company
since June, 1991 and by Dreyfus since February, 1996.
T. Rowe Price Associates, Inc. ("T. Rowe Price") is the Adviser to the T.
Rowe Price Equity Income Portfolio and the T. Rowe Price Growth Stock
Portfolio. As compensation for its services as investment adviser, the Manager
pays T. Rowe Price a monthly fee at the annual rate of .40% of the average
daily net assets of each of the T. Rowe Price Equity Income and T. Rowe Price
Growth Stock Portfolios. T. Rowe Price serves as investment manager to a
variety of individual and institutional investor accounts, including limited
and real estate partnerships and other mutual funds.
Investment decisions with respect to the T. Rowe Price Equity Income
Portfolio are made by an Investment Advisory Committee composed of the
following members: Brian C. Rogers, Chairman, Thomas H. Broadus, Jr., Richard
P. Howard, and William J. Stromberg. The Committee Chairman has day-to-day
responsibility for managing the Portfolio and works with the Committee in
developing and executing the Portfolio's investment program. Mr. Rogers has
been Chairman of the
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Committee since 1993. He joined T. Rowe Price in 1982 and has been managing
investments since 1983.
Investment decisions with respect to the T. Rowe Price Growth Stock Portfolio
are made by an Investment Advisory Committee composed of the following members:
Richard W. Smith, Chairman, James A.C. Kennedy and Brian C. Rogers. The
Committee Chairman has day-to-day responsibility for managing the Portfolio and
works with the Committee in developing and executing the Portfolio's investment
program. Mr. Smith has served on the Committee since 1995 and has been Chairman
of the Committee since February, 1997. He joined T. Rowe Price in 1992. From
1987 to 1992, Mr. Smith was an Investment Analyst for Massachusetts Financial
Services.
Rowe Price-Fleming International, Inc. ("Price-Fleming") is the Adviser to
the T. Rowe Price International Stock Portfolio (formerly the Global Growth
Portfolio). As compensation for its services as investment adviser, the Manager
pays Price-Fleming a monthly fee at an annual rate based on the Portfolio's
average daily net assets as follows: .75% up to $20 million; .60% in excess of
$20 million up to $50 million; and .50% of assets in excess of $50 million. At
such time as the net assets of the Portfolio exceed $200 million, the fee shall
be .50% of total average daily net assets.
Prior to January 1, 1995, Ivory & Sime International, Inc. ("I&S") and Ivory
& Sime plc acted as adviser and sub-adviser, respectively, for the Global
Growth Portfolio. As compensation for its services as investment adviser, the
Manager paid ISI a monthly fee at the annual rate of .45% of the average daily
net assets of the Portfolio up to $400 million and .30% of average daily net
assets in excess of $400 million. As compensation for its services, Ivory &
Sime plc received from ISI 78% of the gross monthly fees paid by the Manager to
ISI.
Price-Fleming was incorporated in Maryland in 1979 as a joint venture between
T. Rowe Price and Robert Fleming Holdings Limited ("Flemings"). Flemings is a
diversified investment organization which participates in a global network of
regional investment offices in New York, London, Zurich, Geneva, Tokyo, Hong
Kong, Manila, Kuala Lampur, South Korea and Taiwan.
T. Rowe Price was incorporated in Maryland in 1947 as successor to the
investment counseling business founded by the late Thomas Rowe Price, Jr., in
1937. Flemings was incorporated in 1974 in the United Kingdom as successor to
the business founded by Robert Fleming in 1873. As of December 31, 1996, T.
Rowe Price and its affiliates managed more than $95 billion of assets of which
Price-Fleming managed the U.S. equivalent of approximately $25 billion.
The common stock of Price-Fleming is 50% owned by a wholly-owned subsidiary
of T. Rowe Price, 25% by a subsidiary of Fleming and 25% by
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Jardine Fleming Group Limited ("Jardine Fleming"). (Half of Jardine Fleming is
owned by Flemings and half by Jardine Matheson Holdings Limited.) T. Rowe Price
has the right to elect a majority of the board of directors of Price-Fleming,
and Flemings has the right to elect the remaining directors, one of whom will
be nominated by Jardine Fleming.
Investment decisions with respect to the T. Rowe Price International Stock
Portfolio are made by an investment advisory group composed of the following
members: Martin G. Wade, Christopher D. Alderson, Richard J. Bruce, Mark J. T.
Edwards, John R. Ford, James B. M. Seddon, Benedict R. F. Thomas and David J.
L. Warren.
Martin Wade joined Price-Fleming in 1979 and has 27 years of experience with
the Fleming Group in research, client service and investment management.
(Fleming Group includes Flemings and/or Jardine Fleming). Christopher Alderson
jointed Price-Fleming in 1988 and has 10 years of experience with the Fleming
Group in research and portfolio management. Peter Askew joined Price-Fleming in
1988 and has 21 years of experience managing multi-currency fixed income
portfolios. Mark Edwards joined Price-Fleming in 1986 and has 15 years of
experience in financial analysis. John Ford joined Price-Fleming in 1982 and
has 16 years of experience with the Fleming Group in research and portfolio
management. James Seddon joined Price-Fleming in 1987 and has nine years of
experience in investment management. Benedict Thomas joined Price-Fleming in
1988 and has seven years of portfolio management experience. David Warren
joined Price-Fleming in 1984 and has 16 years of experience in equity research,
fixed income research and portfolio management.
J.P. Morgan Investment Management Inc. ("Morgan") is the Adviser to the
Enhanced Index Portfolio. As compensation for its services as investment
adviser the Manager pays Morgan a monthly fee at the annual rate of .35% of the
average daily net assets of the Enhanced Index Portfolio.
Morgan is a wholly-owned subsidiary of J.P. Morgan and Co. Incorporated
("J.P. Morgan"), a bank holding company. Through offices in New York City and
abroad, J.P. Morgan, through Morgan and other subsidiaries, including Morgan
Guaranty Trust Company of New York, offers a wide range of services to
governmental, institutional, corporate and individual customers and acts as
investment adviser to individual and institutional clients with combined assets
under management (as of December 31, 1996) of over $178 billion (of which
Morgan advises over $176 billion). J.P. Morgan has a long history of service as
adviser, underwriter and lender to an extensive roster of major companies and
as a financial adviser to national governments. The firm, through its
predecessor firms, has been in business for over a century and has been
managing investments since 1913.
Investment decisions with respect to the Enhanced Index Portfolio are made by
an investment advisory group composed of Frederic A. Nelson, III, James Wiess,
Leon Roisenberg and Timothy J. Devlin.
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Mr. Nelson is a Managing Director of Morgan and is responsible for the U.S.
equity business, including active equity and structured strategies. Mr. Nelson
joined Morgan in 1994 after 14 years at Bankers Trust Company where he was part
of the Global Investment Management Group. Mr. Wiess, a Vice President of
Morgan, is a portfolio manager in the Equity and Balanced Accounts Group with
responsibility for portfolio rebalancing and product research and development
in structured equity strategies. Mr. Wiess joined Morgan in 1992 and from 1984
to 1991 was employed by Oppenheimer & Co. Mr. Roisenberg joined Morgan in 1996
as a Vice President. From 1991 to 1996, Mr. Roisenberg was a quantative
analyst/portfolio manager at Bankers Trust Company. Mr. Devlin joined Morgan in
1996 and is a member of the Structured Equity Group with the dual
responsibilities of client servicing and portfolio management. From 1988 to
1996, Mr. Devlin was at Mitchell Hutchins where he managed quantitatively
driven equity portfolios.
DIVIDENDS, DISTRIBUTIONS AND TAXES
Each Portfolio intends to qualify each year as a "regulated investment
company" under the Internal Revenue Code. By so qualifying, a Portfolio will
not be subject to federal income taxes to the extent that its net investment
income and net realized capital gains are distributed to shareholders.
It is the intention of each Portfolio to distribute substantially all its net
investment income. Although the Trustees of the Fund may decide to declare
dividends at other intervals, dividends from investment income of each
Portfolio are expected to be declared annually (except with respect to the TCW
Money Market Portfolio where dividends will be declared daily and paid monthly)
and will be distributed to the various separate accounts of PFL and not to
Contract owners in the form of additional full and fractional shares of the
Portfolio and not in cash. The result is that the investment performance of the
Portfolios, including the effect of dividends, is reflected in the cash value
of the Contracts. See the prospectus for the Contracts accompanying this
Prospectus.
All net realized long- or short-term capital gains of each Portfolio, if any,
will be declared and distributed at least annually either during or after the
close of the Portfolio's fiscal year and will be reinvested in additional full
and fractional shares of the Portfolio. In certain foreign countries, interest
and dividends are subject to a tax which is withheld by the issuer. U.S. income
tax treaties with certain countries reduce the rates of these withholding
taxes. The Fund intends to provide the documentation necessary to achieve the
lower treaty rate of withholding whenever applicable or to seek refund of
amounts withheld in excess of the treaty rate.
For a discussion of the impact on Contract owners of income taxes PFL may owe
as a result of (i) its ownership of shares of the Portfolios, (ii) its receipt
of dividends and distributions thereon, and (iii) its gains from the purchase
and sale thereof, reference should be made to the prospectus for the Contracts
accompanying this Prospectus.
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SALE AND REDEMPTION OF SHARES
The Fund continuously offers shares of each Portfolio only to separate
accounts of PFL, but may at any time offer shares to a separate account of any
other insurer approved by the Trustees.
AEGON USA Securities, Inc. ("AEGON Securities"), an affiliate of PFL, is the
principal underwriter and distributor of the Contracts. AEGON Securities places
orders for the purchase or redemption of shares of each Portfolio based on,
among other things, the amount of net Contract premiums or purchase payments
transferred to the separate accounts, transfers to or from a separate account
investment division, policy loans, loan repayments, and benefit payments to be
effected on a given date pursuant to the terms of the Contracts. Such orders
are effected, without sales charge, at the net asset value per share for each
Portfolio determined as of the close of regular trading on the New York Stock
Exchange (currently 4:00 p.m., New York City time), on that same date.
The net asset value of the shares of each Portfolio for the purpose of
pricing orders for the purchase and redemption of shares is determined as of
the close of the New York Stock Exchange, Monday through Friday, exclusive of
national business holidays. Net asset value per share is computed by dividing
the value of all assets of a Portfolio (including accrued interest and
dividends), less all liabilities of the Portfolio (including accrued expenses
and dividends payable), by the number of outstanding shares of the Portfolio.
The assets of the TCW Money Market Portfolio are valued at amortized cost and
the assets of the other Portfolios are valued on the basis of their market
values or, in the absence of a market value with respect to any portfolio
securities, at fair value as determined by or under the direction of the Fund's
Board of Trustees including the employment of an independent pricing service,
as described in the Statement of Additional Information.
Shares of the Portfolios may be redeemed on any day on which the Fund is open
for business.
PERFORMANCE INFORMATION
From time to time, the Fund may advertise the "average annual or cumulative
total return" of the TCW Managed Asset Allocation, Value Equity, Dreyfus Small
Cap Value, Dreyfus U.S. Government Securities, T. Rowe Price Equity Income, T.
Rowe Price Growth Stock, T. Rowe Price International Stock, Opportunity Value
and Enhanced Index Portfolios or the "yield" and "effective yield" of the TCW
Money Market and Dreyfus U.S. Government Securities Portfolios and may compare
the performance of the Portfolios with that of other mutual funds with similar
investment objectives as listed in rankings prepared by Lipper Analytical
Services, Inc., or similar independent services monitoring mutual fund
performance, and with appropriate securities or other
- 54 -
<PAGE>
relevant indices. The "average annual total return" of a Portfolio refers to
the average annual compounded rate of return over the stated period that would
equate an initial investment in that Portfolio at the beginning of the period
to its ending redeemable value, assuming reinvestment of all dividends and
distributions and deduction of all recurring charges other than charges and
deductions which are, or may be, imposed under the Contracts. Figures will be
given for the recent one, five and ten year periods and for the life of the
Portfolio if it has not been in existence for any such periods. When
considering "average annual total return" figures for periods longer than one
year, it is important to note that a Portfolio's annual total return for any
given year might have been greater or less than its average for the entire
period. "Cumulative total return" represents the total change in value of an
investment in a Portfolio for a specified period (again reflecting changes in
Portfolio share prices and assuming reinvestment of Portfolio distributions).
The TCW Money Market Portfolio's "yield" refers to the income generated by an
investment in the Portfolio over a seven-day period (which period will be
stated in the advertisement). This income is then "annualized." That is, the
amount of income generated by the investment during that week is assumed to be
generated each week over a 52-week period and is shown as a percentage of the
investment. The "effective yield" is calculated similarly but, when annualized,
the income earned by an investment in the Portfolio is assumed to be
reinvested. The "effective yield" will be slightly higher than the "yield"
because of the compounding effect of this assumed reinvestment. The Dreyfus
U.S. Government Securities Portfolio may advertise its 30-day yield. Such yield
refers to the income that is generated over a stated 30-day (or one month)
period (which period will be stated in the advertisement), divided by the net
asset value per share on the last day of the period. The income is annualized
by assuming that the income during the 30-day period remains the same each
month over one year and compounded semi-annually. The methods used to calculate
"average annual and cumulative total return" and "yield" are described further
in the Statement of Additional Information.
The performance of each Portfolio will vary from time to time in response to
fluctuations in market conditions, interest rates, the composition of the
Portfolio's investments and expenses. Consequently, a Portfolio's performance
figures are historical and should not be considered representative of the
performance of the Portfolio for any future period.
OpCap is the investment adviser of the Managed Portfolio of the Accumulation
Trust (formerly known as the Quest for Value Accumulation Trust) (the
"Accumulation Trust"), a registered open-end investment company whose shares
are sold to certain variable accounts of life insurance companies. The Managed
Portfolio of the Accumulation Trust is substantially similar to the Opportunity
Value Portfolio in that it has the same investment objective as the Opportunity
Value Portfolio and is managed using the same investment strategies and
techniques as contemplated for the Opportunity Value Portfolio.
- 55 -
<PAGE>
The Opportunity Value Portfolio commenced operations in November, 1996 and,
consequently, does not have a significant operating history. See "Financial
Highlights." Set forth below is certain performance information regarding the
Managed Portfolio of the Accumulation Trust which has been obtained from OpCap,
and is set forth in the current prospectus and statement of additional
information of the Accumulation Trust. Investors should not rely on the
following financial information as an indication of the future performance of
the Opportunity Value Portfolio.
AVERAGE ANNUAL TOTAL RETURN OF COMPARABLE PORTFOLIO*(1)
<TABLE>
<CAPTION>
FOR THE PERIOD
FOR THE YEAR FOR THE FIVE YEARS FROM INCEPTION
ENDED DECEMBER 31, ENDED DECEMBER 31, TO DECEMBER 31,
1996 1996 1996(2)
------------------ ------------------ ---------------
<S> <C> <C> <C>
Managed Portfolio of
Accumulation Trust..... 22.77% 19.13% 20.09%
</TABLE>
- -----------
* On September 16, 1994, an investment company called Quest for Value
Accumulation Trust (the "Old Trust") was effectively divided into two
investment funds, the Old Trust and the Accumulation Trust, at which time
the Accumulation Trust commenced operations. The total net assets for the
Managed Portfolio immediately after the transaction was $682,601,380 with
respect to the Old Trust and $51,345,102 with respect to the Accumulation
Trust. For the period prior to September 16, 1994, the performance figures
above for the Managed Portfolio reflect the performance of the
corresponding Portfolio of the Old Trust.
(1) Reflects waiver of all or a portion of the advisory fees and reimbursements
of other expenses. Without such waivers and reimbursements, the average
annual total return during the periods would have been lower.
(2) The Portfolio commenced operations on August 1, 1988.
Morgan is the investment manager of certain Private Accounts. At December 31,
1996 and as of the date of this Prospectus, the Enhanced Index Portfolio had
not commenced operations. However, these Private Accounts are substantially
similar to the Enhanced Index Portfolio in that they have the same investment
objectives as the Enhanced Index Portfolio and are managed using the same
investment strategies and techniques as contemplated for the Enhanced Index
Portfolio.
Investors should not rely on the following financial information as an
indication of the future performance of the Enhanced Index Portfolio. The
performance of the Enhanced Index Portfolio may vary from the Private Account
composite information because the Portfolio will be actively managed and its
investments will vary from time to time and will not be identical to the past
portfolio investments of the Private Accounts. Moreover, the Private Accounts
are not registered under the 1940 Act and therefore are not subject to certain
investment restrictions
- 56 -
<PAGE>
that are imposed by the 1940 Act, which, if imposed, could have adversely
affected the Private Accounts' performances. In addition, the Private Accounts
are not subject to the provisions of the Internal Revenue Code with respect to
"regulated investment companies," which provisions, if imposed, could have
adversely affected the Private Accounts' performances.
The chart below shows hypothetical performance information derived from
historical composite performance of the Private Accounts included in the
Structured Stock Selection Composite. The hypothetical performance figures
represent the actual performance results of the composite of comparable Private
Accounts, adjusted to reflect the deduction of the fees and expenses
anticipated to be paid by the Enhanced Index Portfolio. The actual Private
Account composite performance figures are time-weighted rates of return which
include all income and accrued income and realized and unrealized gains or
losses, but do not reflect the deduction of investment advisory fees actually
charged to the Private Accounts.
HYPOTHETICAL AVERAGE ANNUAL TOTAL RETURN INFORMATION
DERIVED FROM PRIVATE ACCOUNT COMPOSITE
<TABLE>
<CAPTION>
FOR THE PERIOD
FOR THE FOR THE FIVE FROM INCEPTION
YEAR ENDED YEARS ENDED (NOVEMBER 1, 1989)
DECEMBER 31, DECEMBER 31, TO DECEMBER 31,
1996 1996 1996
------------ ------------ ------------------
<S> <C> <C> <C>
Structured Stock Selection
Composite....................... 22.21% 15.45% 14.61%
</TABLE>
----------------------
The calculations of total return assume the reinvestment of all dividends and
capital gains distributions on the reinvestment dates during the period and the
deduction of all recurring expenses that were charged to shareholder accounts.
The above tables do not reflect charges and deductions which are, or may be,
imposed under the Contracts. For a description of such charges and deductions,
see the prospectus accompanying this Prospectus which describes the Contracts.
ORGANIZATION AND CAPITALIZATION OF THE FUND
The Fund was established in November 1988 as a business trust under
Massachusetts law. The Fund has authorized an unlimited number of shares of
beneficial interest which may, without shareholder approval, be divided into an
unlimited number of series. Shares of the Fund are presently divided into ten
series of shares, one for each of the Fund's ten Portfolios. Shares are freely
transferable, are entitled to dividends as declared by the Trustees, and in
liquidation are entitled to receive the net assets of their respective
Portfolios, but not the net assets of the other Portfolios.
Fund shares are entitled to vote at any meeting of shareholders. The Fund
does not generally hold annual meetings of shareholders and will do so only
when required by law. Matters submitted to a shareholder vote
- 57 -
<PAGE>
must be approved by each portfolio of the Fund separately except (i) when
required by the 1940 Act, shares will be voted together as a single class and
(ii) when the Trustees have determined that the matter does not affect all
portfolios, then only shareholders of the affected portfolio will be entitled
to vote on the matter.
Owners of the Contracts have certain voting interests in respect of shares of
the Portfolios. See "Voting Rights" in the prospectus for the Contracts
accompanying this Prospectus for a description of the rights granted Contract
owners to instruct voting of shares.
ADDITIONAL INFORMATION
TRANSFER AGENT AND CUSTODIAN
All cash and securities of the Fund are held by Boston Safe Deposit and Trust
Company as custodian. FDISG, located at 4400 Computer Drive, Westborough,
Massachusetts 01581, serves as transfer agent for the Fund.
INDEPENDENT AUDITORS
Ernst & Young LLP, located at 200 Clarendon Street, Boston, Massachusetts,
02116, serves as the Fund's independent auditors.
----------------------
Statements contained in this Prospectus as to the contents of any contract or
other document referred to are not necessarily complete, and, in each instance,
reference is made to the copy of such contract or other document filed as an
exhibit to the registration statement of which this Prospectus forms a part,
each such statement being qualified in all respects by such reference.
- 58 -
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
The Fund................................................................... 2
Financial Highlights....................................................... 4
Investment Objectives and Policies......................................... 13
TCW Money Market Portfolio................................................ 13
TCW Managed Asset Allocation Portfolio.................................... 16
T. Rowe Price International Stock Portfolio............................... 18
Value Equity Portfolio.................................................... 22
Dreyfus Small Cap Value Portfolio......................................... 23
Dreyfus U.S. Government Securities Portfolio.............................. 25
T. Rowe Price Equity Income Portfolio..................................... 30
T. Rowe Price Growth Stock Portfolio...................................... 32
Opportunity Value Portfolio............................................... 33
Enhanced Index Portfolio.................................................. 35
Investment Strategies..................................................... 37
Management of the Fund..................................................... 45
The Manager............................................................... 45
The Advisers.............................................................. 46
Dividends, Distributions and Taxes......................................... 53
Sale and Redemption of Shares.............................................. 54
Performance Information.................................................... 54
Organization and Capitalization of the Fund................................ 57
Additional Information..................................................... 58
Transfer Agent and Custodian.............................................. 58
Independent Auditors...................................................... 58
</TABLE>
---------------------
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRE-
SENTATION NOT CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFOR-
MATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED.
THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFERING OF ANY SECURITIES OTHER THAN
THE REGISTERED SECURITIES TO WHICH IT RELATES OR AN OFFER TO ANY PERSON IN ANY
STATE OR JURISDICTION OF THE UNITED STATES OR ANY COUNTRY WHERE SUCH OFFER
WOULD BE UNLAWFUL.
ENDEAVOR SERIES TRUST
2101 East Coast Highway, Suite 300
Corona del Mar, California 92625
(800) 854-8393
MANAGER
------------------------------------------
Endeavor Investment Advisers
2101 East Coast Highway, Suite 300
Corona del Mar, California 92625
INVESTMENT ADVISERS
------------------------------------------
TCW Funds Management, Inc.
865 S. Figueroa Street
Los Angeles, California 90071
OpCap Advisors
One World Financial Center
New York, New York 10281
The Dreyfus Corporation
200 Park Avenue
New York, New York 10166
T. Rowe Price Associates, Inc.
100 East Pratt Street
Baltimore, Maryland 21202
Rowe Price-Fleming International, Inc.
100 East Pratt Street
Baltimore, Maryland 21202
J.P. Morgan Investment Management Inc.
522 Fifth Avenue
New York, New York 10036
CUSTODIAN
------------------------------------------
Boston Safe Deposit and Trust Company
One Boston Place
Boston, Massachusetts 02108
<PAGE>
PROSPECTUS
WRL SERIES FUND, INC.
GROWTH PORTFOLIO
201 HIGHLAND AVENUE
LARGO, FLORIDA 33770-2597
TELEPHONE (319) 398-8511
WRL Series Fund, Inc. (the "Fund") is a diversified, open-end management
investment company consisting of separate series or investment portfolios.
This Prospectus pertains only to the Growth Portfolio of the Fund (the
"Portfolio").
The investment objective of the Growth Portfolio is growth of capital. There
can be, of course, no assurance that the Portfolio will achieve its objective.
Shares of the Fund are sold only to the separate accounts (the "Separate
Accounts") of Western Reserve Life Assurance Co. of Ohio ("WRL"), PFL Life
Insurance Company ("PFL"), and AUSA Life Insurance Company, Inc. ("AUSA")
(WRL, PFL, and AUSA together, the "Life Companies") to fund the benefits under
certain variable life insurance policies (the "Policies") and variable annuity
contracts (the "Annuity Contracts"). The Life Companies are affiliates. The
Separate Accounts, which may or may not be registered with the Securities and
Exchange Commission, invest in shares of one or more of the portfolios in
accordance with the allocation instructions received from holders of the
Policies and the Annuity Contracts (collectively, the "Contract Owners"). Such
allocation rights are further described in the prospectuses or disclosure
documents for the Policies and the Annuity Contracts.
WRL Investment Management, Inc. ("WRL Management") and Janus Capital
Corporation serve as the investment adviser ("Investment Adviser") and the
sub-adviser ("Sub-Adviser") respectively, to the Portfolio (collectively,
"Advisers"). See "The Investment Adviser" and "The Sub-Adviser."
This Prospectus sets forth concisely the information about the Portfolio
that prospective investors ought to know before investing. Investors should
read this Prospectus and retain it for future reference.
Additional information about the Fund, the Portfolio and other portfolios of
the Fund has been filed with the Securities and Exchange Commission (the
"SEC") and is available upon request without charge by calling or writing the
Fund. The Statement of Additional Information (the "SAI") pertaining to the
Portfolio bears the same date as this Prospectus and is incorporated by
reference into this Prospectus in its entirety.
----------------------
SHARES OF THE FUND ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR
ENDORSED BY, A BANK OR OTHER FINANCIAL INSTITUTION, AND THE SHARES ARE NOT
FEDERALLY INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL
RESERVE BOARD, OR ANY OTHER AGENCY. INVESTMENTS IN SHARES OF THE FUND INVOLVE
INVESTMENT RISK, INCLUDING POSSIBLE LOSS OF PRINCIPAL AMOUNT INVESTED.
THIS PROSPECTUS MUST BE ACCOMPANIED BY THE CURRENT PROSPECTUS OR DISCLOSURE
DOCUMENT FOR THE APPLICABLE VARIABLE ANNUITY CONTRACT OR FLEXIBLE PREMIUM
VARIABLE LIFE INSURANCE POLICY. ALL PROSPECTUSES SHOULD BE READ AND RETAINED
FOR FUTURE REFERENCE.
----------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE COMMISSION
OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF
THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
----------------------
PROSPECTUS DATED MAY 1, 1997
<PAGE>
TABLE OF CONTENTS
<TABLE>
<S> <C>
Financial Highlights........................................................ 3
Performance Information..................................................... 4
The Growth Portfolio and the Fund........................................... 5
Other Investment Policies and Restrictions.................................. 6
Portfolio Securities and Risk Factors....................................... 8
Management of the Fund...................................................... 14
Other Information........................................................... 18
Distribution and Taxes...................................................... 21
</TABLE>
2
<PAGE>
FINANCIAL HIGHLIGHTS
PER SHARE INCOME AND CAPITAL CHANGES
The information contained in the table below for one share of capital stock
outstanding during the fiscal periods ended on December 31 of each year is
taken from the Fund's audited financial statements, which have been
incorporated by reference in the SAI. The Fund's Annual Report contains
additional performance information for the Portfolio. A copy of the Annual
Report may be obtained without charge upon request.
GROWTH PORTFOLIO
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992 1991 1990 1989 1988 1987
---------- ---------- -------- -------- -------- -------- -------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net Asset Value,
Beginning of Period... $31.66 $ 23.81 $ 26.25 $ 25.83 $ 26.26 $ 17.48 $ 17.85 $ 12.97 $ 11.14 $ 10.14
INCOME FROM INVESTMENT
OPERATIONS
Net Investment Income. .34 .26 .22 .28 .36 .27 .30 .19 .31 .21
Net Gains or Losses on
Securities (both
realized and
unrealized).......... 5.35 10.97 (2.41) .79 .52 10.75 (.33) 6.29 1.83 1.00
---------- ---------- -------- -------- -------- -------- -------- ------- ------- -------
Total Income (Loss)
From Investment
Operations.......... 5.69 11.23 (2.19) 1.07 .88 11.02 (.03) 6.48 2.14 1.21
---------- ---------- -------- -------- -------- -------- -------- ------- ------- -------
LESS DISTRIBUTIONS
Dividends (from net
investment income)... (.35) (.24) (.22) (.28) (.36) (.27) (.30) (.19) (.31) (.21)
Dividends (in excess
of net investment
income).............. (.01) .00 .00 .00 .00 .00 .00 .00 .00 .00
Distributions (from
capital gains)....... (1.99) (3.14) (.00) (.37) (.95) (1.97) (.04) (1.41) .00 .00
Distributions in
excess of capital
gains................ .00 .00 (.03) .00 .00 .00 .00 .00 .00 .00
---------- ---------- -------- -------- -------- -------- -------- ------- ------- -------
Total Distributions.. (2.35) (3.38) (.25) (.65) (1.31) (2.24) (.34) (1.60) (.31) (.21)
---------- ---------- -------- -------- -------- -------- -------- ------- ------- -------
Net Asset Value,
End of Period......... $35.00 $ 31.66 $ 23.81 $ 26.25 $ 25.83 $ 26.26 $ 17.48 $ 17.85 $ 12.97 $ 11.14
========== ========== ======== ======== ======== ======== ======== ======= ======= =======
Total Return*.......... 17.96% 47.12% (8.31%) 3.97% 2.35% 59.79% (.22%) 47.04% 18.62% 10.90%
RATIOS/SUPPLEMENTAL
DATA
Net Assets, End of
Period (000 omitted).. $1,527,409 $1,195,174 $814,383 $934,810 $711,422 $393,511 $129,057 $74,680 $28,497 $15,815
Ratio of Expenses to
Average Net Assets**.. .88% .86% .84% .87% .86% .90% 1.00% 1.00% 1.00% 1.00%
Ratio of Net Investment
Income to Average Net
Assets................ .98% .90% .88% 1.07% 1.44% 1.21% 2.06% 1.18% 2.50% 1.84%
Ratios of Commissions
paid to number of
shares................ 4.93% N/A N/A N/A N/A N/A N/A N/A N/A N/A
Portfolio Turnover Rate
...................... 45.21% 130.48% 107.33% 77.91% 77.70% 7.27% 157.07% 123.80% 76.27% 222.13%
</TABLE>
- ----------
*The total return of the Portfolio reflects the advisory fee and all other
Portfolio expenses and includes reinvestment of dividends and capital gains;
it does not reflect the charges against the corresponding sub-accounts or the
charges and deductions under the applicable Policy or Annuity Contract;
including these charges would reduce total return figures for all periods
shown.
**Ratio is net of advisory fee waiver for the periods ended December 31, 1987,
1988 and 1989 for which periods the ratio of expenses to average net assets
would have been 1.90%, 1.49% and 1.13%, respectively, absent the advisory fee
waiver by WRL.
3
<PAGE>
PERFORMANCE INFORMATION
The Fund may include quotations of the Portfolio's total return or yield in
connection with the total return for the appropriate Separate Account, in
advertisements, sales literature or reports to Contract Owners or to
prospective investors. Total return and yield quotations for the Portfolio
reflect only the performance of a hypothetical investment in the Portfolio
during the particular time period shown as calculated based on the historical
performance of the Portfolio during that period. Such quotations do not in any
way indicate or project future performance. Quotations of total return and
yield will not reflect charges or deductions against the Separate Accounts or
charges and deductions against the Policies or the Annuity Contracts. Where
relevant, the prospectuses for the Policies and the Annuity Contracts contain
performance information which show total return and yield for the Separate
Accounts, Policies or Annuity Contracts.
TOTAL RETURN. Total return refers to the average annual percentage change in
value of an investment in the Portfolio held for a stated period of time as of
a stated ending date. When the Portfolio has been in operation for the stated
period, the total return for such period will be provided if performance
information is quoted. Total return quotations are expressed as average annual
compound rates of return for each of the periods quoted. They also reflect the
deduction of a proportionate share of the Portfolio's investment advisory fees
and expenses, and assume that all dividends and capital gains distributions
during the period are reinvested in the Portfolio when made.
PERFORMANCE SHOWN IN ADVERTISING. The Portfolio may disclose in
advertisements, sales literature and reports to Contract Owners or to
prospective Contract Owners, total returns for the Portfolio for periods in
addition to those required to be presented. It may also disclose other
nonstandardized data, such as cumulative total returns, actual year-by-year
returns, or any combination thereof.
PERFORMANCE RANKINGS AND COMPARISONS TO STANDARD INDEXES. Performance of the
Portfolio may also be compared to: (1) indexes, such as the S&P 500, the Dow
Jones Industrial Average or other widely recognized indexes; (2) other mutual
funds whose performance is reported by all or any of Lipper Analytical
Services, Inc., ("Lipper"), Variable Annuity Research & Data Service ("VARDS")
and Morningstar, Inc. ("Morningstar"), or as reported by other services,
companies, individuals or other industry or financial publications of general
interest, such as Forbes, Money, The Wall Street Journal, Business Week,
Barron's, Kiplinger's Personal Finance and Fortune, which rank and/or rate
mutual funds by overall performance or other criteria; and (3) the Consumer
Price Index. Lipper, VARDS and Morningstar are widely quoted independent
research firms which rank mutual funds according to overall performance,
investment objective, and assets. Unmanaged indexes, such as the S&P 500, may
assume the reinvestment of dividends but usually do not reflect any
"deduction" for
4
<PAGE>
the expenses associated with operating and managing a portfolio. In connection
with a ranking, the Portfolio will also provide information in sales
literature, advertisements, and reports with respect to the ranking, including
the particular category of fund to which it relates, the number of funds in
the category, the period and criteria on which the ranking is based, and the
effect of any fee waivers and/or expense reimbursements.
THE GROWTH PORTFOLIO AND THE FUND
The Fund is a diversified, open-end management investment company registered
under the Investment Company Act of 1940, as amended (the "1940 Act"). The
Growth Portfolio is a series of the Fund. The Fund consists of several series,
or separate investment portfolios, which offer shares for investment by the
Separate Accounts. This Prospectus describes only the Growth Portfolio.
INVESTMENT OBJECTIVE OF THE PORTFOLIO
The Portfolio's investment objective and, unless otherwise noted, its
investment policies and techniques, may be changed by the Board of Directors
of the Fund without shareholder or Contract Owner approval. A change in the
investment objective or policies of the Portfolio may result in the Portfolio
having an investment objective or policies different from that which a
Contract Owner deemed appropriate at the time of investment.
GROWTH PORTFOLIO
The investment objective of the Portfolio is growth of capital.
The Portfolio will invest substantially all of its assets in common stocks
when the Sub-Adviser believes that the relevant market environment favors
profitable investing in those securities. Common stock investments are
selected in industries and companies that the Sub-Adviser believes are
experiencing favorable demand for their products and services, and which
operate in a favorable competitive environment and regulatory climate. The
Sub-Adviser's analysis and selection process focuses on stocks issued by
companies with earnings growth potential. In particular, the Portfolio intends
to buy stocks with earnings growth potential that may not be recognized by the
market. Securities are selected solely for their growth potential; investment
income is not a consideration.
The Portfolio may invest up to 25% of its assets in foreign securities
(which may be purchased through American Depositary Receipts ("ADRs"),
European Depositary Receipts ("EDRs") and Global Depositary Receipts ("GDRs"),
as well as directly), as described below and in the SAI. (See "PORTFOLIO
SECURITIES AND RISK FACTORS--Foreign Securities," p.12.)
Although the Portfolio's assets will be invested primarily in common stocks
at most times, the Portfolio may increase its cash position when the Sub-
Adviser is unable to locate investment opportunities with
5
<PAGE>
desirable risk/reward characteristics. The Portfolio may invest in government
securities, high grade commercial paper, corporate bonds and debentures,
warrants, preferred stocks or certificates of deposit of commercial banks or
other debt securities when the Sub-Adviser perceives an opportunity for
capital growth from such securities, or so that the Portfolio may receive a
return on its uninvested cash. See the SAI for further descriptions of such
securities. In the latter case, investment income may increase and may
constitute a larger portion of the return on the Portfolio's investments, and
the Portfolio may not participate in market advances or declines to the extent
it would if the Portfolio were fully invested in common stocks. The Portfolio
may invest up to 25% of its assets in securities of issuers in a single
industry. The Portfolio does not currently hold or intend to invest more than
5% of its assets in non-investment grade securities. See the SAI for further
information concerning such securities and bond ratings.
The Portfolio may also invest in repurchase agreements and reverse repur-
chase agreements. See "PORTFOLIO SECURITIES AND RISK FACTORS--Repurchase and
Reverse Repurchase Agreements," p. 10.
OTHER INVESTMENT POLICIES AND RESTRICTIONS
The Portfolio is subject to certain other investment policies and
restrictions which are described in the SAI for the Portfolio. Unless
otherwise noted, the investment policies, techniques, and percentage
restrictions described below are non-fundamental and may be changed by the
Fund's Board of Directors without Contract Owner approval. In addition, unless
otherwise stated below, the percentage limitations included in these policies
and elsewhere in this Prospectus apply only at the time of purchase of the
security.
LENDING AND BORROWING
The Portfolio may lend its portfolio securities to qualified institutional
buyers for the purpose of realizing additional income. Such loans must be
continuously secured by liquid assets at least equal to the market value of
the securities loaned and may not together with any other outstanding loans
exceed 25% of the Portfolio's total assets. Securities lending may involve
some credit risk to the Portfolio if the borrower defaults and the Portfolio
is delayed or prevented from recovering the collateral or is otherwise
required to cover a transaction in the security loaned. The Portfolio does not
presently intend to lend securities or make any other loans valued at more
than 5% of its total assets. To secure borrowings, the Portfolio may not
mortgage or pledge its securities in amounts that exceed 15% of its net
assets, at the time the loan or borrowing is made. If portfolio securities are
loaned, collateral values will be continuously maintained at no less than 100%
by marking to market daily. If a material event is to be voted upon
6
<PAGE>
affecting the Portfolio's investment in securities which are on loan, the
Portfolio will take such action as may be appropriate in order to vote its
shares. The Portfolio does not have the right to vote securities on loan, but
would terminate the loan and regain the right to vote if it were considered
important with respect to the investment.
The Portfolio may borrow money from or lend money to other funds that permit
such transactions and are advised by the Sub-Adviser and if the Portfolio
seeks and obtains permission to do so from the SEC. There is no assurance that
such permission would be granted. The Portfolio may also borrow money from
banks. Any such loans or borrowings are expected to be short-term in nature
and used for temporary or emergency purposes, such as to provide cash for
redemptions, and will not exceed 25% of the Portfolio's net assets at the time
the loan or borrowing is made.
PORTFOLIO TURNOVER
A portfolio turnover rate is, in general, the percentage calculated by
taking the lesser of purchases or sales of portfolio securities (excluding
certain short-term securities) for a year and dividing it by the monthly
average of the market value of such securities during the year. (See
"Financial Highlights" for the Portfolio on page 3 for more information on
historical turnover rates.)
Changes in security holdings are made by the Portfolio's Sub-Adviser when it
is deemed necessary. Such changes may result from: liquidity needs; securities
having reached a price or yield objective; anticipated changes in interest
rates or the credit standing of an issuer; or developments not foreseen at the
time of the investment decision.
The Sub-Adviser may engage in a significant number of short-term
transactions if such investing serves the Portfolio's objective. The rate of
portfolio turnover will not be a limiting factor when such short-term
investing is considered appropriate.
Increased turnover results in higher brokerage costs or mark-up charges for
the Portfolio; these charges are ultimately borne by the Contract Owners. For
further discussion of portfolio turnover, see the SAI.
SPECIAL SITUATIONS
The Portfolio may invest in "special situations" from time to time. A
special situation arises when, in the opinion of the Sub-Adviser, the
securities of a particular issuer will be recognized and appreciate in value
due to a specific development with respect to that issuer. Developments
creating a special situation might include, among others,
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a new product or process, a management change, a technological breakthrough,
or other extraordinary corporate event, or differences in market supply and
demand for the security.
Investment in special situations may carry an additional risk of loss in the
event that the anticipated development does not occur or does not attract the
expected attention. The impact of this strategy on the Portfolio will depend
on the Portfolio's size and the extent of the holdings of the special
situation issuer relative to its total assets.
PORTFOLIO SECURITIES AND RISK FACTORS
FUTURES, OPTIONS AND OTHER DERIVATIVES
Subject to certain limitations, the Portfolio may engage in hedging
strategies involving instruments commonly called "derivatives." "Derivatives"
used by the Portfolio include futures contracts and related options, forward
currency contracts, and interest rate swaps, caps and floors. These
instruments are commonly called derivatives because their price is derived
from an underlying index, security or other measure of value.
The Portfolio may engage in futures contracts and options. The Portfolio
intends to use such derivatives primarily for bona fide hedging purposes,
including to protect portfolio positions against market, interest rate or
currency fluctuations, to equitize a cash position, for duration management,
or to reduce the risk inherent in the management of the Portfolio. If used for
other purposes as may be permitted under applicable rules pursuant to which
the Portfolio would remain exempt from the definition of a "commodity pool
operator" under the rules of the CFTC, the aggregate initial margin and
premiums required to establish any non-hedging positions will not exceed 5% of
the fair market value of the Portfolio's net assets.
FORWARD CONTRACTS are contracts to purchase or sell a specified amount of
property for an agreed upon price at a specified time. Forward contracts are
not currently exchange traded and are typically negotiated on an individual
basis. The Portfolio may enter into forward currency contracts to hedge
against declines in the value of non-dollar denominated securities or to
reduce the impact of currency appreciation on purchases of non-dollar
denominated securities. The Portfolio may also enter into forward contracts to
purchase or sell securities or other financial indices.
FUTURES CONTRACTS are contracts that obligate the buyer to receive and the
seller to deliver an instrument or money at a specified price on a specified
date. The Portfolio may buy and sell futures contracts on foreign currencies,
securities and financial indexes including interest rates or an index of U.S.
Government, foreign government, equity or fixed-income securities.
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The Portfolio may also buy options on futures contracts. An option on a
futures contract gives the buyer the right, but not the obligation, to buy or
sell a futures contract at a specific price on or before a specified date.
Futures contracts and options on futures are standardized and traded on
designated exchanges.
INTEREST RATE SWAPS involve the exchange by two parties of their respective
commitments to pay or receive interest (e.g., an exchange or floating rate
payments for fixed rate payments).
INTEREST RATE FUTURES CONTRACTS involve the purchase or sale of contracts
for the future delivery of fixed-income securities at an established price.
The purchase of an interest rate cap entitles the purchaser, to the extent
that a specified index exceeds a predetermined interest rate, to receive
payments of interest on a contractually based principal amount from the party
selling the interest rate cap. The purchase of an interest rate floor entitles
the purchaser, to the extent that a specified index falls below a
predetermined interest rate, to receive payments of interest on a
contractually based principal amount from the party selling the interest rate
floor.
OPTIONS are the right, but not the obligation, to buy or sell a specified
amount of securities or other assets on or before a fixed date at a
predetermined price. The Portfolio may purchase put and call options on
securities, securities indexes and foreign currencies, subject to its
investment restrictions.
CALL OPTIONS give a buyer the right to purchase a portfolio security at a
designated price until a certain date. The option must be "covered"--for
example, the seller may own the securities required to fulfill the contract.
PUT OPTIONS give the buyer the right to sell the security at a designated
price until a certain date. Put options are "covered", for example, by
segregating an amount of cash or securities equal to the exercise price.
STOCK INDEX FUTURES obligate the seller to deliver (and the purchaser to
take) an amount of cash equal to a specified dollar amount times the
difference between the value of a specified stock index at the close of the
last trading day of the contract and the price at which the agreement is made.
No physical delivery of the underlying stocks in the index is made.
OPTIONS ON STOCK INDEX futures contracts, as contrasted with the direct
investment in such a contract, gives the purchaser the right, in return for
the premium paid, to assume a position in a stock index futures contract at a
specified exercise price at any time prior to the expiration date of the
option.
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RISK FACTORS. There can be no assurance the use of derivatives will help the
Portfolio achieve its investment objective. Derivatives involve special risks
and transaction costs, and draw upon skills and experience which are different
from those needed to choose the other securities or instruments in which the
Portfolio invests. Special risks of these instruments include:
INACCURATE MARKET PREDICTIONS. If interest rates, securities prices or
currency markets do not move in the direction expected by the Sub-Adviser
who uses derivatives based on those measures, these instruments may fall in
their intended purpose and result in losses to the Portfolio.
IMPERFECT CORRELATION. Derivatives' prices may be imperfectly correlated
with the prices of the securities, interest rates or currencies being
hedged. When this happens, the expected benefits may be diminished.
ILLIQUIDITY. A liquid secondary market may not be available for a
particular instrument at a particular time. The Portfolio may therefore be
unable to control losses by closing out a derivative position.
TAX CONSIDERATIONS. The Portfolio may have to delay closing out certain
derivative positions to avoid adverse tax consequences.
The risk of loss from investing in derivative instruments is potentially
unlimited.
REPURCHASE AND REVERSE REPURCHASE AGREEMENTS
The Portfolio may invest in repurchase and reverse repurchase agreements. A
repurchase agreement involves the purchase of a security by the Portfolio and
a simultaneous agreement (generally from a bank or broker-dealer) to
repurchase that security back from the Portfolio at a specified price and date
upon demand. This technique offers a method of earning income on idle cash.
The repurchase agreement is effectively secured by the value of the underlying
security. Repurchase agreements not terminable within seven days are
considered illiquid securities.
The Portfolio invests in a reverse repurchase agreement when it sells a
portfolio security to another party, such as a bank or broker-dealer, in
return for cash, and agrees to buy the security back at a future date and
price. Reverse repurchase agreements may be used to provide cash to satisfy
unusually heavy redemption requests or for other temporary or emergency
purposes without the necessity of selling portfolio securities or to earn
additional income on portfolio securities such as U.S. Treasury bills and
notes. While a reverse repurchase agreement is outstanding, the Portfolio will
segregate with its custodian
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cash and other liquid assets to cover its obligation under the agreement.
Reverse repurchase agreements are considered a form of borrowing by the
Portfolio for the purposes of the 1940 Act.
RISK FACTORS. Repurchase agreements involve the risk that the seller will
fail to repurchase the security, as agreed. In that case, the Portfolio will
bear the risk of market value fluctuations until the security can be sold and
may encounter delays and incur costs in liquidating the security. In the event
of bankruptcy or insolvency of the seller, delays and costs are incurred.
Reverse repurchase agreements may expose the Portfolio to greater
fluctuations in the value of its assets.
ILLIQUID SECURITIES
The Portfolio may invest up to 15% of its net assets in securities that are
considered illiquid because of the absence of a readily available market or
due to legal or contractual restrictions on resale. However, certain
restricted securities that are not registered for sale to the general public
but that can be sold to institutional investors ("Rule 144A Securities") may
not be considered illiquid, provided that a dealer or institutional trading
market exists. The institutional trading market is relatively new and
liquidity of the Portfolio's investments could be impaired if such trading
does not further develop or declines. The Sub-Adviser will determine the
liquidity of Rule 144A Securities under guidelines approved by the Fund's
Board of Directors.
RISK FACTORS. Investment in illiquid securities involve certain risks to the
extent that the Portfolio may be unable to dispose of such securities at the
time desired or at a reasonable price. In addition, in order to resell a
restricted security, the Portfolio might have to bear the expense and incur
the delays associated with effecting a registration required in order to
qualify for resale.
WHEN-ISSUED SECURITIES
The Portfolio may purchase new issues of U.S. Government securities on a
"when-issued" basis.
"When-issued" refers to securities whose terms are available, and for which
a market exists, but which are not available for immediate delivery. When-
issued transaction may be expected to occur a month or more before delivery is
due.
The Portfolio may engage in when-issued transactions to obtain what is
considered to be an advantageous price and yield at the time of the
transaction. When the Portfolio engages in when-issued transactions, it will
do so for the purpose of acquiring securities consistent with its investment
objective and policies and not for the purpose of investment leverage.
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RISK FACTORS. At the time of settlement, the market value of the security may
be more or less than the purchase price. The Portfolio bears the risk of such
market value fluctuations. These transactions also involve risk to the
Portfolio if the other party to the transaction defaults on its obligation to
make payment or delivery, and the Portfolio is delayed or prevented from
completing the transaction.
FOREIGN SECURITIES
The Portfolio may invest up to 25% of net assets at the time of purchase in
the securities of foreign issuers and obligors. Investments may be made in both
domestic and foreign companies. Foreign securities include equity and debt
securities of foreign issuers.
If appropriate and available, the Sub-Adviser may purchase foreign securities
through dollar-denominated ADRs, EDRs, GDRs and other types of receipts or
shares evidencing ownership of the underlying foreign securities. While ADRs
are dollar-denominated receipts that are issued by domestic banks and traded in
the United States, EDRs are typically issued by European banks, and GDRs may be
issued by either domestic or foreign banks. In addition, the Portfolio may
invest indirectly in foreign securities through foreign investment funds or
trusts (including passive foreign investment companies).
RISK FACTORS. For U.S. investors, the returns on foreign securities are
influenced not only by the returns on the foreign investments themselves, but
also by several risks which include:
CURRENCY RISK. Changes in the value of the currencies in which the
securities are denominated relative to the U.S. dollar may affect the value
of foreign securities and the value of their dividend or interest payments
and, therefore, the Portfolio's share price and returns.
Generally, in a period when the U.S. dollar commonly rises against foreign
currencies, the return on foreign securities for a U.S. investor are
diminished. By contrast, in a period when the U.S. dollar generally
declines, the returns on foreign securities generally are enhanced.
Exchange rates are affected by numerous factors, including relative
interest rates, balances of trade, levels of foreign investment and
manipulation of central banks. The foreign currency market is essentially
unregulated and can be subject to speculative trading. From time to time,
many countries impose exchange controls which limit or prohibit trading in
certain currencies.
ADRs do not involve the same direct currency and liquidity risks as
securities denominated in foreign currencies. However, the value of the
currency in which the foreign security represented by the ADR is denominated
may affect the value of the ADR.
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To the extent that the Portfolio invests in foreign securities denominated
in foreign currencies, its share price reflects the price movements both of
its securities and of the currencies in which they are denominated. The
share price of the Portfolio that invests in both U.S. and foreign
securities may have a low correlation with movements in the U.S. markets. If
most of the securities in the Portfolio are denominated in foreign
currencies or depend on the value of foreign currencies, the relative
strength of the U.S. dollar against those foreign currencies may be an
important factor in the Portfolio's performance.
CURRENCY TRADING COSTS. The Portfolio incurs costs in converting foreign
currencies into U.S. dollars, and vice versa.
DIFFERENT ACCOUNTING AND REPORTING PRACTICES. Foreign companies are
generally subject to tax laws and to accounting, auditing and financial
reporting standards, practices and requirements different from those that
apply in the U.S.
LESS INFORMATION AVAILABLE. There is generally less public information
available about foreign companies.
MORE DIFFICULT BUSINESS NEGOTIATIONS. The Portfolio may find it difficult
to enforce obligations in foreign countries or to negotiate favorable
brokerage commission rates.
REDUCED LIQUIDITY/INCREASED VOLATILITY. Some foreign securities are less
liquid and their prices more volatile, than securities of comparable U.S.
companies.
SETTLEMENT DELAYS. Settling foreign securities may take longer than
settlements in the U.S.
HIGHER CUSTODY CHARGES. Custodianship of shares may cost more for foreign
securities than it does for U.S. securities.
ASSET VULNERABILITY. In some foreign countries, there is a risk of direct
seizure or appropriation through taxation of assets of the Portfolio.
Certain countries may also impose limits on the removal of securities or
other assets of the Portfolio. Interest, dividends and capital gains on
foreign securities held by the Portfolio may be subject to foreign
withholding taxes.
POLITICAL INSTABILITY. In some countries, political instability, war or
diplomatic developments could affect investments.
These risks may be greater in developing countries or in countries with
limited or developing markets. In particular, developing countries have
relatively unstable governments, economies based on only a few industries,
and securities markets that trade only a small number of securities. As a
result, securities of issuers located in developing countries may have
limited marketability and may be subject to abrupt or erratic price
fluctuations.
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At times, the Portfolio's foreign securities may be listed on exchanges or
traded in markets which are open on days (such as Saturday) when the Portfolio
does not compute a price or accept orders for purchase, sale or exchange of
shares. As a result, the net asset value of the Portfolio may be significantly
affected by trading on days when Contract Owners cannot make transactions.
ADRS are subject to some of the same risks as direct investments in foreign
securities, including the currency risk discussed above. The regulatory
requirements with respect to ADRs that are issued in sponsored and unsponsored
programs are generally similar but the issuers of unsponsored ADRs are not
obligated to disclose material information in the U.S., and, therefore, such
information may not be reflected in the market value of the ADRs.
MANAGEMENT OF THE FUND
Overall responsibility for management and supervision of the Fund rests with
the Fund's Board of Directors. There are currently five Directors, three of
whom are not "interested persons" of the Fund within the meaning of that term
under the 1940 Act. The Board meets regularly four times each year and at
other times as necessary. By virtue of the functions performed by WRL
Management as Investment Adviser and Janus Capital Corporation as Sub-Adviser,
the Fund requires no employees other than its executive officers, none of whom
devotes full time to the affairs of the Fund. These officers are employees of
WRL and receive no compensation from the Fund. The SAI contains the names of
and general background information regarding each Director and executive
officer of the Fund.
THE INVESTMENT ADVISER
WRL Management, located at 201 Highland Avenue, Largo, Florida 33770-2597,
serves as the Fund's Investment Adviser. The Investment Adviser is a direct,
wholly-owned subsidiary of WRL, which is a wholly-owned subsidiary of First
AUSA Life Insurance Company ("First AUSA"), a stock life insurance company
which is wholly-owned by AEGON USA, Inc. ("AEGON"). AEGON is a financial
services holding company whose primary emphasis is on life and health
insurance and annuity and investment products. AEGON is a wholly-owned
indirect subsidiary of AEGON nv, a Netherlands corporation, which is a
publicly traded international insurance group. The Investment Adviser has
served as the investment adviser to the Fund since January 1, 1997. Prior to
that date, WRL served as the investment adviser to the Fund.
Subject to the supervision and direction of the Fund's Board of Directors,
the Investment Adviser is responsible for managing the Portfolio in accordance
with the Portfolio's stated investment objective and policies. As compensation
for its services to the Portfolio, the Investment Adviser receives monthly
compensation at the annual rate of 0.80% of the average daily net assets of
the Portfolio. For the fiscal year ended December 31, 1996, the Fund paid the
Investment Adviser advisory fees of 0.80% of the average daily net assets of
the Portfolio.
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The Investment Adviser is responsible for furnishing continuous advice and
recommendations to the Portfolio as to the acquisition, holding or disposition
of any or all of the securities or other assets which the Portfolio may own or
contemplate acquiring from time to time; to cause the Fund's officers to
attend meetings and furnish oral or written reports, as the Fund may
reasonably require, in order to keep the Board of Directors and appropriate
officers of the Fund fully informed as to the conditions of the investment
portfolio of the Portfolio, the investment recommendations of the Investment
Adviser, and the investment considerations which have given rise to those
recommendations; to supervise the purchase and sale of securities of the
Portfolio as directed by the appropriate officers of the Fund; and to maintain
all books and records required to be maintained by the Investment Adviser
pursuant to the 1940 Act and the rules and regulations promulgated thereunder
with respect to transactions on behalf of the Fund.
The Investment Adviser has voluntarily undertaken, until at least April 30,
1998, to pay expenses on behalf of the Portfolio to the extent normal
operating expenses (including investment advisory fees but excluding interest,
taxes, brokerage fees, commissions and extraordinary charges) exceed, as a
percentage of the Portfolio's average daily net assets, 1.00%. For the fiscal
year ended December 31, 1996, the expenses of the Portfolio, as a percentage
of the Portfolio's average daily net assets, were 0.88%.
In addition to the Investment Adviser's responsibilities discussed above,
the Investment Adviser's advisory agreement with the Fund (the "Advisory
Agreement") contemplates that the Investment Adviser, in connection with the
performance of its responsibilities under the Advisory Agreement, will enter
into sub-advisory agreements ("Sub-Advisory-Agreements") with Sub-Advisers to
provide each Portfolio with portfolio management. Under current law, every
Sub-Advisory Agreement must be submitted to and approved by shareholders and
Contract Owners of a Portfolio before the Sub-Adviser can provide investment
advice to that Portfolio. For example, if a new Sub-Adviser were retained,
shareholders and Contract Owners would be required to approve the Sub-Advisory
agreement with that Sub-Adviser. Similarly, if a Sub-Advisory Agreement were
amended in any material respect, such amendment would generally be deemed to
result in a new contract for which shareholder and Contract Owner approval
would also be required. Moreover, in most instances when there is a change of
control of a Sub-Adviser, shareholder and Contract Owner approval is required.
The Fund's Board of Directors has determined that shareholders and Contract
Owners of each Portfolio have, in effect, elected to have the Investment
Adviser select one or more Sub-Advisers best suited to achieve the Portfolio's
investment objectives. The Board believes that part of a shareholder's and
Contract Owner's investment decision is a determination to have those
selections made by the Investment Adviser, a professional management
organization with personnel having substantial experience in making such
evaluations, selections and terminations.
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Under applicable law, the Fund is not generally required to hold annual
shareholders' meetings, and does not generally hold such meetings, unless
legally required to do so, in order to avoid the attendant costs. The Fund is
currently required to call a meeting of shareholders of a Portfolio whenever
it decides to employ new or additional Sub-Advisers, or to approve a new Sub-
Advisory Agreement after an "assignment," or due to a material change in Sub-
Advisory Agreement terms, with respect to such Portfolio. Given the nature of
the Fund's operations and shareholders' reasons for investing in various of
the Portfolios, such expenses are considered to provide little if any benefit
to shareholders. For these reasons, the Fund and the Investment Adviser have
applied to the SEC for an exemption from the provisions of the 1940 Act to
permit the Fund and the Investment Adviser, subject to certain conditions, to
enter into, materially amend, and terminate, and to permit Sub-Advisers to act
pursuant to, Sub-Advisory Agreements without shareholder or Contract Owner
approval (the "Proposed Sub-Advisory Arrangement").
If the SEC exemption is granted, certain conditions would apply. The
conditions are intended to ensure that shareholders and Contract Owners
receive adequate disclosure about the Sub-Advisers or a decision by the
Investment Adviser and the Fund's Board of Directors to appoint a new Sub-
Adviser or to change materially the terms of a Sub-Advisory Agreement. In
addition, before a Portfolio could rely on the exemption, the Proposed Sub-
Advisory Arrangement must be approved by a majority of the outstanding voting
securities of the Portfolio.
DISTRIBUTION AND SERVICE PLANS
DISTRIBUTION PLAN AND DISTRIBUTION AGREEMENT. Effective January 1, 1997, the
Fund adopted a Plan of Distribution pursuant to Rule 12b-1 under the 1940 Act
("Distribution Plan") and pursuant to the Plan, has entered into a
Distribution Agreement with InterSecurities, Inc. ("ISI"), whose principal
office is located at 201 Highland Avenue, Largo, Florida 33770-2597. ISI is an
affiliate of the Investment Adviser, and serves as principal underwriter for
the Fund.
The expenses the Fund may pay pursuant to the Distribution Plan may include,
but are not necessarily limited to, the following: cost of printing and
mailing Fund prospectuses and statements of additional information, and any
supplements thereto to prospective Contract Owners; costs relating to
development and preparation of Fund advertisements, sales literature and
brokers' and other promotional materials describing and/or relating to the
Fund; expenses in connection with presentation of seminars and sales meetings
describing the Fund; development of consumer-oriented sales materials
describing the Fund; and expenses attributable to "distribution-related
services" provided to the Fund (e.g., salaries and benefits, office expenses,
equipment (i.e., computers, software, office equipment, etc.), training
expenses, travel
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costs, printing costs, supply expenses, programming time and data center
expenses, each as they relate to the promotion of the sale of Fund shares).
Under the Distribution Plan, the Fund, on behalf of the Portfolio, is
authorized to pay to various service providers, as direct payment for expenses
incurred in connection with the distribution of the Portfolio's shares,
amounts equal to actual expenses associated with distributing the Portfolio's
shares, up to a maximum rate of 0.15% on an annualized basis of the average
daily net assets. This fee is measured and accrued daily and paid monthly.
ISI will submit to the Fund's Board of Directors for approval annual
distribution expenses with respect to the Portfolio. ISI allocates to the
Portfolio distribution expenses specifically attributable to the distribution
of shares of the Portfolio. Distribution expenses not specifically
attributable to the distribution of shares of the Portfolio are allocated
among the other Portfolios of the Fund, based upon the ratio of net asset
value of each Portfolio to the net asset value of all Portfolios, or such
other factors as ISI deems fair and are approved by the Fund's Board. ISI has
determined that it will not seek payment by the Fund of distribution expenses
with respect to the Portfolio during the fiscal year ending December 31, 1997.
Prior to ISI seeking reimbursement, Contract Owners will be notified in
advance.
ADMINISTRATIVE AND TRANSFER AGENCY SERVICES. Effective January 1, 1997, the
Fund entered into an Administrative Services and Transfer Agency Agreement
with WRL Investment Services, Inc. ("WRL Services"), located at 201 Highland
Avenue, Largo, Florida 33770-2597, an affiliate of WRL Management and WRL, to
furnish the Fund with administrative services to assist the Fund in carrying
out certain of its functions and operations. Under this Agreement, WRL
Services shall furnish to the Portfolio, subject to the overall supervision of
the Board of Directors, supervisory, administrative, and transfer agency
services, including recordkeeping and reporting. WRL Services is reimbursed by
the Fund monthly on a cost incurred basis. Prior to January 1, 1997, WRL
performed these services in connection with its serving as the Fund's
investment adviser.
THE SUB-ADVISER
Janus Capital Corporation, located at 100 Fillmore Street, Denver, Colorado
80206, serves as the Sub-Adviser to the Portfolio. Thomas H. Bailey is the
President of Janus Capital Corporation. Kansas City Southern Industries, Inc.
("KCSI") owns 83% of the Sub-Adviser. The Sub-Adviser provides investment
management and related services to other mutual funds, and individual,
corporate, charitable and retirement accounts. See "Management of the Fund--
The Sub-Adviser" in the SAI for a more detailed description of the previous
experience of Janus Capital Corporation as an investment adviser.
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Scott W. Schoelzel has served as the portfolio manager for the Portfolio
since January 2, 1996. Mr. Schoelzel also serves as co-portfolio manager of
other mutual funds. Mr. Schoelzel is a Vice president of the Sub-Adviser,
where he has been employed since 1994. From 1991 to 1993, Mr. Schoelzel was a
portfolio manager with Founders Asset Management, Denver, Colorado.
The Sub-Adviser provides investment advisory assistance and portfolio
management advice to the Investment Adviser for the Portfolio. Subject to
review and supervision by the Investment Adviser and the Board of Directors of
the Fund, the Sub-Adviser is responsible for the actual management of the
Portfolio and for making decisions to buy, sell or hold any particular
security, and it places orders to buy or sell securities on behalf of the
Portfolio. The Sub-Adviser bears all of its expenses in connection with the
performance of its services, such as compensating and furnishing office space
for its officers and employees connected with investment and economic
research, trading and investment management of the Portfolio.
For its services, the Sub-Adviser receives monthly compensation from the
Investment Adviser at the annual rate of 0.40% of the average daily net assets
of the Portfolio.
The Sub-Adviser is also responsible for selecting the broker-dealers who
execute the portfolio transactions for the Portfolio. The Sub-Adviser is
authorized to consider sales of the Annuity Contracts described in the
accompanying prospectus by a broker-dealer as a factor in the selection of
broker-dealers to execute portfolio transactions. In placing portfolio
business with all dealers, the Sub-Adviser seeks best execution of each
transaction and all brokerage placement must be consistent with the Rules of
Fair Practice of the National Association of Securities Dealers, Inc. In
addition, the Sub-Adviser may occasionally place portfolio business with
broker-dealers affiliated with the Investment Adviser or the Sub-Adviser; in
such event, the Sub-Adviser always will seek best execution.
OTHER INFORMATION
JOINT TRADING ACCOUNTS
Subject to approval by the Fund's Board of Directors, the Portfolio may
transfer uninvested cash balances on a daily basis into certain joint trading
accounts. Assets in the joint trading accounts are invested in money market
instruments. All other participants in the joint trading accounts will be
registered mutual funds or other clients of the Sub-Adviser or its affiliates.
The Portfolio will participate in the joint trading accounts only to the
extent that the investments of the joint trading accounts are consistent with
the Portfolio's investment policies and restrictions. The Sub-Adviser
anticipates that the investments made by the Portfolio through the joint
trading accounts will be at least as advantageous to the Portfolio as if the
Portfolio had made such investment directly. (See "The Sub-Adviser" in the
SAI.)
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PERSONAL SECURITIES TRANSACTIONS
The Fund permits "Access Persons" as defined by Rule 17j-1 under the 1940
Act to engage in personal securities transactions, subject to the terms of the
Code of Ethics and Insider Trading Policy ("Ethics Policy") that has been
adopted by the Board of Directors of the Fund. Access Persons are required to
follow the guidelines established by this Ethics Policy in connection with all
personal securities transactions and are subject to certain prohibitions on
personal trading. The Fund's Sub-Advisers, pursuant to Rule 17j-1 and other
applicable laws, and pursuant to the terms of the Ethics Policy, must adopt
and enforce their own Code of Ethics and Insider Trading Policies appropriate
to their operations. Each Sub-Adviser is required to report to the Board of
Directors on a quarterly basis with respect to the administration and
enforcement of such Ethics Policy, including any violations thereof which may
potentially affect the Fund.
PURCHASE AND REDEMPTION OF SHARES
Shares of the Portfolio are sold and redeemed at their net asset value next
determined after receipt of a purchase order or notice of redemption in proper
form. Shares are sold and redeemed without the imposition of any sales
commission or redemption charge. However, certain sales and other charges may
apply to the Contract. Such charges are described in the prospectus for the
Contract.
VALUATION OF SHARES
The Portfolio's net asset value per share is ordinarily determined, once
daily, as of the close of the regular session of business on the New York
Stock Exchange ("Exchange") (usually 4:00 p.m., Eastern time), on each day the
Exchange is open.
Net asset value of a Portfolio share is computed by dividing the value of
the net assets of the Portfolio by the total number of shares outstanding in
the Portfolio.
Except for money market instruments maturing in 60 days or less, securities
held by the Portfolio are valued at market value. Securities for which market
values are not readily available are valued at fair value as determined in
good faith by the Advisers under the supervision of the Fund's Board of
Directors. Money market instruments maturing in 60 days or less are valued on
the amortized cost basis. (See the SAI for details.)
THE FUND AND ITS SHARES
The Fund was incorporated under the laws of the State of Maryland on August
21, 1985 and is registered with the SEC as a diversified, open-end, management
investment company.
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<PAGE>
The Portfolio offers its shares only for purchase by the Separate Accounts
of the Life Companies to fund benefits under variable life insurance or
variable annuity contracts issued by the Life Companies. Shares may be offered
to other life insurance companies in the future. Because the Portfolio's
shares are sold to the Separate Accounts established to receive and invest
premiums received under variable life insurance policies and purchase payments
received under the variable annuity contracts, it is conceivable that, in the
future, it may become disadvantageous for variable life insurance Separate
Accounts and variable annuity Separate Accounts to invest in the Portfolio
simultaneously. Neither the Life Companies nor the Fund currently foresees any
such disadvantages or conflicts, either to variable life insurance
policyowners or to variable annuity contract owners. After being notified by
one or more of the Life Companies of a potential or existing conflict, the
Fund's Board of Directors will determine if a material conflict exists and
what action, if any, should be taken in response thereto. Such action could
include the sale of Portfolio shares by one or more of the Separate Accounts,
which could have adverse consequences. Material conflicts could result from,
for example, (1) changes in state insurance laws, (2) changes in Federal
income tax laws, or (3) differences in voting instructions between those given
by variable life insurance policyowners and those given by variable annuity
contract owners. If the Board of Directors were to conclude that separate
funds should be established for variable life and variable annuity separate
accounts, the affected Life Companies will bear the attendant expenses, but
variable life insurance policyowners and variable annuity contract owners
would no longer have the economies of scale typically resulting from a larger
combined fund.
The Fund offers a separate class of common stock for each portfolio. All
shares of the Portfolio and of each of the other portfolios of the Fund have
equal voting rights, except that only shares of a particular portfolio will be
entitled to vote on matters concerning only that portfolio. Each issued and
outstanding share of the Portfolio is entitled to one vote and to participate
equally in dividends and distributions declared by the Portfolio and, upon any
liquidation or dissolution, to participate equally in the net assets of the
Portfolio remaining after satisfaction of outstanding liabilities. The shares
of the Portfolio, when issued, will be fully paid and nonassessable, have no
preference, preemptive, conversion, exchange or similar rights, and will be
freely transferable. Shares do not have cumulative voting rights and the
holders of more than 50% of the shares of the Fund voting for the election of
directors can elect all of the directors of the Fund if they choose to do so,
and in such event holders of the remaining shares would not be able to elect
any directors.
Only the Separate Accounts of the Life Companies may hold shares of the
Portfolio and are entitled to exercise the rights directly as described above.
If and to the extent required by law, Life Companies will vote the Portfolio's
shares held in the Separate Accounts, including
20
<PAGE>
the Portfolio's shares which are not attributable to Contract Owners, at
meetings of the Fund in accordance with instructions received from persons
having voting interests in the corresponding sub-accounts of the Separate
Accounts. Except as required by the 1940 Act, the Fund does not hold regular
or special shareholder meetings. If the 1940 Act or any regulation thereunder
should be amended, or if present interpretation thereof should change, and as
a result it is determined that the Life Companies are permitted to vote the
Portfolio's shares in their own right, they may elect to do so. The rights of
Contract Owners are described in more detail in the prospectuses or disclosure
documents for the Annuity Contracts.
REPORTS TO CONTRACT OWNERS
The fiscal year of the Portfolio ends on December 31 of each year. The Fund
will send to the Portfolio's Contract Owners, at least semi-annually, reports
showing the Portfolio's composition and other information. An annual report,
containing financial statements, audited by the Fund's independent
accountants, will be sent to Contract Owners each year.
CUSTODIAN AND DIVIDEND DISBURSING AGENT
Investors Bank & Trust Company, 89 South Street, Boston, MA 02111, acts as
Custodian and Dividend Disbursing Agent of the Portfolio's assets.
ADDITIONAL INFORMATION
The telephone number or the address of the Fund appearing on the first page
of this Prospectus should be used for requests for additional information.
DISTRIBUTION AND TAXES
DIVIDENDS AND DISTRIBUTIONS
The Portfolio intends to distribute substantially all of the net investment
income, if any. Dividends from investment income, if any, of the Portfolio
normally are declared and paid semi-annually in additional shares of the
Portfolio at net asset value. Distributions of net realized capital gains from
security transactions and net gains from foreign currency transactions, if
any, normally are declared and paid in additional shares of the Portfolio at
the end of the fiscal year.
TAXES
The Portfolio has qualified and expects to continue to qualify as a
regulated investment company under Subchapter M of the Internal Revenue Code
of 1986, as amended ("Code"). As such, the Portfolio is not subject to Federal
income tax on that part of its investment company taxable income (consisting
generally of net investment income, net gains from certain foreign currency
transactions, and net short-term capital
21
<PAGE>
gain, if any) and any net capital gain (the excess of net long-term capital
gain over net short-term capital loss) that it distributes to its
shareholders. It is the Portfolio's intention to distribute all such income
and gains.
Shares of the Portfolio are offered only to the Separate Accounts (which are
insurance company separate accounts that fund the Contract). Under the Code,
no tax is imposed on an insurance company with respect to income of a
qualifying separate account properly allocable to the value of eligible
variable annuity or variable life insurance contracts. For a discussion of the
taxation of life insurance companies and the Separate Account, as well as the
tax treatment of the Contract and the Contract Owners thereof, see "Certain
Federal Income Tax Consequences" included in the prospectus for the Contract.
The Portfolio intends to comply with the diversification requirements
imposed by section 817(h) of the Code and the regulations thereunder. These
requirements are in addition to the diversification requirements imposed on
the Portfolio by Subchapter M and the 1940 Act. These requirements place
certain limitations on the assets of each separate account that may be
invested in securities of a single issuer, and, because section 817(h) and the
regulations thereunder treat the Portfolio's assets as assets of the related
Separate Accounts, these limitations also apply to the Portfolio's assets that
may be invested in securities of a single issuer. Specifically, the
regulations provide that, except as permitted by the "safe harbor" described
below, as of the end of each calendar quarter or within 30 days thereafter no
more than 55% of the Portfolio's total assets may be represented by any one
investment, no more than 70% by any two investments, no more than 80% by any
three investments, and no more than 90% by any four investments.
Section 817(h) provides, as a safe harbor, that a separate account will be
treated as being adequately diversified if the diversification requirements
under Subchapter M are satisfied and no more than 55% of the value of the
account's total assets are cash and cash items, government securities, and
securities of other regulated investment companies. For purposes of section
817(h), all securities of the same issuer, all interests in the same real
property project, and all interests in the same commodity are treated as a
single investment. In addition, each U.S. Government agency or instrumentality
is treated as a separate issuer, while the securities of a particular foreign
government and its agencies, instrumentalities, and political subdivisions
will be considered securities issued by the same issuer. Failure of the
Portfolio to satisfy the section 817(h) requirements would result in taxation
of the Separate Accounts, the insurance companies, the Contract, and tax
consequences to the Contract Owners thereof, other than as described in the
prospectus for the Contract.
The foregoing is only a summary of some of the important Federal income tax
considerations generally affecting the Portfolio and its Contract Owners; see
the SAI for a more detailed discussion. Prospective Contract Owners are urged
to consult their tax advisors.
22
<PAGE>
WRL SERIES FUND, INC.
GROWTH PORTFOLIO
201 HIGHLAND AVENUE
LARGO, FLORIDA 33770-2597
TELEPHONE (319) 398-8511
INVESTMENT ADVISER:
WRL Investment Management, Inc. 201 Highland Avenue Largo, FL 33770-2597
SUB-ADVISER:
Janus Capital Corporation 100 Fillmore Street Denver, CO 80206
CUSTODIAN:
Investors Bank & Trust Company 89 South Street Boston, MA 02111
INDEPENDENT ACCOUNTANTS:
Price Waterhouse LLP 1055 Broadway Kansas City, MO 64105
TRANSFER AGENT:
WRL Investment Services, Inc. 201 Highland Avenue Largo, FL 33770-2597
DISTRIBUTOR:
InterSecurities, Inc. 201 Highland Avenue Largo, FL 33770-2597
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REP-
RESENTATION NOT CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH IN-
FORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHO-
RIZED. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFERING OF ANY SECURITIES
OTHER THAN THE REGISTERED SECURITIES TO WHICH IT RELATES OR AN OFFER TO ANY
PERSON IN ANY STATE OR JURISDICTION OF THE UNITED STATES OR ANY COUNTRY
WHERE SUCH OFFER WOULD BE UNLAWFUL.
23
<PAGE>
PROSPECTUS
APRIL 25, 1997
Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 . Phone No. (609) 282-2800
----------------
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company which has a wide range of investment objectives
among its sixteen separate funds. Those offered pursuant to this Prospectus
are hereinafter referred to as the "Funds" or individually as a "Fund". A
separate class of common stock ("Common Stock") is issued for each Fund. The
Company is offering shares of its Class A Common Stock pursuant to this
Prospectus.
The shares of the Funds are sold to separate accounts ("Separate Accounts")
of certain insurance companies (the "Insurance Companies") to fund benefits
under variable annuity contracts ("Variable Annuity Contracts") and/or
variable life insurance contracts (together with the Variable Annuity
Contracts, the "Contracts") issued by such companies. The Insurance Companies
will redeem shares to the extent necessary to provide benefits under the
respective Contracts or for such other purposes as may be consistent with the
respective Contracts. Certain Insurance Companies are wholly owned
subsidiaries of Merrill Lynch & Co., Inc., as is the Company's investment
adviser, Merrill Lynch Asset Management, L.P. (the "Investment Adviser"). The
investment objectives and certain investment policies of the Funds, each of
whose name is preceded by "Merrill Lynch," are as follows:
BASIC VALUE FOCUS FUND. Capital appreciation and, secondarily, income by
investing in securities, primarily equities, that management of the Fund
believes are undervalued and therefore represent basic investment value.
DEVELOPING CAPITAL MARKETS FOCUS FUND. Long-term capital appreciation by
investing in securities, principally equities, of issuers in countries
having smaller capital markets.
HIGH CURRENT INCOME FUND. As high a level of current income as is
consistent with its investment policies and prudent investment management,
and as a secondary objective, capital appreciation when consistent with the
foregoing objective. The Fund invests principally in fixed-income
securities that are rated in the lower rating categories of the established
rating services or in unrated securities of comparable quality.
THE HIGH CURRENT INCOME FUND AND DEVELOPING CAPITAL MARKETS FOCUS FUND
INVEST OR MAY INVEST IN HIGH YIELD BONDS (COMMONLY KNOWN AS "JUNK BONDS"),
WHICH INVOLVE SPECIAL RISKS. SEE "INVESTMENT OBJECTIVES AND POLICIES OF THE
FUNDS--RISKS OF HIGH YIELD SECURITIES."
----------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED
UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO
THE CONTRARY IS A CRIMINAL OFFENSE.
----------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE COMPANY
THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION IN A STATEMENT OF ADDITIONAL
INFORMATION, DATED APRIL 25, 1997, AND IS AVAILABLE ON REQUEST AND WITHOUT
CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE NUMBER
SET FORTH ABOVE. THE STATEMENT OF ADDITIONAL INFORMATION IS HEREBY
INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
----------------
Merrill Lynch Asset Management--Investment Adviser
Merrill Lynch Funds Distributor, Inc.-- Distributor
<PAGE>
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE FUND OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE FUND OR BY THE DISTRIBUTOR IN ANY STATE
IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
----------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Financial Highlights....................................................... 3
The Insurance Companies.................................................... 5
Investment Objectives and Policies of the Funds............................ 5
Directors.................................................................. 15
Investment Adviser......................................................... 15
Portfolio Transactions and Brokerage....................................... 17
Purchase of Shares......................................................... 17
Redemption of Shares....................................................... 17
Dividends, Distributions and Taxes......................................... 17
Performance Data........................................................... 18
Additional Information..................................................... 19
Appendix A................................................................. A-1
Appendix B................................................................. B-1
</TABLE>
2
<PAGE>
FINANCIAL HIGHLIGHTS
The financial information in the tables below has been audited in
conjunction with annual audits of the financial statements of each of the
Company's Funds by Deloitte & Touche LLP, independent auditors. Financial
Statements and the independent auditors' report thereon for the fiscal year
ended December 31, 1996 are included in the Statement of Additional
Information. The following per share data and ratios have been derived from
information provided in the Company's audited financial statements. Further
information about the performance of the Company is contained in the Company's
most recent annual report to shareholders which may be obtained, without
charge, by calling or by writing the Company at the telephone number or
address on the front cover of this prospectus.
<TABLE>
<CAPTION>
DEVELOPING CAPITAL MARKETS
BASIC VALUE FOCUS FUND FOCUS FUND
--------------------------------------------- ---------------------------------
FOR THE YEAR FOR THE
FOR THE YEAR ENDED FOR THE PERIOD ENDED PERIOD MAY 2,
DECEMBER 31, JULY 1, 1993+ DECEMBER 31, 1994+ TO
---------------------------- TO DECEMBER 31, ------------------ DECEMBER 31,
1996 1995 1994 1993 1996 1995 1994
-------- -------- -------- --------------- ------- ------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
INCREASE (DECREASE) IN
NET ASSET VALUE:
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of year...... $ 13.10 $ 11.10 $ 10.95 $ 10.00 $ 9.32 $ 9.51 $ 10.00
-------- -------- -------- ------- ------- ------- -------
Investment income--net.. .17 .18 .17 .04 .20 .20 .09
Realized and unrealized
gain (loss) on
investments and foreign
currency transactions--
net.................... 2.37 2.49 .08 .91 .76 (.30) (.58)
-------- -------- -------- ------- ------- ------- -------
Total from investment
operations............. 2.54 2.67 .25 .95 .96 (.10) (.49)
-------- -------- -------- ------- ------- ------- -------
Less dividends and
distributions:
Investment income--net.. (.18) (.19) (.10) -- (.23) (.09) --
Realized gain on
investments--net....... (.72) (.48) -- -- -- -- --
-------- -------- -------- ------- ------- ------- -------
Total dividends and
distributions.......... (.90) (.67) (.10) -- (.23) (.09) --
-------- -------- -------- ------- ------- ------- -------
Net asset value, end of
year................... $ 14.74 $ 13.10 $ 11.10 $ 10.95 $ 10.05 $ 9.32 $ 9.51
======== ======== ======== ======= ======= ======= =======
Total Investment
Return:**
Based on net asset value
per share.............. 20.69% 25.49% 2.36% 9.50%# 10.59% (1.08)% (4.90)%#
======== ======== ======== ======= ======= ======= =======
RATIOS TO AVERAGE NET
ASSETS:
Expenses, net of
reimbursement.......... .66% .72% .86%* 1.25% 1.25% 1.29%*
======== ======== ======== ======= ======= ======= =======
Expenses................ .66% .66% .72% .86%* 1.31% 1.36% 1.35%*
======== ======== ======== ======= ======= ======= =======
Investment income--net.. 1.37% 1.68% 2.08% 1.69%* 2.42% 2.73% 2.18%*
======== ======== ======== ======= ======= ======= =======
SUPPLEMENTAL DATA:
Net assets, end of year
(in thousands)......... $524,930 $306,463 $164,307 $47,207 $95,599 $55,209 $36,676
======== ======== ======== ======= ======= ======= =======
Portfolio turnover...... 68.41% 74.10% 60.55% 30.86% 87.33% 62.53% 29.79%
======== ======== ======== ======= ======= ======= =======
Average commission rate
paid##................. $ .0549 -- -- -- $ .0003### -- --
======== ======== ======== ======= ======= ======= =======
</TABLE>
- --------
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of Operations.
# Aggregate total investment return.
## For fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases
and sales of equity securities.
### The "Average Commission Rate Paid" includes commissions paid in foreign
currencies, which have been converted into U.S. dollars using the
prevailing exchange rate on the date of the transaction. Such conversions
may significantly affect the average rate shown.
3
<PAGE>
FINANCIAL HIGHLIGHTS (CONCLUDED)
<TABLE>
<CAPTION>
HIGH CURRENT INCOME FUND
------------------------------------------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------------------------
1996+ 1995 1994 1993 1992 1991 1990 1989 1988 1987
-------- -------- -------- -------- ------- ------ ------ ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INCREASE (DECREASE) IN
NET ASSET VALUE:
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of year...... $ 11.25 $ 10.61 $ 12.06 $ 11.13 $ 10.23 $ 8.14 $10.21 $ 10.85 $ 10.55 $ 11.42
-------- -------- -------- -------- ------- ------ ------ ------- ------- -------
Investment income--net.. 1.08 1.09 1.05 .95 1.07 1.19 1.40 1.29 1.21 1.23
Realized and unrealized
gain (loss) on
investments--net....... .12 .65 (1.47) .95 .90 2.10 (2.08) (.64) .20 (.79)
-------- -------- -------- -------- ------- ------ ------ ------- ------- -------
Total from investment
operations............. 1.20 1.74 (.42) 1.90 1.97 3.29 (.68) .65 1.41 .44
-------- -------- -------- -------- ------- ------ ------ ------- ------- -------
Less dividends and
distributions:
Investment income--
net................... (1.06) (1.10) (1.03) (.97) (1.07) (1.20) (1.39) (1.29) (1.11) (1.23)
Realized gain on
investments--net...... -- -- -- -- -- -- -- -- -- (.08)
-------- -------- -------- -------- ------- ------ ------ ------- ------- -------
Total dividends and
distributions.......... (1.06) (1.10) (1.03) (.97) (1.07) (1.20) (1.39) (1.29) (1.11) (1.31)
-------- -------- -------- -------- ------- ------ ------ ------- ------- -------
Net asset value, end of
year................... $ 11.39 $ 11.25 $ 10.61 $ 12.06 $ 11.13 $10.23 $ 8.14 $ 10.21 $ 10.85 $ 10.55
======== ======== ======== ======== ======= ====== ====== ======= ======= =======
TOTAL INVESTMENT RE-
TURN:*
Based on net asset value
per share.............. 11.27% 17.21% (3.59)% 17.84% 20.05% 43.00% (7.63)% 6.14% 13.87% 3.82%
======== ======== ======== ======== ======= ====== ====== ======= ======= =======
RATIOS TO AVERAGE NET
ASSETS:
Expenses................ .54% .55% .61% .72% .89% 1.10% 1.15% 1.22% 1.07% 1.01%
======== ======== ======== ======== ======= ====== ====== ======= ======= =======
Investment income--net.. 9.50% 9.92% 9.73% 8.62% 10.06% 12.49% 14.52% 11.98% 11.22% 10.88%
======== ======== ======== ======== ======= ====== ====== ======= ======= =======
SUPPLEMENTAL DATA:
Net assets, end of year
(in thousands)......... $414,615 $356,352 $255,719 $163,428 $26,343 $9,649 $8,106 $12,942 $13,960 $13,075
======== ======== ======== ======== ======= ====== ====== ======= ======= =======
Portfolio turnover...... 48.92% 41.60% 51.88% 35.67% 28.21% 51.54% 26.43% 53.52% 33.91% 56.07%
======== ======== ======== ======== ======= ====== ====== ======= ======= =======
</TABLE>
- -------------------------
* Total investment returns exclude insurance-related fees and expenses.
+ Based on average shares outstanding during the year.
4
<PAGE>
THE INSURANCE COMPANIES
The Company was organized to fund benefits under Contracts issued by Family
Life Insurance Company ("Family Life"), formerly a wholly owned subsidiary of
Merrill Lynch & Co., Inc. ("ML&Co."). On June 12, 1991, Family Life was sold
to a non-affiliated corporation and most (although not all) of its Contracts
were transferred to Merrill Lynch Life Insurance Company ("MLLIC") and ML Life
Insurance Company of New York ("ML of New York"). Shares of the Funds
currently are sold to Separate Accounts of Family Life, MLLIC and ML of New
York as well as other insurance companies not affiliated with Family Life,
MLLIC or ML of New York (together with MLLIC, ML of New York and Family Life,
"Insurance Companies") to fund certain variable life insurance contracts
and/or variable annuities issued by such companies.
The rights of the Insurance Companies as shareholders should be
distinguished from the rights of a Contract owner, which are set forth in the
Contract. A Contract owner has no interest in the shares of a Fund, but only
in the Contract. The Contract is described in the Prospectus for each
Contract. That Prospectus describes the relationship between increases or
decreases in the net asset value of shares of a Fund, and any distributions on
such shares, and the benefits provided under a Contract. The Prospectus for
the Contracts also describes various fees payable to the Insurance Companies
and charges to the Separate Accounts made by the Insurance Companies with
respect to the Contracts. Since shares of the Funds will be sold only to the
Insurance Companies for the Separate Accounts, the terms "shareholder" and
"shareholders" in this Prospectus refer to the Insurance Companies. MLLIC and
ML of New York are wholly owned subsidiaries of ML&Co., as is the Investment
Adviser.
INVESTMENT OBJECTIVES AND POLICIES OF THE FUNDS
INVESTMENT OBJECTIVES
Each Fund of the Company has a different investment objective, which it
pursues through separate investment policies as described below. The
differences in objectives and policies among the Funds can be expected to
affect the return of each Fund and the degree of market and financial risk to
which each Fund is subject. Each Fund is classified as "diversified," as
defined in the Investment Company Act of 1940, as amended (the "Investment
Company Act" or the "Act"), except for the Developing Capital Markets Focus
Fund, which is classified as "non-diversified." The investment objectives and
classification of each Fund may not be changed without the approval of the
holders of a majority of the outstanding shares of each Fund affected. The
investment objectives and policies of each Fund are discussed below. There can
be no assurance that any Fund will achieve its investment objective.
Fixed Income Security Ratings. No Fund other than the High Current Income
Fund and Developing Capital Markets Focus Fund invests in fixed-income
securities which are rated below investment grade (i.e., securities rated Ba
or below by Moody's or BB or below by Standard & Poor's). However, securities
purchased by a Fund may subsequently be downgraded. Such securities may
continue to be held and will be sold only if, in the judgement of the
Investment Adviser, it is advantageous to do so. Securities in the lowest
category of investment grade debt securities may have speculative
characteristics which may lead to weakened capacity to pay interest and
principal during periods of adverse economic conditions. See Appendix A for a
fuller description of corporate bond ratings.
HIGH CURRENT INCOME FUND
The primary investment objective of the High Current Income Fund, like the
Prime Bond Fund, is to obtain the highest level of current income that is
consistent with the investment policies of the Fund and with prudent
investment management. As a secondary objective, the Fund seeks capital
appreciation when consistent with its primary objective. There can be no
assurance that the Fund's investment objectives will be achieved.
The High Current Income Fund seeks high current income by investing
principally in fixed-income securities that are rated in the lower rating
categories of the established rating services (Baa or lower by Moody's and BBB
or lower by Standard & Poor's), or in unrated securities of comparable
quality. Securities rated below Baa by Moody's and below BBB by Standard &
Poor's are commonly known as "junk bonds." Additional
5
<PAGE>
information regarding various bond ratings is set forth in Appendix A to the
Prospectus. The market price of fixed-income securities such as those
purchased by the Fund is affected by changes in interest rates generally. As
interest rates rise, the market value of fixed-income securities will fall,
adversely affecting the net asset value of the Fund.
Although they can be expected to provide higher yields, lower-rated
securities such as those purchased by the Fund may be subject to greater
market fluctuations and risks of loss of income and principal than lower-
yielding, higher-rated fixed-income securities. Such securities are generally
issued by corporations which are not as financially secure or as creditworthy
as issuers of higher-rated securities. There is, accordingly, a greater risk
that the issuers of higher-yielding securities will not be able to pay
principal and interest on such securities, especially during periods of
adverse economic conditions. Because investment in such high-yield securities
entails relatively greater risk of loss of income or principal, an investment
in the High Current Income Fund may not be appropriate as the exclusive
investment to fund the Contracts for all Contract Owners. See "Risks of High
Yield Securities."
Selection and supervision by the management of the Company of investments in
lower-rated fixed-income securities involves continuous analysis of individual
issuers, general business conditions and other factors which may be too time
consuming or too costly for the average investor. The furnishing of these
services does not, of course, guarantee successful results. The analysis of
issuers may include, among other things, historic and current financial
condition, current and anticipated cash flow and borrowing requirements, value
of assets in relation to historical cost, strength of management,
responsiveness to business conditions, credit standing, and current and
anticipated results of operations. Analysis of general business conditions and
other factors may include anticipated changes in economic activity and
interest rates, the availability of new investment opportunities, and the
economic outlook for specific industries. While the Investment Adviser
considers as one factor in its credit analysis the ratings assigned by the
rating services, the Investment Adviser performs its own independent credit
analysis of issuers and consequently, the Fund may invest, without limit, in
unrated securities if such securities offer, in the opinion of the Investment
Adviser, a relatively high yield without undue risk. As a result, the High
Current Income Fund's ability to achieve its investment objective may depend
to a greater extent on the Investment Adviser's own credit analysis than the
Funds which invest in higher-rated securities. Although the High Current
Income Fund will invest primarily in lower-rated securities, it will not
invest in securities rated Ca or lower by Moody's and CC or lower by Standard
& Poor's unless the Investment Adviser believes that the financial condition
of the issuer or the protection afforded to the particular securities is
stronger than would otherwise be indicated by such low ratings. However,
securities purchased by the Fund may subsequently be downgraded. Such
securities may continue to be held and will be sold only if, in the judgement
of the Investment Adviser, it is advantageous to do so.
When changing economic conditions and other factors cause the yield
difference between lower-rated and higher-rated securities to narrow, the Fund
may purchase higher-rated securities if the Investment Adviser believes that
the risk of loss of income and principal may be substantially reduced with
only a relatively small reduction in yield.
The securities in the Fund will be varied from time to time depending upon
the judgement of management as to prevailing conditions in the economy and the
securities markets and the prospects for interest rate changes among different
categories of fixed-income securities. It is anticipated that under normal
circumstances more than 90% of the Fund's assets will be invested in fixed-
income securities, including convertible and non-convertible debt securities
and preferred stock. Although it is expected that, in general, the Fund will
not invest in common stocks, rights or other equity securities, it will
acquire or hold such securities (if consistent with the objectives of the
Fund) when such securities are acquired in unit offerings with fixed-income
securities or in connection with an actual or proposed conversion or exchange
of fixed-income securities. In addition, under unusual market or economic
conditions, the High Current Income Fund for defensive purposes may invest up
to 100% of its assets in U.S. Government or Government agency securities,
money market securities or other fixed-income securities deemed by the
Investment Adviser to be consistent with a defensive posture, or may hold its
assets in cash. The yield on such securities may be lower than the yield on
lower-rated fixed-income securities.
6
<PAGE>
The table below shows the average monthly dollar-weighted market value, by
Standard & Poor's rating category, of the securities held by the High Current
Income Fund during the year ended December 31, 1996.
<TABLE>
<CAPTION>
% MARKET
% VALUE
NET CORPORATE
RATING* ASSETS BONDS
------- ------ ---------
<S> <C> <C>
BBB................................................... 0.7% 0.8%
BB.................................................... 29.2 33.8
B..................................................... 47.5 55.2
CCC................................................... 4.2 4.7
NR**.................................................. 5.0 5.5
-----
100.0%
=====
</TABLE>
- --------
* A description of corporate bond ratings of Standard & Poor's is set forth
in Appendix A to the Prospectus.
** Bonds which are not rated by Standard & Poor's. Such bonds may be rated by
nationally recognized statistical rating organizations other than Standard
& Poor's, or may not be rated by any other organizations.
BASIC VALUE FOCUS FUND
The investment objective of the Basic Value Focus Fund is to seek capital
appreciation and, secondarily, income by investing in securities, primarily
equities, that management of the Fund believes are undervalued and therefore
represent basic investment value. There can be no assurance that the Fund's
investment objectives will be achieved. The Fund seeks special opportunities
in securities that are selling at a discount, either from book value or
historical price-earnings ratios, or seem capable of recovering from
temporarily out of favor considerations. Particular emphasis is placed on
securities which provide an above-average dividend return and sell at a below-
average price-earnings ratio.
The investment policy of the Basic Value Focus Fund is based on the belief
that the pricing mechanism of the securities market lacks total efficiency and
has a tendency to inflate prices of securities in favorable market climates
and depress prices of securities in unfavorable climates. Based on this
premise, management believes that favorable changes in market prices are more
likely to begin when securities are out of favor, earnings are depressed,
price-earnings ratios are relatively low, investment expectations are limited,
and there is no real general interest in the particular security or industry
involved. On the other hand, management believes that negative developments
are more likely to occur when investment expectations are generally high,
stock prices are advancing or have advanced rapidly, price-earnings ratios
have been inflated, and the industry or issue continues to gain new investment
acceptance on an accelerated basis. In other words, management believes that
market prices of securities with relatively high price-earnings ratios are
more susceptible to unexpected adverse developments while securities with
relatively low price-earnings ratios are more favorably positioned to benefit
from favorable, but generally unanticipated, events. This investment policy
departs from traditional philosophy. Management of the Fund believes that the
market risk involved in this policy is moderated somewhat by an emphasis on
securities with above-average dividend returns.
The current institutionally-dominated market tends to ignore, to some
extent, the numerous secondary issues whose market capitalizations are below
those of the relatively few larger size growth companies. It is expected that
the Basic Value Focus Fund's portfolio generally will have significant
representation in this secondary segment of the market. The basic orientation
of the Fund's investment policies is such that at times a large portion of its
common stock holdings may carry less than favorable research ratings from
research analysts.
Investment emphasis is on equities, primarily common stock and, to a lesser
extent, securities convertible into common stocks. The Basic Value Focus Fund
also may invest in preferred stocks and non-convertible debt securities rated
investment grade and utilize covered call options with respect to portfolio
securities as described in Appendix B. It reserves the right as a defensive
measure to hold other types of securities, including U.S. Government and
Government agency securities, money market securities or other fixed-income
securities deemed by the Investment Adviser to be consistent with a defensive
posture, or cash, in such proportions as, in the opinion of management,
prevailing market or economic conditions warrant. The Fund may invest up to
10% of its total assets, taken at market value at the time of acquisition, in
the securities of foreign issuers.
7
<PAGE>
DEVELOPING CAPITAL MARKETS FOCUS FUND
The investment objective of the Developing Capital Markets Focus Fund is to
seek long-term capital appreciation by investing in securities, principally
equities, of issuers in countries having smaller capital markets. Under normal
conditions, at least 65% of the Fund's net assets will be invested in such
equity securities. The investment objective of the Fund is a fundamental
policy and may not be changed without approval of a majority of the Fund's
outstanding shares. There can be no assurance that the Fund's investment
objective will be achieved. The Fund may employ a variety of investments and
techniques to hedge against market and currency risk. See Appendix B.
Investing on an international basis involves special considerations. Investing
in smaller capital markets entails the risk of significant volatility in the
Fund's security prices. See "Other Portfolio Strategies--Foreign Securities."
The Fund is designed for investors seeking to complement their U.S. holdings
through foreign investments. The Fund should be considered as a long-term
investment and a vehicle for diversification and not as a balanced investment
program.
For purposes of its investment objective, the Fund considers countries
having smaller capital markets to be all countries other than the four
countries having the largest equity market capitalizations. Currently, these
four countries are Japan, the United Kingdom, the United States and Germany.
At December 31, 1996, those countries' equity market capitalizations totalled
approximately 69.84% of the world's equity market capitalization according to
data provided by Morgan Stanley Capital International. The Fund will at all
times, except during defensive periods, maintain investments in at least three
countries having smaller capital markets.
The Fund seeks to benefit from economic and other developments in smaller
capital markets. The investment objective of the Fund reflects the belief that
investment opportunities may result from an evolving long-term international
trend favoring more market-oriented economies, a trend that may especially
benefit certain countries having smaller capital markets. This trend may be
facilitated by local or international political, economic or financial
developments that could benefit the capital markets of such countries. Certain
such countries, particularly so-called "emerging" countries (such as Malaysia,
Mexico and Thailand) which may be in the process of developing more market-
oriented economies, may experience relatively high rates of economic growth.
Other countries (such as France, the Netherlands and Spain), although having
relatively mature smaller capital markets, may also be in a position to
benefit from local or international developments encouraging greater market
orientation and diminishing governmental intervention in economic affairs.
Many investors, particularly individuals, lack the information, capability
or inclination to invest in countries having smaller capital markets. It also
may not be permissible for such investors to invest directly in certain such
markets. Unlike many intermediary investment vehicles, such as closed-end
investment companies that invest in a single country, the Fund intends to
diversify investment risk among the capital markets of a number of countries.
The Fund will not necessarily seek to diversify investments on a geographical
basis or on the basis of the level of economic development of any particular
country.
In its investment decision-making, the Investment Adviser will emphasize the
allocation of assets among certain countries' capital markets, rather than the
selection of particular industries or issuers. Because of the general
illiquidity of the capital markets in some countries, the Fund may invest in a
relatively small number of leading or actively traded companies in a country's
capital markets in the expectation that the investment experience of the
securities of such companies will substantially represent the investment
experience of the country's capital markets as a whole.
The Fund also may invest in debt securities of issuers in countries having
smaller capital markets. Capital appreciation in debt securities may arise as
a result of a favorable change in relative foreign exchange rates, in relative
interest rate levels, or in the creditworthiness of issuers. In accordance
with its investment objective, the Fund will not seek to benefit from
anticipated short-term fluctuations in currency exchange rates. The Fund may,
from time to time, invest in debt securities with relatively high yields (as
compared to other debt securities meeting the Fund's investment criteria),
notwithstanding that the Fund may not anticipate that such securities will
experience substantial capital appreciation. See "Risks of High Yield
Securities" below. Such income can be used, however, to offset the operating
expenses of the Fund.
8
<PAGE>
The Fund may invest in debt securities issued or guaranteed by foreign
governments (including foreign states, provinces and municipalities) or their
agencies and instrumentalities ("governmental entities"), issued or guaranteed
by international organizations designated or supported by multiple foreign
governmental entities (which are not obligations of foreign governments) to
promote economic reconstruction or development ("supranational entities"), or
issued by foreign corporations or financial institutions.
Supranational entities include international organizations designated or
supported by governmental entities to promote economic reconstruction or
development and international banking institutions and related government
agencies. Examples include the World Bank, the European Steel and Coal
Community, the Asian Development Bank and the Inter-American Development Bank.
The governmental members, or "stockholders," usually make initial capital
contributions to the supranational entity and in many cases are committed to
make additional capital contributions if the supranational entity is unable to
repay its borrowings.
The Fund has established no rating criteria for the debt securities in which
it may invest, and such securities may not be rated at all for
creditworthiness. Securities rated in the medium to lower rating categories of
nationally recognized statistical rating organizations and unrated securities
of comparable quality are predominantly speculative with respect to the
capacity to pay interest and repay principal in accordance with the terms of
the security and generally involve a greater volatility of price than
securities in higher rating categories. In purchasing such securities, the
Fund will rely on the Investment Adviser's judgement, analysis and experience
in evaluating the creditworthiness of an issuer of such securities. The
Investment Adviser will take into consideration, among other things, the
issuer's financial resources, its sensitivity to economic conditions and
trends, its operating history, the quality of the issuer's management and
regulatory matters. The Fund does not intend to purchase debt securities that
are in default or which the Investment Adviser believes will be in default.
See "Other Portfolio Strategies--Foreign Securities" and "Risks of High Yield
Securities" below.
For purposes of the Fund's investment objective, an issuer ordinarily will
be considered to be located in the country where the primary trading market of
its securities is located. The Fund, however, may consider a company to be
located in countries having smaller capital markets, without reference to its
domicile or to the primary trading market of its securities, when at least 50%
of its non-current assets, capitalization, gross revenues or profits in any
one of the two most recent fiscal years represents (directly or indirectly
through subsidiaries) assets or activities located in such countries. The Fund
also may consider closed-end investment companies to be located in the country
or countries in which they primarily make their portfolio investments.
Foreign investments in smaller capital markets involve risks not involved in
domestic investment, including fluctuations in foreign exchange rates, future
political and economic developments, different legal systems and the existence
or possible imposition of exchange controls or other foreign or United States
governmental laws or restrictions applicable to such investments. These risks
are often heightened for investments in small capital markets. With respect to
certain countries, there may be the possibility of expropriation of assets,
confiscatory taxation, high rates of inflation, political or social
instability or diplomatic developments which could affect investment in those
countries. In addition, certain foreign investments may be subject to foreign
withholding taxes.
There may be less publicly available information about an issuer in a
smaller capital market than would be available about a United States company,
and it may not be subject to accounting, auditing and financial reporting
standards and requirements comparable to those of United States companies. As
a result, traditional investment measurements, such as price/earnings ratios,
as used in the United States, may not be applicable in certain capital
markets.
The Fund reserves the right, as a temporary defensive measure or to provide
for redemptions or in anticipation of investment in countries having smaller
capital markets, to hold cash or cash equivalents (in U.S. dollars or foreign
currencies) and short-term securities, including money market securities. The
Fund may invest in the securities of foreign issuers in the form of American
Depositary Receipts (ADRs), European Depositary Receipts (EDRs), Global
Depositary Receipts (GDRs) or other securities convertible into securities of
foreign issuers. The Fund may invest in unsponsored ADRs. The issuers of
unsponsored ADRs are not obligated to disclose material information in the
United States, and therefore, there may not be a correlation between such
information and the market value of such ADRs.
9
<PAGE>
NON-DIVERSIFIED FUNDS
The Developing Capital Markets Focus Fund is classified as a non-diversified
investment company under the Investment Company Act. However, the Fund will
have to limit its investments to the extent required by the diversification
requirements applicable to regulated investment companies under the Internal
Revenue Code. To qualify as a regulated investment company, a Fund, at the
close of each fiscal quarter, may not have more than 25% of its total assets
invested in the securities (except obligations of the U.S. Government, its
agencies or instrumentalities) of any one issuer and with respect to 50% of
its assets, (i) may not have more than 5% of its total assets invested in the
securities of any one issuer and (ii) may not own more than 10% of the
outstanding voting securities of any one issuer.
INVESTMENT RESTRICTIONS
The Company has adopted a number of restrictions and policies relating to
the investment of its assets and its activities which are fundamental policies
and may not be changed without the approval of the holders of the Company's
outstanding voting securities (including a majority of the shares of each
Fund). Investors are referred to the Statement of Additional Information for a
complete description of such restrictions and policies.
OTHER PORTFOLIO STRATEGIES
Restricted Securities. Each of the Funds is subject to limitations on the
amount of illiquid securities it may purchase; however, each Fund may purchase
without regard to that limitation certain securities that are not registered
under the Securities Act of 1933, as amended (the "Securities Act"), including
(a) commercial paper exempt from registration under Section 4(2) of the
Securities Act, and (b) securities that can be offered and sold to "qualified
institutional buyers" under Rule 144A under the Securities Act, provided that
the Company's Board of Directors continuously determines, based on the trading
markets for the specific Rule 144A security, that it is liquid. The Board of
Directors may adopt guidelines and delegate to the Investment Adviser the
daily function of determining and monitoring liquidity of restricted
securities. The Board has determined that securities sold under Rule 144A
which are freely tradeable in their primary market offshore should be deemed
liquid. The Board, however, will retain sufficient oversight and be ultimately
responsible for the determinations.
Since it is not possible to predict with assurance exactly how the market
for restricted securities sold and offered under Rule 144A will develop, the
Board of Directors will carefully monitor the Funds' investments in these
securities, focusing on such factors, among others, as valuation, liquidity
and availability of information. This investment practice could have the
effect of increasing the level of illiquidity in a Fund to the extent that
qualified institutional buyers become for a time uninterested in purchasing
these restricted securities.
Foreign Securities. The High Current Income, Basic Value Focus and
Developing Capital Markets Focus Funds may invest in securities of foreign
issuers. Investments in foreign securities, particularly those of non-
governmental issuers, involve considerations and risks which are not
ordinarily associated with investing in domestic issuers. These considerations
and risks include changes in currency rates, currency exchange control
regulations, the possibility of expropriation, the unavailability of financial
information or the difficulty of interpreting financial information prepared
under foreign accounting standards, less liquidity and more volatility in
foreign securities markets, the impact of political, social or diplomatic
developments, and the difficulty of assessing economic trends in foreign
countries. If it should become necessary, a Fund could encounter greater
difficulties in invoking legal processes abroad than would be the case in the
United States. Transaction costs in foreign securities may be higher. The
operating expense ratio of a Fund investing in foreign securities can be
expected to be higher than that of an investment company investing exclusively
in United States securities because the expenses of the Fund, such as
custodial costs, are higher. In addition, net investment income earned by a
Fund on a foreign security may be subject to withholding and other taxes
imposed by foreign governments which will reduce a Fund's net investment
income. The Investment Adviser will consider these and other factors before
investing in foreign securities, and will not make such investments unless, in
its opinion, such investments will meet the standards and objectives of a
particular Fund. No Fund which may invest in foreign securities will
concentrate its investments in any particular country. The Developing Capital
Markets Focus Fund may from time to time be substantially invested in non-
dollar-denominated securities of foreign issuers. For a Fund that invests in
foreign securities denominated or quoted in currencies other than the United
States dollar, changes in
10
<PAGE>
foreign currency exchange rates may affect the value of securities in the
portfolio and the unrealized appreciation or depreciation of investments
insofar as United States investors are concerned, and a Fund's return on
investments in non-dollar-denominated securities may be reduced or enhanced as
a result of changes in foreign currency rates during the period in which the
Fund holds such investments. Foreign currency exchange rates are determined by
forces of supply and demand in the foreign exchange markets. These forces are,
in turn, affected by international balance of payments and other economic and
financial conditions, government intervention, speculation and other factors.
With respect to certain countries, there may be the possibility of
expropriation of assets, confiscatory taxation, high rates of inflation,
political or social instability or diplomatic developments which could affect
investment in those countries. The High Current Income Fund will purchase only
securities issued in dollar denominations.
The Developing Capital Markets Focus Fund may invest a significant portion
of its assets in securities of foreign issuers in smaller capital markets,
while each of the other Funds which is permitted to invest in foreign
securities may from time to time invest in securities of such foreign issuers.
Foreign investments involve risks, including fluctuations in foreign exchange
rates, future political and economic developments, different legal systems,
the existence or possible imposition of exchange controls, or other foreign or
United States governmental laws or restrictions are often heightened for
investments in smaller capital markets.
There may be less publicly available information about an issuer in a
smaller capital market than would be available about a United States company,
and it may not be subject to accounting, auditing and financial reporting
standards and requirements comparable to those of United States companies. As
a result, traditional investment measurements, such as price/earnings ratios,
as used in the United States, may not be applicable in certain capital
markets.
Smaller capital markets, while often growing in trading volume, have
substantially less volume than United States markets, and securities in many
smaller capital markets are less liquid and their prices may be more volatile
than securities of comparable United States companies. Brokerage commissions,
custodial services, and other costs relating to investment in smaller capital
markets are generally more expensive than in the United States. Such markets
have different clearance and settlement procedures, and in certain markets
there have been times when settlements have been unable to keep pace with the
volume of securities transactions, making it difficult to conduct such
transactions. Further, satisfactory custodial services for investment
securities may not be available in some countries having smaller capital
markets, which may result in a Fund which invests in these markets incurring
additional costs and delays in transporting and custodying such securities
outside such countries. Delays in settlement could result in temporary periods
when assets of such a Fund are uninvested and no return is earned thereon. The
inability of a Fund to make intended security purchases due to settlement
problems could cause the Fund to miss attractive investment opportunities.
Inability to dispose of a portfolio security due to settlement problems could
result either in losses to the Fund due to subsequent declines in value of the
portfolio security or, if the Fund has entered into a contract to sell the
security, could result in possible liability to the purchaser. There is
generally less government supervision and regulation of exchanges, brokers and
issuers in countries having smaller capital markets than there is in the
United States.
As a result, management of a Fund which invests in foreign securities may
determine that, notwithstanding otherwise favorable investment criteria, it
may not be practicable or appropriate to invest in a particular country. A
Fund may invest in countries in which foreign investors, including management
of the Fund, have had no or limited prior experience. Due to its emphasis on
securities of issuers located in smaller capital markets, the Developing
Capital Markets Focus Fund should be considered as a vehicle for
diversification and not as a balanced investment program.
Certain of the Funds may invest in debt securities issued by foreign
governments. Investments in foreign government debt securities, particularly
those of emerging market country governments, involve special risks. Certain
emerging market countries have historically experienced, and may continue to
experience, high rates of inflation, high interest rates, exchange rate
fluctuations, large amounts of external debt, balance of payments and trade
difficulties and extreme poverty and unemployment. The issuer or governmental
authority that controls the repayment of an emerging market country's debt may
not be able or willing to repay the principal and/or interest when due in
accordance with the terms of such debt. A debtor's willingness or ability to
repay principal and
11
<PAGE>
interest due in a timely manner may be affected by, among other factors, its
cash flow situation, and, in the case of a government debtor, the extent of
its foreign reserves, the availability of sufficient foreign exchange on the
date a payment is due, the relative size of the debt service burden to the
economy as a whole and the political constraints to which a government debtor
may be subject. Government debtors may default on their debt and may also be
dependent on expected disbursements from foreign governments, multilateral
agencies and others abroad to reduce principal and interest arrearages on
their debt. Holders of government debt, including the Fund, may be requested
to participate in the rescheduling of such debt and to extend further loans to
government debtors.
As a result of the foregoing, a government obligor may default on its
obligations. If such an event occurs, a Fund may have limited legal recourse
against the issuer and/or guarantor. Remedies must, in some cases, be pursued
in the courts of the defaulting party itself, and the ability of the holder of
foreign government debt securities to obtain recourse may be subject to the
political climate in the relevant country. Government obligors in developing
and emerging market countries are among the world's largest debtors to
commercial banks, other governments, international financial organizations and
other financial institutions. The issuers of the government debt securities in
which a Fund may invest have in the past experienced substantial difficulties
in servicing their external debt obligations, which led to defaults on certain
obligations and the restructuring of certain indebtedness. Restructuring
arrangements have included, among other things, reducing and rescheduling
interest and principal payments by negotiating new or amended credit
agreements.
The Developing Capital Markets Focus Fund intends to invest in securities of
foreign issuers in smaller capital markets. Some countries with smaller
capital markets prohibit or impose substantial restrictions on investments in
their capital markets, particularly their equity markets, by foreign entities
such as the Fund. As illustrations, certain countries require governmental
approval prior to investments by foreign persons, or limit the amount of
investment by foreign persons in a particular company, or limit the investment
by foreign persons to only a specific class of securities of a company which
may have less advantageous terms than securities of the company available for
purchase by nationals.
A number of countries, such as South Korea, Taiwan and Thailand, have
authorized the formation of closed-end investment companies to facilitate
indirect foreign investment in their capital markets. In accordance with the
Investment Company Act, the Developing Capital Markets Focus Fund may invest
up to 10% of its total assets in securities of such closed-end investment
companies. This restriction on investments in securities of closed-end
investment companies may limit opportunities for the Fund to invest indirectly
in certain smaller capital markets. Shares of certain closed-end investment
companies may at times be acquired only at market prices representing premiums
to their net asset values. If a Fund acquires shares in closed-end investment
companies, shareholders would bear both their proportionate share of expenses
in the Fund (including management and advisory fees) and, indirectly, the
expenses of such closed-end investment companies. A Fund also may seek, at its
own cost, to create its own investment entities under the laws of certain
countries.
In some countries, banks or other financial institutions may constitute a
substantial number of the leading companies or the companies with the most
actively traded securities. Also, the Investment Company Act restricts a
Fund's investments in any equity security of an issuer which, in its most
recent fiscal year, derived more than 15% of its revenues from "securities
related activities," as defined by the rules thereunder. These provisions may
also restrict a Fund's investments in certain foreign banks and other
financial institutions.
Lending of Portfolio Securities. Each Fund of the Company may from time to
time lend securities (but not in excess of 20% of its total assets) from its
portfolio to brokers, dealers and financial institutions and receive
collateral in cash or securities issued or guaranteed by the U.S. Government
which, while the loan is outstanding, will be maintained at all times in an
amount equal to at least 100% of the current market value of the loaned
securities plus accrued interest. Such cash collateral will be invested in
short-term securities, the income from which will increase the return to the
Fund.
Forward Commitments. Each of the Funds may purchase securities on a when-
issued basis, and they may purchase or sell such securities for delayed
delivery. These transactions occur when securities are purchased or
12
<PAGE>
sold by a Fund with payment and delivery taking place in the future to secure
what is considered an advantageous yield and price to the Fund at the time of
entering into the transaction. The value of the security on the delivery date
may be more or less than its purchase price. A Fund entering into such
transactions will maintain a segregated account with its custodian of cash or
liquid securities in an aggregate amount equal to the amount of its
commitments in connection with such delayed delivery and purchase
transactions.
Standby Commitment Agreements. The High Current Income and Developing
Capital Markets Focus Funds may from time to time enter into standby
commitment agreements. Such agreements commit the respective Fund, for a
stated period of time, to purchase a stated amount of a fixed income security
which may be issued and sold to the Fund at the option of the issuer. The
price and coupon of the security is fixed at the time of the commitment. At
the time of entering into the agreement the Fund is paid a commitment fee
which is typically approximately 0.5% of the aggregate purchase price of the
security which the Fund has committed to purchase. The Fund will at all times
maintain a segregated account with its custodian of cash or liquid securities
in an amount equal to the purchase price of the securities underlying the
commitment. There can be no assurance that the securities subject to a standby
commitment will be issued, and the value of the security, if issued, on the
delivery date may be more or less than its purchase price.
Portfolio Strategies Involving Options, Futures and Foreign Exchange
Transactions. Certain Funds may use derivative instruments, including options
and futures and purchase and sell foreign exchange. Transactions involving
such instruments expose these Funds to certain risks. Each Fund's use of these
instruments and the associated risks are described in detail in Appendix B
attached to this Prospectus.
RISKS OF HIGH YIELD SECURITIES
The High Current Income Fund and Developing Capital Markets Focus Fund may
invest a substantial portion of their assets in high yield, high risk
securities or junk bonds, which are regarded as being predominantly
speculative as to the issuer's ability to make payments of principal and
interest. Investment in such securities involves substantial risk. Issuers of
junk bonds may be highly leveraged and may not have available to them more
traditional methods of financing. Therefore, the risks associated with
acquiring the securities of such issuers generally are greater than is the
case with higher-rated securities. For example, during an economic downturn or
a sustained period of rising interest rates, issuers of high yield securities
may be more likely to experience financial stress, especially if such issuers
are highly leveraged. During recessionary periods, such issuers may not have
sufficient revenues to meet their interest payment obligations. The issuer's
ability to service its debt obligations also may be adversely affected by
specific issuer developments, or the issuer's inability to meet specific
projected business forecasts, or the unavailability of additional financing.
The risk of loss due to default by the issuer is significantly greater for the
holders of junk bonds because such securities may be unsecured and may be
subordinated to other creditors of the issuer. While the high yield securities
in which the High Current Income Fund or Developing Capital Markets Focus Fund
may invest normally do not include securities which, at the time of
investment, are in default or the issuers of which are in bankruptcy, there
can be no assurance that such events will not occur after a Fund purchases a
particular security, in which case a Fund may experience losses and incur
costs.
In an effort to minimize the risk of issuer default or bankruptcy, the High
Current Income Fund and the Developing Capital Markets Focus Fund each will
diversify its holdings among many issuers. However, there can be no assurance
that diversification will protect a Fund from widespread defaults brought
about by a sustained economic downturn.
High yield securities tend to be more volatile than higher-rated fixed-
income securities, so that adverse economic events may have a greater impact
on their prices and yields than on higher-rated fixed-income securities. Zero
coupon bonds and bonds which pay interest and/or principal in additional bonds
rather than in cash are especially volatile. Like higher-rated fixed-income
securities, junk bonds are generally purchased and sold through dealers who
make a market in such securities for their own accounts. However, there are
fewer dealers in this market, which may be less liquid than the market for
higher-rated fixed-income securities, even under normal economic conditions.
Also, there may be significant disparities in the prices quoted for such bonds
13
<PAGE>
by various dealers. Adverse economic conditions or investor perceptions
(whether or not based on economic fundamentals) may impair the liquidity of
this market, and may cause the prices the High Current Income Fund and the
Developing Capital Markets Focus Fund receive for their junk bonds to be
reduced, or a Fund may experience difficulty in liquidating a portion of its
portfolio when necessary to meet the Fund's liquidity needs or in response to
a specific economic event such as a deterioration in the creditworthiness of
the issuer. Under such conditions, judgement may play a greater role in
valuing certain of each Fund's portfolio securities than in the case of
securities trading in a more liquid market.
Adverse publicity and investor perceptions, which may not be based on
fundamental analysis, also may decrease the value and liquidity of junk bonds,
particularly in a thinly traded market. Factors adversely affecting the market
value of such securities are likely to affect adversely the net asset value of
the High Current Income Fund and the Developing Capital Markets Focus Fund. In
addition, each Fund may incur additional expenses to the extent that it is
required to seek recovery upon a default on a portfolio holding or to
participate in the restructuring of the obligation.
Sovereign Debt. The junk bonds in which the High Current Income Fund and
Developing Capital Markets Focus Fund may invest include junk bonds issued by
sovereign entities. Investment in such sovereign debt involves a high degree
of risk. The governmental entity that controls the repayment of sovereign debt
may not be able or willing to repay the principal and/or interest when due in
accordance with the terms of such debt. A governmental entity's willingness or
ability to repay principal and interest due in a timely manner may be affected
by, among other factors, its cash flow situation, the extent of its foreign
reserves, the availability of sufficient foreign exchange on the date a
payment is due, the relative size of the debt service burden to the economy as
a whole, the governmental entity's policy towards the International Monetary
Fund and the political constraints to which a governmental entity may be
subject. Governmental entities may also be dependent on expected disbursements
from foreign governments, multilateral agencies and others abroad to reduce
principal and interest arrearages on their debt. The commitment on the part of
these governments, agencies and others to make such disbursements may be
conditioned on a governmental entity's implementation of economic reforms
and/or economic performance and the timely service of such debtor's
obligations. Failure to implement such reforms, achieve such levels of
economic performance or repay principal or interest when due may result in the
cancellation of such third parties' commitments to lend funds to the
governmental entity, which may further impair such debtor's ability or
willingness to timely service its debts. Consequently, governmental entities
may default on their sovereign debt.
Holders of sovereign debt, including the High Current Income Fund and the
Developing Capital Markets Focus Fund, may be requested to participate in the
rescheduling of such debt and to extend further loans to governmental
entities. In the event of a default by a governmental entity, there may be few
or no effective legal remedies available to a Fund and there can be no
assurance a Fund will be able to collect on defaulted sovereign debt in whole
or in part.
INSURANCE LAW RESTRICTIONS
In order for shares of the Company's Funds to remain eligible investments
for the Separate Accounts, it may be necessary, from time to time, for a Fund
to limit its investments in certain types of securities in accordance with the
insurance laws or regulations of the various states in which the Contracts are
sold.
The New York insurance law requires that investments of each Fund be made
with the degree of care of an "ordinarily prudent person." The Investment
Adviser believes that compliance with this standard will not have any negative
impact on the performance of any of the Funds.
OTHER CONSIDERATIONS
The Investment Adviser will use its best efforts to assure that each Fund of
the Company complies with certain investment limitations of the Internal
Revenue Service to assure favorable income tax treatment for the Contracts. It
is not expected that such investment limitations will materially affect the
ability of any Fund to achieve its investment objective.
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DIRECTORS
The Directors of the Company consist of six individuals, five of whom are
not "interested persons" of the Company as defined in the Investment Company
Act of 1940. The Directors of the Company are responsible for the overall
supervision of the operations of the Company and perform the various duties
imposed on the directors of the investment companies by the Investment Company
Act of 1940. The Board of Directors elects officers of the Company annually.
The Directors of the Company and their principal employment are as follows:
Arthur Zeikel*--President of the Investment Adviser and its affiliate, Fund
Asset Management, L.P. ("FAM"); President and Director of Princeton Services,
Inc. ("Princeton Services"); Executive Vice President of ML&Co.; and Director
of the Merrill Lynch Funds Distributor, Inc. (the "Distributor").
Joe Grills--Member of the Committee on Investment of Employee Benefit Assets
of the Financial Executives Institute ("CIEBA"); Member of CIEBA's Executive
Committee; and Member of the Investment Advisory Committee of the State of New
York Common Retirement Fund and the Howard Hughes Medical Institute; Director,
Duke Management Company, LaSalle Street Fund and Kimco Realty Corporation.
Walter Mintz--Special Limited Partner of Cumberland Partners (investment
partnership).
Robert S. Salomon, Jr.--Principal of STI Management (investment adviser).
Melvin R. Seiden--Director of Silbanc Properties, Ltd. (real estate,
consulting and investments).
Stephen R. Swensrud--Chairman of Fernwood Associates (financial
consultants).
INVESTMENT ADVISER
Merrill Lynch Asset Management L.P. ("MLAM"), an indirect wholly owned
subsidiary of Merrill Lynch & Co., Inc., is the investment adviser (the
"Investment Adviser") for the Fund. The general partner of the Investment
Adviser is Princeton Services, Inc., a wholly owned subsidiary of Merrill
Lynch & Co., Inc. The principal address of the Investment Adviser is 800
Scudders Mill Road, Plainsboro, New Jersey 08536 (mailing address: Box 9011,
Princeton, New Jersey 08543-9011). The Investment Adviser or its affiliate,
Fund Asset Management, L.P. ("FAM"), acts as the investment adviser for over
130 other registered investment companies. The Investment Adviser also offers
portfolio management and portfolio analysis services to individuals and
institutions. In the aggregate, as of March 31, 1997, MLAM and FAM had a total
of approximately $247.2 billion in investment company and other portfolio
assets under management including assets of certain affiliates.
While the Investment Adviser is at all times subject to the direction of the
Board of Directors of the Company, the Investment Advisory Agreements provide
that the Investment Adviser, subject to review by the Board of Directors, is
responsible for the actual management of the Funds and has responsibility for
making decisions to buy, sell or hold any particular security. The Investment
Adviser provides the portfolio managers for the Funds, who consider
information from various sources, make the necessary investment decisions and
effect transactions accordingly. The Investment Adviser is also obligated to
perform certain administrative and management services for the Company
(certain of which it may delegate to third parties) and is obligated to
provide all the office space, facilities, equipment and personnel necessary to
perform its duties under the Agreements. The Investment Adviser has access to
the full range of the securities and economic research facilities of Merrill
Lynch.
During the Company's fiscal year ended December 31, 1996, the advisory fees
expense incurred by the Company totaled $24,131,430 of which $1,881,541
related to the High Current Income Fund (representing .49% of its average net
assets), $2,414,605 related to the Basic Value Focus Fund (representing .60%
of its average net assets), and, $765,718 related to the Developing Capital
Markets Focus Fund (representing 1.00% of its average net assets) of which
$52,388 was voluntarily waived by MLAM.
- -------------------------
* Interested person, as defined in the Investment Company Act of 1940, of the
Company.
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During the Company's fiscal year ended December 31, 1996, the total
operating expenses of the Company's Funds (including the advisory fees paid to
the Investment Adviser), before any fee waiver or reimbursement of a portion
of such expenses were as follows: $2,096,102 related to the High Current
Income Fund (representing .54% of its average net assets), $2,657,872 related
to the Basic Value Focus Fund (representing .66% of its average net assets),
and, $1,009,535 related to the Developing Capital Markets Focus Fund
(representing 1.31% of its average net assets).
The Investment Adviser has entered into a sub-advisory agreement (the "Sub-
Advisory Agreement") with MLAM U.K., an indirect wholly owned subsidiary of ML
& Co., and an affiliate of the Investment Adviser, pursuant to which the
Investment Adviser pays MLAM U.K. a fee for providing investment advisory
services to the Investment Adviser with respect to the Funds in an amount to
be determined from time to time by the Investment Adviser and MLAM U.K. but in
no event in excess of the amount that the Investment Adviser actually receives
for providing services to the Funds pursuant to the Investment Advisory
Agreement.
The Investment Adviser and Merrill Lynch Life Agency, Inc. ("MLLA") have
entered into two agreements which limit the operating expenses paid by each
Fund in a given year to 1.25% of its average daily net assets (the
"Reimbursement Agreements"). The reimbursement agreements, dated April 30,
1985 and February 11, 1992, provide that any expenses in excess of 1.25% of
average daily net assets will be reimbursed to the Fund by the Investment
Adviser which, in turn, will be reimbursed by MLLA.
The Investment Adviser has entered into administrative services agreements
with certain Insurance Companies, including MLLIC and ML of New York, pursuant
to which the Investment Adviser compensates such companies for administrative
responsibilities relating to the Company which are performed by such Insurance
Companies.
CODE OF ETHICS
The Board of Directors of the Company has adopted a Code of Ethics under
Rule 17j-1 of the Act which incorporates the Code of Ethics of the Investment
Adviser (together, the "Codes"). The Codes significantly restrict the personal
investing activities of all employees of the Investment Adviser and, as
described below, impose additional, more onerous, restrictions on fund
investment personnel.
The Codes require that all employees of the Investment Adviser preclear any
personal securities investment (with limited exceptions, such as government
securities). The preclearance requirement and associated procedures are
designed to identify any substantive prohibition or limitation applicable to
the proposed investment. The substantive restrictions applicable to all
employees of the Investment Adviser include a ban on acquiring any securities
in a "hot" initial public offering and a prohibition from profiting on short-
term trading in securities. In addition, no employee may purchase or sell any
security which at the time is being purchased or sold (as the case may be), or
to the knowledge of the employee is being considered for purchase or sale, by
any fund advised by the Investment Adviser. Furthermore, the Codes provide for
trading "blackout periods" which prohibit trading by investment personnel of
the Company within periods of trading by the Company in the same (or
equivalent) security (15 or 30 days depending upon the transaction).
PORTFOLIO MANAGERS
The following is information with respect to the Portfolio Managers for each
of the Company's Funds.
Kevin Rendino has served as the Basic Value Focus Fund's Portfolio Manager
since July 1993, and is primarily responsible for the Fund's day-to-day
management. He has served as Vice President of MLAM since December 1993;
Senior Research Analyst from 1990 to 1992; Corporate Analyst from 1988 to
1990.
Aldona Schwartz has served as the High Current Income Fund's Portfolio
Manager since July 1993, and is primarily responsible for the Fund's day-to-
day management. She has served as Vice President of MLAM since 1991 and
employee of the Investment Adviser since 1986.
Grace Pineda has served as the Developing Capital Markets Focus Fund's
Portfolio Manager since May 1994, and is primarily responsible for the Fund's
day-to-day management. She has served as Vice President of MLAM since 1989.
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PORTFOLIO TRANSACTIONS AND BROKERAGE
None of the Company's Funds has any obligation to deal with any dealer or
group of dealers in the execution of transactions in portfolio securities.
Subject to policy established by the Board of Directors of the Company, the
Investment Adviser is primarily responsible for the Company's portfolio
decisions and the placing of the Company's portfolio transactions. In placing
orders, it is the policy of each Fund to obtain the most favorable net
results, taking into account various factors, including price, dealer spread
or commission, if any, size of the transactions and difficulty of execution.
While the Investment Adviser generally seeks reasonably competitive spreads or
commissions, the Company will not necessarily be paying the lowest spread or
commission available.
Under the Investment Company Act of 1940, persons affiliated with the
Company are prohibited from dealing with the Company as a principal in the
purchase and sale of the Company's portfolio securities unless an exemptive
order allowing such transactions is obtained from the Securities and Exchange
Commission. Affiliated persons of the Company may serve as its broker in over-
the-counter transactions conducted on an agency basis. During the year ended
December 31, 1996, the Company engaged in 16 transactions pursuant to such
order involving approximately $64.9 million of securities. For the year ended
December 31, 1996, the Company paid brokerage commissions of $6,656,814, of
which $266,405 was paid to Merrill Lynch.
PURCHASE OF SHARES
The Company continuously offers shares of Class A Common Stock in each of
its Funds to the Insurance Companies at prices equal to the respective per
share net asset value of the Funds. Merrill Lynch Funds Distributor, Inc., a
wholly owned subsidiary of the Investment Adviser, acts as the distributor of
the shares. Net asset value is determined in the manner set forth below under
"Additional Information--Determination of Net Asset Value."
The Company and the Distributor reserve the right to suspend the sale of
shares of each Fund in response to conditions in the securities markets or
otherwise.
REDEMPTION OF SHARES
The Company is required to redeem all full and fractional shares of the
Funds for cash. The redemption price is the net asset value per share next
determined after the initial receipt of proper notice of redemption.
DIVIDENDS, DISTRIBUTIONS AND TAXES
It is the Company's intention to distribute substantially all of the net
investment income, if any, of each Fund. For dividend purposes, net investment
income of each Fund, other than the Domestic Money Market and Reserve Assets
Funds, will consist of all payments of dividends or interest received by such
Fund less the estimated expenses of such Fund (including fees payable to the
Investment Adviser).
Dividends from net investment income of the High Current Income Fund are
declared and reinvested monthly in additional full and fractional shares at
net asset value. Dividends from net investment income of the Basic Value Focus
and Developing Capital Markets Focus Funds are declared and reinvested at
least annually in additional full and fractional shares of the respective
Funds.
All net realized long-term or short-term capital gains of the Company, if
any, are declared and distributed annually after the close of the Company's
fiscal year to the shareholders of the Fund or Funds to which such gains are
attributable. Short-term capital gains are taxable as ordinary income.
TAX TREATMENT OF THE COMPANY
Each Fund intends to continue to qualify as a regulated investment company
under certain provisions of the Internal Revenue Code of 1986, as amended (the
"Code"). Under such provisions, a Fund will not be subject to
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<PAGE>
federal income tax on such part of its net ordinary income and net realized
capital gains which it distributes to shareholders. One of the requirements to
qualify for treatment as a regulated investment company under the Code is that
a Fund, among other things, derive less than 30% of its gross income in each
taxable year from gains (without deduction of losses) from the sale or other
disposition of stocks, securities and certain options, futures or forward
contracts held for less than three months. This requirement may limit the
ability of certain Funds to dispose of certain securities at times when
management of the Company might otherwise deem such disposition appropriate or
desirable.
If a Fund earns original issue discount income in a taxable year which is
not represented by correlative cash income, or if a Fund receives property
rather than cash in payment of interest, shareholders will be allocated income
greater than the amount of cash distributed to them. In addition, the Fund may
have to dispose of securities and use the proceeds thereof to make
distributions in amounts necessary to satisfy its distribution requirements
under the Code.
TAX TREATMENT OF INSURANCE COMPANIES AS SHAREHOLDERS
Dividends paid by the Company from its ordinary income and distributions of
the Company's net realized capital gains are includable in the respective
Insurance Company's gross income. Distributions of the Company's net realized
long-term capital gains retain their character as long-term capital gains in
the hands of the Insurance Companies if certain requirements are met. The tax
treatment of such dividends and distributions depends on the respective
Insurance Company's tax status. To the extent that income of the Company
represents dividends on common or preferred stock, rather than interest
income, its distributions to the Insurance Companies will be eligible for the
present 70% dividends received deduction applicable in the case of a life
insurance company as provided in the Code. See the Prospectus for the
Contracts for a description of the respective Insurance Company's tax status
and the charges which may be made to cover any taxes attributable to the
Separate Account. Not later than 60 days after the end of each calendar year,
the Company will send to the Insurance Companies a written notice required by
the Code designating the amount and character of any distributions made during
such year.
PERFORMANCE DATA
From time to time the average annual total return and yield of one or more
of the Company's Funds for various specified time periods may be included in
advertisements or information furnished by the Insurance Companies to present
or prospective Contract owners. Average annual total return and yield are
computed in accordance with formulas specified by the Securities and Exchange
Commission.
Average annual total return quotations for the specified periods will be
computed by finding the average annual compounded rates of return (based on
net investment income and any realized and unrealized capital gains or losses
on portfolio investments over such periods) that would equate the initial
amount invested to the redeemable value of such investment at the end of each
period. Average annual total return will be computed assuming all dividends
and distributions are reinvested and taking into account all applicable
recurring and nonrecurring expenses.
Yield quotations will be computed based on a 30-day period by dividing (a)
the net income based on the yield to maturity of each security earned during
the period by (b) the average daily number of shares outstanding during the
period that were entitled to receive dividends multiplied by the offering
price per share on the last day of the period. The yield for the 30-day period
ending December 31, 1996 was 9.30% for the High Current Income Fund.
Total return and yield figures are based on the Fund's historical
performance and are not intended to indicate future performance. The Fund's
total return and yield will vary depending on market conditions, the
securities comprising the Fund's portfolio, the Fund's operating expenses and
the amount of realized and unrealized net capital gains or losses during the
period. The value of an investment in the Fund will fluctuate and an
investor's shares, when redeemed, may be worth more or less than their
original cost. The yield and total return quotations
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<PAGE>
may be of limited use for comparative purposes because they do not reflect
charges imposed at the Separate Account level which, if included, would
decrease the yield.
On occasion, one or more of the Company's Funds may compare its performance
to that of the S&P 500 Index, the Value Line Composite Index, the Dow Jones
Industrial Average, or performance data published by Lipper Analytical
Services, Inc., or Variable Annuity Research Data Service or contained in
publications such as Morningstar Publications, Inc., Chase Investment
Performance Digest, Money Magazine, U.S. News & World Report, Business Week,
Financial Services Weekly, Kiplinger Personal Finances, CDA Investment
Technology, Inc., Forbes Magazine, Fortune Magazine, Wall Street Journal, USA
Today, Barrons, Strategic Insight, Donaghues, Investors Business Daily and
Ibbotson Associates. As with other performance data, performance comparisons
should not be considered indicative of the Fund's relative performance for any
future period.
ADDITIONAL INFORMATION
DETERMINATION OF NET ASSET VALUE
The net asset value of the shares of each Fund is determined once daily by
the Investment Adviser immediately after the declaration of dividends, if any,
and is determined as of fifteen minutes following the close of trading on each
day the New York Stock Exchange is open for business. The New York Stock
Exchange is open on business days other than national holidays (except for
Martin Luther King Day, when it is open) and Good Friday. The net asset value
per share of each Fund is computed by dividing the sum of the value of the
securities held by that Fund plus any cash or other assets (including interest
and dividends accrued) minus all liabilities (including accrued expenses) by
the total number of shares outstanding of that Fund at such time, rounded to
the nearest cent. Expenses, including the investment advisory fees payable to
the Investment Adviser, are accrued daily.
Securities held by each Fund will be valued as follows: Portfolio securities
that are traded on stock exchanges are valued at the last sale price (regular
way) as of the close of business on the day the securities are being valued,
or, lacking any sales, at the last available bid price. Securities traded in
the over-the-counter ("OTC") market are valued at the last available bid price
in the OTC market prior to the time of valuation. Portfolio securities that
are traded both in the OTC market and on a stock exchange are valued according
to the broadest and most representative market, and it is expected that for
debt securities this ordinarily will be the OTC market. When a Fund writes an
option, the amount of the premium received is recorded on the books as an
asset and an equivalent liability. The amount of the liability is subsequently
valued to reflect the current market value of the option written, based upon
the last sale price in the case of exchange-traded options or, in the case of
options being traded in the OTC market, the last asked price. Options
purchased are valued at their last sale price in the case of exchange-traded
options or, in the case of options traded in the OTC market, the last bid
price. Futures contracts are valued at settlement price at the close of the
applicable exchange. Securities and assets for which market quotations are not
readily available are valued at fair value as determined in good faith by or
under the direction of the Board of Directors of the Company. Any assets or
liabilities initially expressed in terms of non-U.S. dollar currencies are
translated into U.S. dollars at the prevailing market rates as quoted by one
or more banks or dealers on the day of valuation.
The Company has used pricing services, including Merrill Lynch Securities
Pricing(TM) Service ("MLSPS"), to value securities held by the High Current
Income and Prime Bond Funds and to value bonds held by other of the Company's
Funds. The Board of Directors of the Company has examined the methods used by
the pricing services in estimating the value of securities held by the Funds
and believes that such methods will reasonably and fairly approximate the
price at which those securities may be sold and result in a good faith
determination of the fair value of such securities; however, there is no
assurance that securities can be sold at the prices at which they are valued.
During the fiscal year ended December 31, 1996, the High Current Income Fund
paid MLSPS $7,269, for such services.
ORGANIZATION OF THE COMPANY
The Company was incorporated on October 16, 1981, and operations of its
Reserve Assets Fund commenced on November 12, 1981. Operations of the Prime
Bond, High Current Income, Quality Equity and
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Equity Growth Funds commenced on April 20, 1982. The Natural Resources Focus
Fund and the American Balanced Fund commenced operations on June 1, 1988 and
June 1, 1988, respectively. The Domestic Money Market Fund and the Global
Strategy Focus Fund commenced operations on February 20 and February 28, 1992,
respectively. The Basic Value Focus, Global Bond Focus, Global Utility Focus
and International Equity Focus Funds commenced operations on July 1, 1993. The
Developing Capital Markets Focus Fund and Government Bond Fund commenced
operations on May 2, 1994. The Index 500 Fund commenced operations on December
13, 1996. The authorized capital stock of the Company consists of
3,400,000,000 shares of Class A Common Stock, par value $0.10 per share, and
3,400,000,000 shares of Class B Common Stock, par value $0.10 per share. The
shares of Class A and Class B Common Stock are each divided into sixteen
classes designated Merrill Lynch Reserve Assets Fund Common Stock, Merrill
Lynch Prime Bond Fund Common Stock, Merrill Lynch High Current Income Fund
Common Stock, Merrill Lynch Quality Equity Fund Common Stock, Merrill Lynch
Equity Growth Fund Common Stock, Merrill Lynch Natural Resources Focus Fund
Common Stock, Merrill Lynch American Balanced Fund Common Stock, Merrill Lynch
Global Strategy Focus Fund Common Stock, Merrill Lynch Domestic Money Market
Fund Common Stock, Merrill Lynch Basic Value Focus Fund Common Stock, Merrill
Lynch Global Bond Focus Fund Common Stock, Merrill Lynch Global Utility Focus
Fund Common Stock, Merrill Lynch International Equity Focus Fund Common Stock,
Merrill Lynch Developing Capital Markets Focus Fund Common Stock, Merrill
Lynch Government Bond Fund Common Stock and Merrill Lynch Index 500 Common
Stock, respectively. The Company may, from time to time, at the sole
discretion of its Board of Directors and without the need to obtain the
approval of its shareholders or of Contract Owners, offer and sell shares of
one or more of such classes. Each class consists of 100,000,000 Class A shares
and 100,000,000 Class B shares except for Domestic Money Market Fund Common
Stock which consists of 1,300,000,000 Class A shares and 1,300,000,000 Class B
shares, Reserve Assets Fund Common Stock which consists of 500,000,000 Class A
shares and 500,000,000 Class B shares and Global Bond Focus Fund Common Stock
and Global Strategy Focus Fund Common Stock, each of which consists of
200,000,000 Class A shares and 200,000,000 Class B shares. All shares of
Common Stock have equal voting rights, except that only shares of the
respective classes are entitled to vote on matters concerning only that class.
Pursuant to the Investment Company Act of 1940 and the rules and regulations
thereunder, certain matters approved by a vote of all shareholders of the
Company may not be binding on a class whose shareholders have not approved
such matter. Each issued and outstanding share of a class is entitled to one
vote and to participate equally in dividends and distributions declared with
respect to such class and in net assets of such class upon liquidation or
dissolution remaining after satisfaction of outstanding liabilities. The
shares of each class, when issued, will be fully paid and nonassessable, have
no preference, preemptive, conversion, exchange or similar rights, and will be
freely transferable. Holders of shares of any class are entitled to redeem
their shares as set forth under "Redemption of Shares." Shares do not have
cumulative voting rights and the holders of more than 50% of the shares of the
Company voting for the election of directors can elect all of the directors of
the Company if they choose to do so and in such event the holders of the
remaining shares would not be able to elect any directors. The Company does
not intend to hold meetings of shareholders unless under the Investment
Company Act of 1940 shareholders are required to act on any of the following
matters: (i) election of directors; (ii) approval of an investment advisory
agreement; (iii) approval of a distribution agreement; and (iv) ratification
of the selection of independent accountants.
The Board of Directors of the Company has authorized the issuance of shares
of Class B Common Stock with respect to each of the Company's Funds, with the
existing shares of Common Stock of each Fund to be designated Class A Common
Stock of such Fund. The Board of Directors have also authorized the Company to
enter into a Distribution Plan with Merrill Lynch Funds Distributor, Inc.
under which the Company would pay distribution fees in respect of the shares
of its Class B Common Stock. No shares of Class B Common Stock have been
issued; however, the Company may commence issuing shares of Class B Common
Stock later in 1997 pursuant to a separate or amended Prospectus.
MLLIC purchased $100 worth of Shares of the Basic Value Focus Fund on June
28, 1993. MLLIC purchased, on July 1, 1993, $2,000,000 worth of shares of the
Basic Value Focus Fund. MLLIC purchased on May 2, 1994 $8,000,000 worth of
shares of the Developing Capital Markets Focus Fund. The organizational
expenses of each of the Company's Funds are paid by the Investment Adviser.
The Investment Adviser is reimbursed by MLLIC for all such expenses over a
five-year period.
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INDEPENDENT AUDITORS
Deloitte & Touche LLP, 117 Campus Drive, Princeton, New Jersey 08540, has
been selected as the independent auditors of the Company. The selection of
independent auditors is subject to annual ratification by the Company's
shareholders.
CUSTODIAN
The Bank of New York ("BONY"), 110 Washington Street, New York, New York
10286, acts as Custodian of the Company's assets, except that Brown Brothers
Harriman & Co., 40 Water Street, Boston, Massachusetts 02109, acts as
Custodian for assets of the Company's Developing Capital Markets Focus Fund.
TRANSFER AND DIVIDEND DISBURSING AGENT
Merrill Lynch Financial Data Services, Inc. ("MLFDS"), which is a wholly
owned subsidiary of Merrill Lynch & Co., Inc., acts as the Company's Transfer
Agent and is responsible for the issuance, transfer and redemption of shares
and the opening and maintenance of shareholder accounts. MLFDS will receive an
annual fee of $5,000 per Fund and will be entitled to reimbursement of out-of-
pocket expenses.
LEGAL COUNSEL
Rogers & Wells, New York, New York, is counsel for the Company.
REPORTS TO SHAREHOLDERS
The fiscal year of the Company ends on December 31 of each year. The Company
will send to its shareholders at least semi-annually reports showing the
Funds' portfolio securities and other information. An annual report containing
financial statements, audited by independent auditors, will be sent to
shareholders each year.
ADDITIONAL INFORMATION
This Prospectus does not contain all of the information included in the
Registration Statement filed with the Securities and Exchange Commission under
the Securities Act of 1933 and the Investment Company Act of 1940, with
respect to the securities offered hereby, certain portions of which have been
omitted pursuant to the rules and regulations of the Securities and Exchange
Commission.
The Statement of Additional Information, dated April 25, 1997, which forms a
part of the Registration Statement, is incorporated by reference into this
Prospectus. The Statement of Additional Information may be obtained without
charge as provided on the cover page of this Prospectus. The Registration
Statement, including the exhibits filed therewith, may be examined at the
office of the Securities and Exchange Commission in Washington, D.C.
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APPENDIX A
U.S. GOVERNMENT SECURITIES
For temporary or defensive purposes, each Fund may invest in the various
types of marketable securities issued by or guaranteed as to principal and
interest by the U.S. Government and supported by the full faith and credit of
the U.S. Treasury. U.S. Treasury obligations differ mainly in the length of
their maturity. Treasury bills, the most frequently issued marketable
government security, have a maturity of up to one year and are issued on a
discount basis.
GOVERNMENT AGENCY SECURITIES
For temporary or defensive purposes, each Fund may invest in government
agency securities, which are debt securities issued by government sponsored
enterprises, federal agencies and international institutions. Such securities
are not direct obligations of the Treasury but involve government sponsorship
or guarantees by government agencies or enterprises. The Funds may invest in
all types of government agency securities currently outstanding or to be
issued in the future.
DEPOSITORY INSTITUTIONS MONEY INSTRUMENTS
For temporary or defensive purposes, each Fund may invest in depositary
institutions money instruments, such as certificates of deposit, including
variable rate certificates of deposit, bankers' acceptances, time deposits and
bank notes. Certificates of deposit are generally short-term, interest-bearing
negotiable certificates issued by commercial banks, savings banks or savings
and loan associations against funds deposited in the issuing institution.
Variable rate certificates of deposit are certificates of deposit on which the
interest rate is periodically adjusted prior to their stated maturity, usually
at 30, 90 or 180 day intervals ("coupon dates"), based upon a specified market
rate. As a result of these adjustments, the interest rate on these obligations
may be increased or decreased periodically. Often, dealers selling variable
rate certificates of deposit to the Funds agree to repurchase such
instruments, at the Funds' option, at par on the coupon dates. The dealers'
obligations to repurchase these instruments are subject to conditions imposed
by the various dealers; such conditions typically are the continued credit
standing of the issuer and the existence of reasonably orderly market
conditions. The Funds are also able to sell variable rate certificates of
deposit in the secondary market. Variable rate certificates of deposit
normally carry a higher interest rate than comparable fixed rate certificates
of deposit because variable rate certificates of deposit generally have a
longer stated maturity than comparable fixed rate certificates of deposit. As
a matter of policy, the Domestic Money Market Fund will invest only in these
types of instruments issued by U.S. issuers.
A bankers' acceptance is a time draft drawn on a commercial bank by a
borrower usually in connection with an international commercial transaction
(to finance the import, export, transfer or storage of goods). The borrower is
liable for payment as well as the bank, which unconditionally guarantees to
pay the draft at its face amount on the maturity date. Most acceptances have
maturities of six months or less and are traded in secondary markets prior to
maturity.
For temporary or defensive purposes, the Developing Capital Markets Focus
Fund may invest in certificates of deposit and bankers' acceptances issued by
foreign branches or subsidiaries of U.S. banks ("Eurodollar" obligations) or
U.S. branches or subsidiaries of foreign banks ("Yankeedollar" obligations).
The Fund may invest only in Eurodollar obligations which by their terms are
general obligations of the U.S. parent bank and meet the other criteria
discussed below. Yankeedollar obligations in which the Fund may invest must be
issued by U.S. branches or subsidiaries of foreign banks which are subject to
state or federal banking regulations in the U.S. and by their terms must be
general obligations of the foreign parent. In addition, the Fund will limit
its investments in Yankeedollar obligations to obligations issued by banking
institutions with more than $1 billion in assets.
For temporary or defensive purposes, the Developing Capital Markets Focus
Fund may also invest in U.S. dollar-denominated obligations of foreign
depository institutions and their foreign branches and subsidiaries, such as
certificates of deposit, bankers' acceptances, time deposits and deposit
notes. The obligations of such foreign branches and subsidiaries may be the
general obligation of the parent bank or may be limited to the issuing branch
or subsidiary by the terms of the specific obligation or by government
regulation.
A-1
<PAGE>
Except as otherwise provided above with respect to investment in
Yankeedollar and other foreign bank obligations no Fund may invest in any bank
money instrument issued by a commercial bank or a savings and loan association
unless the bank or association is organized and operating in the United
States, has total assets of at least $1 billion and its deposits are insured
by the Federal Deposit Insurance Corporation (the "FDIC"); provided that this
limitation shall not prohibit the investment of up to 10% of the total assets
of a Fund (taken at market value at the time of each investment) in
certificates of deposit issued by banks and savings and loan associations with
assets of less than $1 billion if the principal amount of each such
certificate of deposit is fully insured by the FDIC.
SHORT-TERM DEBT INSTRUMENTS
For temporary or defensive purposes, each Fund may invest in commercial
paper (including variable amount master demand notes and insurance company
funding agreements), which refers to short-term, unsecured promissory notes
issued by corporations, partnerships, trusts and other entities to finance
short-term credit needs and by trusts issuing asset-backed commercial paper.
Commercial paper is usually sold on a discount basis and has a maturity at the
time of issuance not exceeding nine months. Variable amount master demand
notes are demand obligations that permit the investment of fluctuating amounts
at varying market rates of interest pursuant to arrangements 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 notes are direct
lending arrangements between the lender and borrower, it is not generally
contemplated that such instruments will be traded and there is no secondary
market for the notes. Typically, agreements relating to such notes provide
that the lender may not sell or otherwise transfer the note without the
borrower's consent. Such notes provide that the interest rate on the amount
outstanding is adjusted periodically, typically on a daily basis, in
accordance with a stated short-term interest rate benchmark. Because the
interest rate of a variable amount master note is adjusted no less often than
every 60 days and since repayment of the note may be demanded at any time, the
Investment Adviser values such a note in accordance with the amortized cost
basis described under "Determination of Net Asset Value" in the Statement of
Additional Information.
For temporary or defensive purposes, the Developing Capital Markets Focus
Fund may also invest in U.S. dollar-denominated commercial paper and other
short-term obligations issued by foreign entities. Such investments are
subject to quality standards similar to those applicable to investments in
comparable obligations of domestic issuers. Investments in foreign entities in
general involve the same risks as those described in the Statement of
Additional Information in connection with investments in Eurodollar,
Yankeedollar and foreign bank obligations.
REPURCHASE AGREEMENTS
Repurchase Agreements; Purchase and Sale Contracts. Each Fund may invest in
securities pursuant to repurchase agreements or purchase and sale contracts.
Under a repurchase agreement, the seller agrees, upon entering into the
contract with the Fund, to repurchase a security (typically a security issued
or guaranteed by the U.S. government) at a mutually agreed upon time and
price, thereby determining the yield during the term of the agreement. This
results in a fixed yield for the Fund insulated from fluctuations in the
market value of the underlying security during such period, although, to the
extent the repurchase agreement is not denominated in U.S. dollars, the Fund's
return may be affected by currency fluctuations. Repurchase agreements may be
entered into only with a member bank of the Federal Reserve System, a primary
dealer in U.S. government securities or an affiliate thereof. A purchase and
sale contract is similar to a repurchase agreement, but purchase and sale
contracts, unlike repurchase agreements, allocate interest on the underlying
security to the purchaser during the term of the agreement and generally do
not require the seller to provide additional securities in the event of a
decline in the market value of the purchased security during the term of the
agreement. If the seller were to default on its obligation to repurchase a
security under a repurchase agreement or purchase and sale contract and the
market value of the underlying security at such time was less than the Fund
had paid to the seller, the Fund would realize a loss. Repurchase agreements
maturing in more than seven days will be considered "illiquid securities."
A-2
<PAGE>
DESCRIPTION OF CORPORATE BOND RATINGS
Moody's Investors Service, Inc.:
Aaa--Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to
as "gilt-edge." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized
are most unlikely to impair the fundamentally strong position of such
issues.
Aa--Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally
known as high-grade bonds. They are rated lower than the best bonds because
margins of protection may not be as large as in Aaa securities or
fluctuation of protective elements may be of greater amplitude or there may
be other elements present which make the long-term risks appear somewhat
larger than in Aaa securities.
A--Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper medium-grade obligations. Factors giving
security to principal and interest are considered adequate but elements may
be present which suggest a susceptibility to impairment sometime in the
future.
Baa--Bonds which are rated Baa are considered 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 length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
Ba--Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well assured. Often the protection of
interest and principal payments may be very moderate and thereby not well
safeguarded both during good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B--Bonds which are rated B generally lack characteristics of a desirable
investment. Assurance of interest and principal payments or of maintenance
of other terms of the contract over any period of time may be small.
Caa--Bonds which are rated Caa are of poor standing. Such issues may be
in default or there may be present elements of danger with respect to
principal or interest.
Ca--Bonds which are rated Ca represent obligations which are speculative
in a high degree. Such issues are often in default or have other market
shortcomings.
C--Bonds which are rated C are the lowest rated class of bonds and issues
so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Note: Moody's applies numerical modifiers, 1, 2 and 3 in each generic rating
classification from Aa through B in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the
modifier 3 indicates that the issue ranks in the lower end of its generic
rating category.
Standard & Poor's Corporation:
AAA--This is the highest rating assigned by Standard & Poor's to a debt
obligation and indicates an extremely strong capacity to pay principal and
interest.
AA--Bonds rated AA also qualify as high-quality debt obligations.
Capacity to pay principal and interest is very strong, and in the majority
of instances they differ from AAA issues only in small degree.
A--Bonds rated A have a strong capacity to pay principal and interest,
although they are somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions.
BBB--Bonds rated BBB are regarded as having an adequate capacity to pay
principal and interest. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay principal and interest for
bonds in this category than for bonds in the A category.
A-3
<PAGE>
BB--B--CCC--CC--Bonds rated BB, B, CCC, and CC are regarded, on balance,
as predominantly speculative with respect to the issuer's capacity to pay
interest and repay principal in accordance with the terms of the
obligations. BB indicates the lowest degree of speculation and CC the
highest degree of speculation. While such bonds will likely have some
quality and protective characteristics, these are outweighed by large
uncertainties or major risk exposures to adverse conditions.
NR--Not rated by the indicated rating agency.
Plus (+) or Minus (-): The ratings from "AA" to "B" may be modified by
the addition of a plus or minus sign to show relative standing within the
major rating categories.
A-4
<PAGE>
APPENDIX B
Certain Funds of the Company are authorized to use derivative instruments,
including options, and futures, and to purchase and sell foreign exchange, as
described below. Such instruments are referred to collectively herein as
"Strategic Instruments."
OPTIONS ON SECURITIES AND SECURITIES INDICES
Purchasing Options. The Developing Capital Markets Focus Fund is authorized
to purchase put options on securities held in its portfolio or securities
indices the performance of which is substantially correlated with securities
held in its portfolio. When the Fund purchases a put option, in consideration
for an upfront payment (the "option premium") the Fund acquires a right to
sell to another party specified securities owned by the Fund at a specified
price (the "exercise price") on or before a specified date (the "expiration
date"), in the case of an option on securities, or to receive from another
party a payment based on the amount a specified securities index declines
below a specified level on or before the expiration date, in the case of an
option on a securities index. The purchase of a put option limits the Fund's
risk of loss in the event of a decline in the market value of the portfolio
holdings underlying the put option prior to the option's expiration date. If
the market value of the portfolio holdings associated with the put option
increases rather than decreases, however, the Fund will lose the option
premium and will consequently realize a lower return on the portfolio holdings
than would have been realized without the purchase of the put.
The Developing Capital Markets Focus Fund is authorized to purchase call
options on securities it intends to purchase or securities indices the
performance of which are substantially correlated with the performance of the
types of securities it intends to purchase. When the Fund purchases a call
option, in consideration for the option premium the Fund acquires a right to
purchase from another party specified securities at the exercise price on or
before the expiration date, in the case of an option on securities, or to
receive from another party a payment based on the amount a specified
securities index increases beyond a specified level on or before the
expiration date, in the case of an option on a securities index. The purchase
of a call option may protect the Fund from having to pay more for a security
as a consequence of increases in the market value for the security during a
period when the Fund is contemplating its purchase, in the case of an option
on a security, or attempting to identify specific securities in which to
invest in a market the Fund believes to be attractive, in the case of an
option on an index (an "anticipatory hedge"). In the event the Fund determines
not to purchase a security underlying a call option, however, the Fund may
lose the entire option premium.
The Developing Capital Markets Focus Fund is also authorized to purchase put
or call options in connection with closing out put or call options it has
previously sold.
Writing Options. The Basic Value Focus Fund and the Developing Capital
Markets Focus Fundare each authorized to write (i.e., sell) call options on
securities held in its portfolio or securities indices the performance of
which is substantially correlated with securities held in its portfolio. When
a Fund writes a call option, in return for an option premium the Fund gives
another party the right to buy specified securities owned by the Fund at the
exercise price on or before the expiration date, in the case of an option on
securities, or agrees to pay to another party an amount based on any gain in a
specified securities index beyond a specified level on or before the
expiration date, in the case of an option on a securities index. The Fund may
write call options to earn income, through the receipt of option premiums. In
the event the party to which the Fund has written an option fails to exercise
its rights under the option because the value of the underlying securities is
less than the exercise price, the Fund will partially offset any decline in
the value of the underlying securities through the receipt of the option
premium. By writing a call option, however, the Fund limits its ability to
sell the underlying securities, and gives up the opportunity to profit from
any increase in the value of the underlying securities beyond the exercise
price, while the option remains outstanding.
The Developing Capital Markets Focus Fund may also write put options on
securities or securities indices. When the Fund writes a put option, in return
for an option premium the Fund gives another party the right to sell to the
Fund a specified security at the exercise price on or before the expiration
date, in the case of an option on a security, or agrees to pay to another
party an amount based on any decline in a specified securities index below
B-1
<PAGE>
a specified level on or before the expiration date, in the case of an option
on a securities index. The Fund may write put options to earn income, through
the receipt of option premiums. In the event the party to which the Fund has
written an option fails to exercise its rights under the option because the
value of the underlying securities is greater than the exercise price, the
Fund will profit by the amount of the option premium. By writing a put option,
however, the Fund will be obligated to purchase the underlying security at a
price that may be higher than the market value of the security at the time of
exercise as long as the put option is outstanding, in the case of an option on
a security, or make a cash payment reflecting any decline in the index, in the
case of an option on an index. Accordingly, when the Fund writes a put option
it is exposed to a risk of loss in the event the value of the underlying
securities falls below the exercise price, which loss potentially may
substantially exceed the amount of option premium received by the Fund for
writing the put option. The Fund will write a put option on a security or a
securities index only if the Fund would be willing to purchase the security at
the exercise price for investment purposes (in the case of an option on a
security) or is writing the put in connection with trading strategies
involving combinations of options--for example, the sale and purchase of
options with identical expiration dates on the same security or index but
different exercise prices (a technique called a "spread").
The Developing Capital Markets Focus Fund is also authorized to sell call or
put options in connection with closing out call or put options it has
previously purchased.
Other than with respect to closing transactions, a Fund will only write call
or put options that are "covered." A call or put option will be considered
covered if the Fund has segregated assets with respect to such option in the
manner described in "Risk Factors in Options, Futures, and Currency
Instruments" below. A call option will also be considered covered if a Fund
owns the securities it would be required to deliver upon exercise of the
option (or, in the case of option on a securities index, securities which are
substantially correlated with the performance of such index) or owns a call
option, warrant or convertible instrument which is immediately exercisable
for, or convertible into, such security.
Types of Options. A Fund may engage in transactions in options on securities
or securities indices on exchanges and in the over-the-counter ("OTC")
markets. In general, exchange-traded options have standardized exercise prices
and expiration dates and require the parties to post margin against their
obligations, and the performance of the parties' obligations in connection
with such options is guaranteed by the exchange or a related clearing
corporation. OTC options have more flexible terms negotiated between the buyer
and the seller, but generally do not require the parties to post margin and
are subject to greater risk of counterparty default. See "Additional Risk
Factors of OTC Transactions" below.
FUTURES
The Developing Capital Markets Focus Fund may engage in transactions in
futures and options thereon. Futures are standardized, exchange-traded
contracts which obligate a purchaser to take delivery, and a seller to make
delivery, of a specific amount of a commodity at a specified future date at a
specified price. No price is paid upon entering into a futures contract.
Rather, upon purchasing or selling a futures contract the Fund is required to
deposit collateral ("margin") equal to a percentage (generally less than 10%)
of the contract value. Each day thereafter until the futures position is
closed, the Fund will pay additional margin representing any loss experienced
as a result of the futures position the prior day or be entitled to a payment
representing any profit experienced as a result of the futures position the
prior day.
The sale of a futures contract limits the Fund's risk of loss through a
decline in the market value of portfolio holdings correlated with the futures
contract prior to the futures contract's expiration date. In the event the
market value of the portfolio holdings correlated with the futures contract
increases rather than decreases, however, the Fund will realize a loss on the
futures position and a lower return on the portfolio holdings than would have
been realized without the purchase of the futures contract.
The purchase of a futures contract may protect the Fund from having to pay
more for securities as a consequence of increases in the market value for such
securities during a period when the Fund was attempting to identify specific
securities in which to invest in a market the Fund believes to be attractive.
In the event that such securities decline in value or the Fund determines not
to complete an anticipatory hedge transaction relating to a futures contract,
however, the Fund may realize a loss relating to the futures position.
B-2
<PAGE>
The Fund will limit transactions in futures and options on futures to
financial futures contracts (i.e., contracts for which the underlying
commodity is a currency or securities or interest rate index) purchased or
sold for hedging purposes (including anticipatory hedges). The Fund will
further limit transactions in futures and options on futures to the extent
necessary to prevent the Fund from being deemed a "commodity pool" under
regulations of the Commodity Futures Trading Commission.
FOREIGN EXCHANGE TRANSACTIONS
The Developing Capital Markets Focus Fund may engage in spot and forward
foreign exchange transactions and currency swaps, purchase and sell options on
currencies and purchase and sell currency futures and related options thereon
(collectively, "Currency Instruments") for purposes of hedging against the
decline in the value of currencies in which its portfolio holdings are
denominated against the US dollar.
Forward foreign exchange transactions are OTC contracts to purchase or sell
a specified amount of a specified currency or multinational currency unit at a
price and future date set at the time of the contract. Spot foreign exchange
transactions are similar but require current, rather than future, settlement.
The Fund will enter into foreign exchange transactions only for purposes of
hedging either a specific transaction or a portfolio position. The Fund may
enter into a foreign exchange transaction for purposes of hedging a specific
transaction by, for example, purchasing a currency needed to settle a security
transaction or selling a currency in which the Fund has received or
anticipates receiving a dividend or distribution. A Fund may enter into a
foreign exchange transaction for purposes of hedging a portfolio position by
selling forward a currency in which a portfolio position of the Fund is
denominated or by purchasing a currency in which the Fund anticipates
acquiring a portfolio position in the near future. The Fund may also hedge
portfolio positions through currency swaps, which are transactions in which
one currency is simultaneously bought for a second currency on a spot basis
and sold for the second currency on a forward basis.
The Fund may also hedge against the decline in the value of a currency
against the US dollar through use of currency futures or options thereon.
Currency futures are similar to forward foreign exchange transactions except
that futures are standardized exchange-traded contracts. See "Futures" above.
The Fund may also hedge against the decline in the value of a currency
against the US dollar through the use of currency options. Currency options
are similar to options on securities, but in consideration for an option
premium the writer of a currency option is obligated to sell (in the case of a
call option) or purchase (in the case of a put option) a specified amount of a
specified currency on or before the expiration date for a specified amount of
another currency. The Fund may engage in transactions in options on currencies
either on exchanges or OTC markets. See "Types of Options" above and
"Additional Risk Factors of OTC Transactions" below.
The Fund will not speculate in Currency Instruments. Accordingly, the Fund
will not hedge a currency in excess of the aggregate market value of the
securities which it owns (including receivables for unsettled securities
sales), or has committed to or anticipates purchasing, which are denominated
in such currency. The Fund may, however, hedge a currency by entering into a
transaction in a Currency Instrument denominated in a currency other than the
currency being hedged (a "cross-hedge"). The Fund will only enter into a
cross-hedge if the Investment Adviser believes that (i) there is a
demonstrable high correlation between the currency in which the cross-hedge is
denominated and the currency being hedged, and (ii) executing a cross-hedge
through the currency in which the cross-hedge is denominated will be
significantly more cost-effective or provide substantially greater liquidity
than executing a similar hedging transaction by means of the currency being
hedged.
Risk Factors in Hedging Foreign Currency Risks. While a Fund's use of
Currency Instruments to effect hedging strategies is intended to reduce the
volatility of the net asset value of the Fund's shares, the net asset value of
the Fund's shares will fluctuate. Moreover, although Currency Instruments will
be used with the intention of hedging against adverse currency movements,
transactions in Currency Instruments involve the risk that anticipated
currency movements will not be accurately predicted and that the Fund's
hedging strategies will be ineffective. To the extent that a Fund hedges
against anticipated currency movements which do not occur, the Fund may
realize losses, and decrease its total return, as the result of its hedging
transactions. Furthermore, a
B-3
<PAGE>
Fund will only engage in hedging activities from time to time and may not be
engaging in hedging activities when movements in currency exchange rates
occur. It may not be possible for a Fund to hedge against currency exchange
rate movements, even if correctly anticipated, in the event that (i) the
currency exchange rate movement is so generally anticipated that the Fund is
not able to enter into a hedging transaction at an effective price, or (ii)
the currency exchange rate movement relates to a market with respect to which
Currency Instruments are not available (such as certain developing markets)
and it is not possible to engage in effective foreign currency hedging.
RISK FACTORS IN OPTIONS, FUTURES, AND CURRENCY INSTRUMENTS
Use of Strategic Instruments for hedging purposes involves the risk of
imperfect correlation in movements in the value of the Strategic Instruments
and the value of the instruments being hedged. If the value of the Strategic
Instruments moves more or less than the value of the hedged instruments a Fund
will experience a gain or loss which will not be completely offset by
movements in the value of the hedged instruments.
Each Fund intends to enter into transactions involving Strategic Instruments
only if there appears to be a liquid secondary market for such instruments or,
in the case of illiquid instruments traded in OTC transactions, such
instruments satisfy the criteria set forth below under "Additional Risk
Factors of OTC Transactions." However, there can be no assurance that, at any
specific time, either a liquid secondary market will exist for a Strategic
Instrument or the Fund will otherwise be able to sell such instrument at an
acceptable price. It may therefore not be possible to close a position in a
Strategic Instrument without incurring substantial losses, if at all.
Certain transactions in Strategic Instruments (e.g., forward foreign
exchange transactions, futures transactions, sales of put options) may expose
a Fund to potential losses which exceed the amount originally invested by the
Fund in such instruments. When a Fund engages in such a transaction, the Fund
will deposit in a segregated account at its custodian liquid securities with a
value at least equal to the Fund's exposure, on a mark-to-market basis, to the
transaction (as calculated pursuant to requirements of the Securities and
Exchange Commission). Such segregation will ensure that the Fund has assets
available to satisfy its obligations with respect to the transaction, but will
not limit the Fund's exposure to loss.
ADDITIONAL RISK FACTORS OF OTC TRANSACTIONS; LIMITATIONS ON THE USE OF OTC
STRATEGIC INSTRUMENTS
Certain Strategic Instruments traded in OTC markets, including indexed
securities and OTC options, may be substantially less liquid than other
instruments in which a Fund may invest. The absence of liquidity may make it
difficult or impossible for the Fund to sell such instruments promptly at an
acceptable price. The absence of liquidity may also make it more difficult for
the Fund to ascertain a market value for such instruments. A Fund will
therefore acquire illiquid OTC instruments (i) if the agreement pursuant to
which the instrument is purchased contains a formula price at which the
instrument may be terminated or sold, or (ii) for which the Investment Adviser
anticipates the Fund can receive on each business day at least two independent
bids or offers, unless a quotation from only one dealer is available, in which
case that dealer's quotation may be used.
The staff of the Securities and Exchange Commission has taken the position
that purchased OTC options and the assets underlying written OTC options are
illiquid securities. Each Fund has therefore adopted an investment policy
pursuant to which it will not purchase or sell OTC options (including OTC
options on futures contracts) if, as a result of such transactions, the sum of
the market value of OTC options currently outstanding which are held by the
Fund, the market value of the securities underlying OTC call options currently
outstanding which have been sold by the Fund and margin deposits on the Fund's
outstanding OTC options exceeds 15% of the total assets of the Fund, taken at
market value, together with all other assets of the Fund which are deemed to
be illiquid or are otherwise not readily marketable. However, if an OTC option
is sold by the Fund to a dealer in U.S. government securities recognized as a
"primary dealer" by the Federal Reserve Bank of New York and the Fund has the
unconditional contractual right to repurchase such OTC option at a
predetermined price, then the Fund will treat as illiquid such amount of the
underlying securities as is equal to the repurchase price less the amount by
which the option is "in-the-money" (i.e., current market value of the
underlying security minus the option's exercise price).
B-4
<PAGE>
Because Strategic Instruments traded in OTC markets are not guaranteed by an
exchange or clearing corporation and generally do not require payment of
margin to the extent that a Fund has unrealized gains in such instruments or
has deposited collateral with its counterparty, the Fund is at risk that its
counterparty will become bankrupt or otherwise fail to honor its obligations.
A Fund will attempt to minimize the risk that a counterparty will become
bankrupt or otherwise fail to honor its obligations by engaging in
transactions in Strategic Instruments traded in OTC markets only with
financial institutions which have substantial capital or which have provided
the Fund with a third-party guaranty or other credit enhancement.
ADDITIONAL LIMITATIONS ON THE USE OF STRATEGIC INSTRUMENTS
No Fund may use any Strategic Instrument to gain exposure to an asset or
class of assets that it would be prohibited by its investment restrictions
from purchasing directly.
B-5
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
THE ENDEAVOR ML VARIABLE ANNUITY
Issued through
PFL ENDEAVOR VARIABLE
ANNUITY ACCOUNT
Offered by
PFL LIFE INSURANCE COMPANY
4333 Edgewood Road, N.E.
Cedar Rapids, Iowa 52499-0001
This Statement of Additional Information expands upon subjects discussed in
the current Prospectus for the Endeavor ML Variable Annuity (the "Policy")
offered by PFL Life Insurance Company. You may obtain a copy of the Prospectus
dated May 1, 1997 by calling 1-800-525-6205, or by writing to the Administrative
and Service Office, Financial Markets Division--Variable Annuity Dept., 4333
Edgewood Road, N.E., Cedar Rapids, Iowa 52499-0001. Terms used in the current
Prospectus for the Policy are incorporated in this Statement of Additional
Information.
THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT A PROSPECTUS AND SHOULD BE
READ ONLY IN CONJUNCTION WITH THE PROSPECTUSES FOR THE POLICY, ENDEAVOR SERIES
TRUST, THE GROWTH PORTFOLIO OF THE WRL SERIES FUND, INC., AND THE MERRILL LYNCH
VARIABLE SERIES FUNDS, INC.
Dated: May 1, 1997
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
<S> <C>
The Policy--General Provisions.......................................... 3
Owner.............................................................. 3
Entire Policy...................................................... 3
Delay of Payment and Transfers..................................... 3
Misstatement of Age or Sex......................................... 4
Reallocation of Policy Values After the Annuity Commencement Date.. 4
Assignment......................................................... 4
Evidence of Survival............................................... 4
Non-Participating.................................................. 5
Amendments......................................................... 5
Federal Tax Matters (49)................................................ 5
Tax Status of the Policy........................................... 5
Taxation of PFL.................................................... 6
Investment Experience................................................... 6
State Regulation of PFL................................................. 11
Administration.......................................................... 11
Records and Reports..................................................... 11
Distribution of the Policies (55)....................................... 11
Custody of Assets....................................................... 11
Historical Performance Data (19)........................................ 12
Money Market Yields................................................ 12
Other Subaccount Yields............................................ 13
Total Returns...................................................... 13
Other Performance Data............................................. 14
Hypothetical Performance Data...................................... 14
Legal Matters........................................................... 15
Independent Auditors.................................................... 15
Other Information....................................................... 15
Financial Statements (18)............................................... 15
</TABLE>
(Numbers in parenthesis indicate corresponding pages of the Prospectus).
2
<PAGE>
In order to supplement the description in the Prospectus, the following
provides additional information about PFL and the Policy which may be of
interest to an Owner.
THE POLICY--GENERAL PROVISIONS
Owner
The Policy shall belong to the Owner upon issuance of the Policy after
completion of an application and delivery of the initial Premium Payment. While
the Annuitant is living, the Owner may: (1) assign the Policy; (2) surrender the
Policy; (3) amend or modify the Policy with PFL's consent; (4) receive annuity
payments or name a Payee to receive the payments; and (5) exercise, receive and
enjoy every other right and benefit contained in the Policy. The exercise of
these rights may be subject to the consent of any assignee or irrevocable
Beneficiary; and of the Owner's spouse in a community of marital property state.
A Successor Owner can be named in the Policy application or in a Written
Notice. The Successor Owner will become the new Owner upon the Owner's death, if
the Owner predeceases the Annuitant. If no Successor Owner survives the Owner
and the Owner predeceases the Annuitant, the Owner's estate will become the
Owner.
The Owner may change the ownership of the Policy in a Written Notice. When
this change takes effect, all rights of ownership in the Policy will pass to the
new Owner. A change of ownership may have adverse tax consequences.
When there is a change of Owner or Successor Owner, the change will take
effect as of the date the Owner signs the Written Notice, subject to any payment
PFL has made or action PFL has taken before recording the change. Changing the
Owner or naming a new Successor Owner cancels any prior choice of Successor
Owner, but does not change the designation of the Beneficiary or the Annuitant.
If ownership is transferred (except to the Owner's spouse) because the
Owner dies before the Annuitant, the Cash Value generally must be distributed to
the Successor Owner within five years of the Owner's death, or payments must be
made for a period certain or for the Successor Owner's lifetime so long as any
period certain does not exceed that Successor Owner's life expectancy, if the
first payment begins within one year of the Owner's death.
Entire Policy
The Policy and any endorsements thereon and the Policy application
constitute the entire contract between PFL and the Owner. All statements in the
application are representations and not warranties. No statement will cause the
Policy to be void or to be used in defense of a claim unless contained in the
application.
Delay of Payment and Transfers
Payment of any amount due from the Mutual Fund Account in respect of a
surrender, the Death Benefit or the death of the Owner of a Nonqualified Policy
generally will occur within seven business days from the date the Written Notice
(and any other required documentation or information) is received, except that
PFL may be permitted to defer such payment from the Mutual Fund Account if: (1)
the New York Stock Exchange is closed for other than usual weekends or holidays
or trading on the Exchange is otherwise restricted; or (2) an emergency exists
as defined by the SEC or the SEC requires that trading be restricted; or (3) the
SEC permits a delay for the protection of Owners. In addition, transfers of
amounts from the Subaccounts may be deferred under these circumstances.
3
<PAGE>
Certain delays and restrictions apply to transfers of amounts out of the
Fixed Account. See page 26 of the Policy Prospectus.
Misstatement of Age or Sex
If the age or sex of the Annuitant has been misstated, PFL will change the
annuity benefit payable to that which the Premium Payments would have purchased
for the correct age or sex. The dollar amount of any underpayment made by PFL
shall be paid in full with the next payment due such person or the Beneficiary.
The dollar amount of any overpayment made by PFL due to any misstatement shall
be deducted from payments subsequently accruing to such person or Beneficiary.
Any underpayment or overpayment will include interest at 5% per year, from the
date of the wrong payment to the date of the adjustment. The age of the
Annuitant may be established at any time by the submission of proof satisfactory
to PFL.
Reallocation of Annuity Purchase Values After the Annuity Commencement Date
After the Annuity Commencement Date, the Policy Owner may reallocate the
value of a designated number of Annuity Units of a Subaccount of the Mutual Fund
Account then credited to a Policy into an equal value of Annuity Units of one or
more other Subaccounts of the Mutual Fund Account, or the Fixed Account. The
reallocation shall be based on the relative value of the Annuity Units of the
Account(s) or Subaccount(s) at the end of the Business Day on the next payment
date. The minimum amount which may be reallocated is the lesser of (1) $10 of
monthly income or (2) the entire monthly income of the Annuity Units in the
Account or Subaccount from which the transfer is being made. If the monthly
income of the Annuity Units remaining in an Account or Subaccount after a
reallocation is less than $10, PFL reserves the right to include the value of
those Annuity Units as part of the transfer. The request must be in writing to
PFL's Administrative and Service Office. There is no charge assessed in
connection with such reallocation. PFL reserves the right to limit the number of
times a reallocation of Annuity Purchase Value may be made in any given Policy
Year.
Assignment
During the lifetime of the Annuitant the Policy Owner may assign any rights
or benefits provided by the Policy. An assignment will not be binding on PFL
until a copy has been filed at its Administrative and Service Office. The rights
and benefits of the Policy Owner and Beneficiary are subject to the rights of
the assignee. PFL assumes no responsibility for the validity or effect of any
assignment. Any claim made under an assignment shall be subject to proof of
interest and the extent of the assignment. An assignment may have tax
consequences.
Unless the Policy Owner so directs by filing written notice with PFL, no
Beneficiary may assign any payments under the Policy before they are due. To the
extent permitted by law, no payments will be subject to the claims of any
Beneficiary's creditors.
Evidence of Survival
PFL reserves the right to require satisfactory evidence that a person is
alive if a payment is based on that person being alive. No payment will be made
until PFL receives such evidence.
Non-Participating
4
<PAGE>
The Policy will not share in PFL's surplus earnings; no dividends will be
paid.
Amendments
No change in the Policy is valid unless made in writing by PFL and approved
by one of PFL's officers. No Registered Representative has authority to change
or waive any provision of the Policy.
PFL reserves the right to amend the Policies to meet the requirements of
the Code, regulations or published rulings. A Policy Owner can refuse such a
change by giving Written Notice, but a refusal may result in adverse tax
consequences.
FEDERAL TAX MATTERS
Tax Status of the Policy
Diversification Requirements. Section 817(h) of the Code provides that in
order for a variable contract which is based on a segregated asset account to
qualify as an annuity contract under the Code, the investments made by such
account must be "adequately diversified" in accordance with Treasury
regulations. The Treasury regulations issued under Section 817(h) (Treas. Reg.
ss. 1.817-5) apply a diversification requirement to each of the Subaccounts of
the Mutual Fund Account. The Mutual Fund Account, through the Underlying Funds
and their Portfolios, intends to comply with the diversification requirements of
the Treasury. PFL has entered into agreements regarding participation in Merrill
Lynch Variable Series Funds, Inc., the Endeavor Series Trust and WRL Series
Fund, Inc. that require the Underlying Funds and their Portfolios to be operated
in compliance with the Treasury regulations.
Owner Control. In certain circumstances, owners of variable annuity
contracts may be considered the owners, for Federal income tax purposes, of the
assets of the separate account used to support their contracts. In those
circumstances, income and gains from the separate account assets would be
includable in the variable annuity contractowner's gross income. Several years
ago, the IRS state in published rulings that a variable contract owner will be
considered the owner of separate account assets if the contractowner possesses
incidents of ownership in those assets, such as the ability to exercise
investment control over the assets. More recently, the Treasury Department
announced, in connection with the issuance of regulations concerning investment
diversification, that those regulations "do not provide guidance concerning the
circumstances in which investor control of the investments of a segregated asset
account may cause the investor, rather than the insurance company, to be treated
as the owner of the assets in the account." This announcement also stated that
guidance would be issued by way of regulations or rulings on the "extent to
which policyholders may direct their investments to particular subaccounts
without being treated as owners of underlying assets."
The ownership rights under the contract are similar to, but different
in certain respects from those described by the IRS in rulings in which it was
determined that contractowners were not owners of separate account assets. For
example, the Owner of a Policy has the choice of one or more Subaccounts in
which to allocate premiums and Policy Values, and may be able to transfer among
these accounts more frequently than in such rulings. These differences could
result in policyowners being treated as the owners of the assets of the Mutual
Fund Account. In addition, PFL does not know what standards will be set forth,
if any, in the regulations or rulings with the Treasury Department has stated it
expects to issue. PFL therefore reserves the right to modify the Policies as
necessary to attempt to prevent the policyowners from being considered the
owners of a pro rata share of the assets of the Mutual Fund Account.
Distribution Requirements. The Code also requires that Nonqualified
Policies contain specific provisions for distribution of Policy proceeds upon
the death of any Owner. In order to be treated as an annuity contract for
federal income tax purposes, the Code requires that such Policies provide that
if any Owner dies on or after the Annuity
5
<PAGE>
Commencement Date and before the entire interest in the Policy has been
distributed, the remaining portion must be distributed at least as rapidly as
under the method in effect on such Owner's death. If any Owner dies before the
Annuity Commencement Date, the entire interest in the Policy must generally be
distributed within 5 years after such Owner's date of death or be used to
purchase an immediate annuity under which payments will begin within one year of
such Owner's death and will be made for the life of the Beneficiary or for a
period not extending beyond the life expectancy of the Beneficiary. However, if
upon such Owner's death prior to the Annuity Commencement Death, such Owner's
surviving spouse becomes the sole new Owner under the Policy, then the Policy
may be continued with the surviving spouse as the new Owner. If any Owner is not
a natural person, then for purposes of these distribution requirements, the
primary Annuitant shall be treated as the Owner and any death or change of such
primary Annuitant shall be treated as the Death of the Owner. The Nonqualified
Policies contain provisions intended to comply with these requirements of the
Code. No regulations interpreting these requirements of the Code have yet been
issued and thus no assurance can be given that the provisions contained in the
Policies satisfy all such Code requirements. The provisions contained in the
Policies will be reviewed and modified if necessary to assure that they comply
with the Code requirements when clarified by regulation or otherwise.
Taxation of PFL
PFL at present is taxed as a life insurance company under part I of
Subchapter L of the Code. The Mutual Fund Account is treated as part of PFL and,
accordingly, will not be taxed separately as a "regulated investment company"
under Subchapter M of the Code. PFL does not expect to incur any federal income
tax liability with respect to investment income and net capital gains arising
from the activities of the Mutual Fund Account retained as part of the reserves
under the Policy. Based on this expectation, it is anticipated that no charges
will be made against the Mutual Fund Account for federal income taxes. If, in
future years, any federal income taxes are incurred by PFL with respect to the
Mutual Fund Account, PFL may make a charge to the Mutual Fund Account.
INVESTMENT EXPERIENCE
An "Investment Experience Factor" is used to determine the value of
Accumulation Units and Annuity Units, and to determine annuity payment rates.
Accumulation Units
Upon allocation to the selected Subaccount of the Mutual Fund Account,
Premium Payments are converted into Accumulation Units of the Subaccount. The
number of Accumulation Units to be credited is determined by dividing the dollar
amount allocated to each Subaccount by the value of an Accumulation Unit for
that Subaccount as next determined after the Premium Payment is received at the
Administrative and Service Office or, in the case of the initial Premium
Payment, when the Policy application is completed, whichever is later. The value
of an Accumulation Unit was arbitrarily established at $1 (except the WRL Growth
Subaccount which was established at $10) at the inception of each Subaccount.
Thereafter, the value of an Accumulation Unit is determined as of the close of
trading on each day the New York Stock Exchange and PFL's Administrative and
Service Office are open for business.
An index (the "Investment Experience Factor") which measures the investment
performance of a Subaccount during a Valuation Period is used to determine the
value of an Accumulation Unit for the next subsequent Valuation Period. The
Investment Experience Factor may be greater or less than or equal to one;
therefore, the value of an Accumulation Unit may increase, decrease or remain
the same from one Valuation Period to the next. The Policy Owner bears this
investment risk. The Net Investment Performance of a Subaccount and deduction of
certain charges affect the Accumulation Unit Value.
6
<PAGE>
The Investment Experience Factor for any Subaccount for any Valuation
Period is determined by dividing (a) by (b) and subtracting (c) from the result,
where:
(a) is the net result of:
(1) the net asset value per share of the shares held in the
Subaccount determined at the end of the current Valuation Period, plus
(2) The per share amount of any dividend or capital gain
distribution made with respect to the shares held in the Subaccount if
the ex-dividend date occurs during the current Valuation Period, plus
or minus
(3) a per share credit or charge for any taxes determined by PFL
to have resulted from the investment operations of the Subaccount.
(b) is the result of the net asset value per share of the shares held
in the Subaccount determined as of the end of the immediately preceding
Valuation Period.
(c) is the charge for Mortality and Expense Risk during the Valuation
Period (equal on an annual basis to 1.25% for both the 5% Annually
Compounding Death Benefit and the Annual Step-Up Death Benefit and 1.10%
for the Return of Premium Death Benefit) of the daily net asset value of
the Subaccount, plus the .15% Administrative Charge plus the Distribution
Financing Charge of .15%. The Distribution Financing Charge is assessed
only during the first seven Policy Years. The cumulative amount of the
Distribution Financing Charge, plus the Surrender Charge, will never exceed
8.5% of the cumulative Premium Payments for a Policy.
Illustration of Accumulation Unit Value Calculations
Formula and Illustration for Determining
the Investment Experience Factor
Assume either the 5% Annually Compounding Death Benefit
or the Annual Step-Up Death Benefit is in effect
Investment Experience Factor = (A + B - C) - E
---------
(D)
Where: A = The Net Asset Value of an Underlying Fund share as of the end of the
current Valuation Period.
Assume A = $11.57
B = The per share amount of any dividend or capital gains distribution
since the end of the immediately preceding Valuation Period.
Assume B = 0
C = The per share charge or credit for any taxes reserved for at
the end of the current Valuation Period.
Assume C = 0
7
<PAGE>
D = The Net Asset Value of an Underlying Fund share at the end of
the immediately preceding Valuation Period.
Assume D = $11.40
E = The daily deduction for the Mortality and Expense Risk Fee, the
Administrative Charge, and the Distribution Financing Charge, which
totals 1.55% on an annual basis for the first seven years and 1.40%
thereafter. On a daily basis, F equals .0000421409 for the first
seven years, and .0000380909 thereafter.
Then, the Investment Experience Factor =
(11.57 + 0 - 0) - .0000421409 = Z = 1.0148701398 for the first seven years and
-------------
(11.40)
(11.57 + 0 - 0) - .0000380909 = 1.0148741898 thereafter.
-------------
(11.40)
Formula and Illustration for Determining Accumulation Unit Value
Accumulation Unit Value = A x B
Where: A = The Accumulation Unit Value for the immediately preceding Valuation
Period.
Assume = $ X
B = The Net Investment Factor for the current Valuation Period.
Assume = Y
Then, the Accumulation Unit Value = $ X x Y = $ Z
Annuity Unit Value And Annuity Payment Rates
The amount of Variable Annuity Payments will vary with Annuity Unit Values.
Annuity Unit Values rise if the net investment performance of the Subaccount
exceeds the assumed interest rate of 5% annually. Conversely, Annuity Unit
Values fall if the net investment performance of the Subaccount is less than the
assumed rate. The value of a variable Annuity Unit in each Subaccount was
established at $1.00 on the date operations began for that Subaccount. The value
of a variable Annuity Unit on any subsequent Business Day is equal to (a)
multiplied by (b) multiplied by (c), where:
(a) is the variable Annuity Unit Value on the immediately preceding
Business Day;
(b) is the net investment factor of the valuation period; and
(c) is the investment result adjustment factor for the valuation period.
8
<PAGE>
The investment result adjustment factor for the valuation period is the
product of discount factors of .99986634 per day to recognize the 5% effective
annual Assumed Investment Return. The valuation period is the period from the
close of the immediately preceding Business Day to the close of the current
Business Day.
The net investment factor for the Policy used to calculate the value of a
variable Annuity Unit in each Subaccount for the valuation period is determined
by dividing (i) by (ii) and subtracting (iii) from the result, where:
(i) is the result of:
(1) the net asset value of a fund share held in the Mutual Fund
Account for that Subaccount determined at the end of the current
valuation period; plus
(2) the per share amount of any dividend or capital gain
distributions made by the fund for shares held in the Mutual Fund
Account for that Subaccount if the ex-dividend date occurs during the
valuation period.
(ii) is the net asset value of a fund share held in the Mutual Fund
Account for that Subaccount determined as of the end of the immediately
preceding valuation period.
(iii) is a factor representing the Mortality and Expense Risk Fee, the
Administrative Charge and the Distribution Financing Charge (only applies
during the first seven policy years and only applies before the Annuity
Commencement Date). This factor is equal, on an annual basis and assuming
the Distribution Financing Charge is still applicable, to 1.55% for the 5%
Annually Compounding Death Benefit and the Annual Step-Up Death Benefit
(1.40% for the Return of Premium Death Benefit) of the daily net asset
value of a fund share held in the Mutual Fund Account for that Subaccount.
The dollar amount of subsequent Variable Annuity Payments will depend upon
changes in applicable Annuity Unit Values.
The annuity payment rates vary according to the Annuity Option elected and
the sex and adjusted age of the Annuitant at the Annuity Commencement Date. The
Policy also contains a table for determining the adjusted age of the Annuitant.
Illustration of Calculations for Annuity Unit Value
and Variable Annuity Payments
Formula and Illustration for Determining Annuity Unit Value
Annuity Unit Value = A x B x C
Where: A = Annuity Unit Value for the immediately preceding Valuation Period.
Assume = $ X
B = Investment Experience Factor for the Valuation Period for which the
Annuity Unit Value is being calculated.
Assume = Y
C = A factor to neutralize the assumed interest rate of 5% built into
the Annuity Tables used.
Assume = Z
Then, the Annuity Unit Value is: $ X x Y x Z = $ Q
9
<PAGE>
Formula and Illustration for Determining Amount
of First Monthly Variable Annuity Payment
First Monthly Variable Annuity Payment = A x B
------
$1,000
Where: A = The Annuity Purchase Value as of the Annuity Commencement Date.
Assume = $ X
B = The Annuity purchase rate per $1,000 based upon the option
selected, the sex and adjusted age of the Annuitant according to the tables
contained in the Policy.
Assume = $ Y
Then, the first Monthly Variable Annuity Payment = $ X x $ Y = $ Z
-----
1,000
Formula and Illustration for Determining the Number of Annuity
Units Represented by Each Monthly Variable Annuity Payment
Number of Annuity Units = A
-
B
Where: A = The dollar amount of the first monthly Variable Annuity Payment.
Assume = $ X
B = The Annuity Unit Value for the Valuation Date on which the first
monthly payment is due.
Assume = $ Y
Then, the number of Annuity Units = $ X = Z
----
$ Y
10
<PAGE>
STATE REGULATION OF PFL
PFL is subject to the laws of Iowa governing insurance companies and to
regulation by the Iowa Division of Insurance. An annual statement in a
prescribed form is filed with the Division of Insurance each year covering the
operation of PFL for the preceding year and its financial condition as of the
end of such year. Regulation by the Division of Insurance includes periodic
examination to determine PFL's contract liabilities and reserves so that the
Division may determine the items are correct. PFL's books and accounts are
subject to review by the Division of Insurance at all times and a full
examination of its operations is conducted periodically by the National
Association of Insurance Commissioners. In addition, PFL is subject to
regulation under the insurance laws of other jurisdictions in which it may
operate.
ADMINISTRATION
PFL performs administrative services for the Policies. These services
include issuance of the Policies, maintenance of records concerning the
Policies, and certain valuation services.
RECORDS AND REPORTS
All records and accounts relating to the Mutual Fund Account will be
maintained by PFL. As presently required by the Investment Company Act of 1940
and regulations promulgated thereunder, PFL will mail to all Policy Owners at
their last known address of record, at least annually, reports containing such
information as may be required under that Act or by any other applicable law or
regulation. Policy Owners will also receive confirmation of each financial
transaction and any other reports required by law or regulation.
DISTRIBUTION OF THE POLICIES
The Policies are offered to the public through brokers licensed under the
federal securities laws and state insurance laws. The offering of the Policies
is continuous and PFL does not anticipate discontinuing the offering of the
Policies. However, PFL reserves the right to discontinue the offering of the
Policies. AEGON USA Securities, Inc., an affiliate of PFL, will be the principal
underwriter of the Policies. AEGON USA Securities, Inc. has entered into
agreements with broker-dealers for the distribution of the Policies.
CUSTODY OF ASSETS
The assets of each of the Subaccounts of the Mutual Fund Account are held
by PFL. The assets of each of the Subaccounts of the Mutual Fund Account are
segregated and held separate and apart from the assets of the other Subaccounts
and from PFL's general account assets. PFL maintains records of all purchases
and redemptions of shares of the Underlying Funds held by each of the
Subaccounts. Additional protection for the assets of the Mutual Fund Account is
afforded by PFL's fidelity bond, presently in the amount of $5,000,000, covering
the acts of officers and employees of PFL.
11
<PAGE>
HISTORICAL PERFORMANCE DATA
Money Market Yields
PFL may from time to time disclose the current annualized yield of the TCW
Money Market Subaccount, which invests in the TCW Money Market Portfolio, for a
7-day period in a manner which does not take into consideration any realized or
unrealized gains or losses on shares of the TCW Money Market Portfolio or on its
portfolio securities. This current annualized yield is computed by determining
the net change (exclusive of realized gains and losses on the sale of securities
and unrealized appreciation and depreciation) at the end of the 7-day period in
the value of a hypothetical account having a balance of 1 unit of the TCW Money
Market Subaccount at the beginning of the 7-day period, dividing such net change
in account value by the value of the account at the beginning of the period to
determine the base period return, and annualizing this quotient on a 365-day
basis. The net change in account value reflects (i) net income from the
Portfolio attributable to the hypothetical account; and (ii) charges and
deductions imposed under a Policy that are attributable to the hypothetical
account. The charges and deductions include the per unit charges for the
hypothetical account for (i) the Administrative Charges; and (ii) the Mortality
and Expense Risk Fee and Distribution Financing Charge. Current Yield will be
calculated according to the following formula:
Current Yield = ((NCS-ES)/UV) x (365/7)
Where:
NCS = The net change in the value of the Portfolio (exclusive of realized
gains and losses on the sale of securities and unrealized appreciation and
depreciation) for the 7-day period attributable to a hypothetical account
having a balance of 1 Subaccount unit.
ES = Per unit expenses of the Subaccount for the 7-day period.
UV = The unit value on the first day of the 7-day period.
Because of the charges and deductions imposed under a Policy, the yield for
the TCW Money Market Subaccount will be lower than the yield for the TCW Money
Market Portfolio. The yield calculations do not reflect the effect of any
premium taxes or Surrender Charges that may be applicable to a particular
Policy. Surrender Charges range from 7% to 0% of the amount of premium withdrawn
based on the number of years since payment of the premium.
PFL may also disclose the effective yield of the TCW Money Market
Subaccount for the same 7-day period, determined on a compounded basis. The
effective yield is calculated by compounding the base period return according to
the following formula:
Effective Yield = (1 + ((NCS - ES) / UV))/365/7/ - 1
Where:
NCS = The net change in the value of the Portfolio (exclusive of realized
gains and losses on the sale of securities and unrealized appreciation and
depreciation) for the 7-day period attributable to a hypothetical account
having a balance of 1 Subaccount unit.
ES = Per unit expenses of the Subaccount for the 7-day period.
UV = The unit value on the first day of the 7-day period.
12
<PAGE>
The yield on amounts held in the TCW Money Market Subaccount normally will
fluctuate on a daily basis. Therefore, the disclosed yield for any given past
period is not an indication or representation of future yields or rates of
return. The TCW Money Market Subaccount's actual yield is affected by changes in
interest rates on money market securities, average portfolio maturity of the TCW
Money Market Portfolio, the types and quality of portfolio securities held by
the TCW Money Market Portfolio and its operating expenses. For the seven days
ended December 31, 1996, the yield of the TCW Money Market Subaccount was 2.73%,
and the effective yield was 2.76%.
Other Subaccount Yields
PFL may from time to time advertise or disclose the current annualized
yield of one or more of the Subaccounts of the Mutual Fund Account (except the
TCW Money Market Subaccount) for 30-day periods. The annualized yield of a
Subaccount refers to income generated by the Subaccount over a specific 30-day
period. Because the yield is annualized, the yield generated by a Subaccount
during the 30-day period is assumed to be generated each 30-day period over a
12-month period. The yield is computed by: (i) dividing the net investment
income of the Subaccount less Subaccount expenses for the period, by (ii) the
maximum offering price per unit on the last day of the period times the daily
average number of units outstanding for the period, (iii) compounding that yield
for a 6-month period, and (iv) multiplying that result by 2. Expenses
attributable to the Subaccount include (i) the Administrative Charge and (ii)
the Mortality and Expense Risk Fee and Distribution Financing Charge. The 30-day
yield is calculated according to the following formula:
Yield = 2 x ((((NI - ES)/(U x UV)) + 1)/6/ - 1)
Where:
NI = Net investment income of the Subaccount for the 30-day period
attributable to the Subaccount's unit.
ES = Expenses of the Subaccount for the 30-day period.
U = The average number of units outstanding.
UV = The unit value at the close (highest) of the last day in the 30-day
period.
Because of the charges and deductions imposed by the Mutual Fund Account,
the yield for a Subaccount of the Mutual Fund Account will be lower than the
yield for its corresponding Portfolio. The yield calculations do not reflect the
effect of any premium taxes that may be applicable to a particular Policy.
Surrender Charges range from 7% to 0% of the amount of premium withdrawn based
on the number of years since payment of the premium.
The yield on amounts held in the Subaccounts of the Mutual Fund Account
normally will fluctuate over time. Therefore, the disclosed yield for any given
past period is not an indication or representation of future yields or rates of
return. A Subaccount's actual yield is affected by the types and quality of its
investments and its operating expenses.
Total Returns
PFL may from time to time also advertise or disclose total returns for one
or more of the Subaccounts of the Mutual Fund Account for various periods of
time. One of the periods of time will include the period measured from the date
the Subaccount commenced operations. When a Subaccount has been in operation for
1, 5 and 10 years, respectively, the total return for these periods will be
provided. Total returns for other periods of time may from
13
<PAGE>
time to time also be disclosed. Total returns represent the average annual
compounded rates of return that would equate an initial investment of $1,000 to
the redemption value of that investment as of the last day of each of the
periods. The ending date for each period for which total return quotations are
provided will be for the most recent month end practicable, considering the type
and media of the communication and will be stated in the communication.
Total returns will be calculated using Subaccount Unit Values which PFL
calculates on each Business Day based on the performance of the Subaccount's
underlying Portfolio, and the deductions for the Mortality and Expense Risk Fee,
the Distribution Financing Charge, and the Administrative Charge. Total return
calculations will reflect the effect of Surrender Charges that may be applicable
to a particular period. The total return will then be calculated according to
the following formula:
P(1 + T)/n/ = ERV
Where:
T = The average annual total return net of Subaccount recurring charges.
ERV = The ending redeemable value of the hypothetical account at the end of the
period.
P = A hypothetical initial payment of $1,000.
N = The number of years in the period.
Other Performance Data
PFL may from time to time also disclose average annual total returns in a
non-standard format in conjunction with the standard format described above. The
non-standard format will be identical to the standard format except that the
Surrender Charge percentage will be assumed to be 0%.
PFL may from time to time also disclose cumulative total returns in
conjunction with the standard format described above. The cumulative returns
will be calculated using the following formula assuming that the Surrender
Charge percentage will be 0%.
CTR = (ERV / P) - 1
Where:
CTR = The cumulative total return net of Subaccount recurring charges for the
period.
ERV = The ending redeemable value of the hypothetical investment at the end of
the period.
P = A hypothetical initial payment of $1,000.
All non-standard performance data will only be advertised if the standard
performance data for the same period, as well as for the required period, is
also disclosed.
Hypothetical Performance Data
From time to time, sales literature or advertisements may quote average
annual total returns for periods prior to the date the Mutual Fund Account
commenced operations. Such performance information for the Subaccounts will be
calculated based on the performance of the various Portfolios and the assumption
that the Subaccounts were in
14
<PAGE>
existence for the same periods as those indicated for the Portfolios, with the
level of Policy charges that were in effect at the inception of the Subaccounts.
LEGAL MATTERS
Legal advice relating to certain matters under the federal securities laws
applicable to the issue and sale of the Policies has been provided to PFL by
Sutherland, Asbill & Brennan L.L.P., of Washington D.C.
INDEPENDENT AUDITORS
The Financial Statements of PFL as of December 31, 1996 and 1995, and for
each of the three years in the period ended December 31, 1996, and the Financial
Statements of PFL Endeavor Variable Annuity Account (which comprises a portion
of the PFL Endeavor VA Separate Account) at December 31, 1996, and for each of
the two years in the period then ended, included in this Statement of Additional
Information have been audited by Ernst & Young LLP, Independent Auditors, 801
Grand Avenue, Suite 3400, Des Moines, Iowa, 50309-2764.
OTHER INFORMATION
A Registration Statement has been filed with the Securities and Exchange
Commission, under the Securities Act of 1933 as amended, with respect to the
Policies discussed in this Statement of Additional Information. Not all of the
information set forth in the Registration Statement, amendments and exhibits
thereto has been included in the Prospectus or this Statement of Additional
Information. Statements contained in the Prospectus and this Statement of
Additional Information concerning the content of the Policies and other legal
instruments are intended to be summaries. For a complete statement of the terms
of these documents, reference should be made to the instruments filed with the
Securities and Exchange Commission.
FINANCIAL STATEMENTS
The values of the interest of Policy Owners in the Mutual Fund Account will
be affected solely by the investment results of the selected Subaccount(s).
Financial Statements of PFL Endeavor Variable Annuity Account (which comprises a
portion of the PFL Endeavor VA Separate Account) are contained herein. The
Financial Statements of PFL, which are included in this Statement of Additional
Information, should be considered only as bearing on the ability of PFL to meet
its obligations under the Policies. They should not be considered as bearing on
the investment performance of the assets held in the Mutual Fund Account.
15
<PAGE>
- --------------------------------------------------------------------------------
THE PFL ENDEAVOR VARIABLE ANNUITY ACCOUNT
REPORT OF INDEPENDENT AUDITORS
THE BOARD OF DIRECTORS AND CONTRACT OWNERS OF
THE PFL ENDEAVOR VARIABLE ANNUITY ACCOUNT,
PFL LIFE INSURANCE COMPANY:
We have audited the accompanying balance sheet of The PFL Endeavor Variable
Annuity Account (comprising, respectively, the TCW Money Market, TCW Managed
Asset Allocation, T. Rowe Price International Stock, Value Equity, Dreyfus
Small Cap Value, Dreyfus U.S. Government Securities, T. Rowe Price Equity
Income, T. Rowe Price Growth Stock, Opportunity Value and Growth subaccounts)
as of December 31, 1996, and the related statements of operations and changes
in contract owners' equity for the periods indicated therein. These financial
statements are the responsibility of the Variable Account's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. Our
procedures included confirmation of mutual fund shares owned as of December 31,
1996 by correspondence with the mutual funds' transfer agent. An audit also
includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of each of the respective
subaccounts constituting The PFL Endeavor Variable Annuity Account at December
31, 1996, and the results of their operations and changes in their contract
owners' equity for the periods indicated therein in conformity with generally
accepted accounting principles.
Ernst & Young LLP
Des Moines, Iowa
January 31, 1997
16
<PAGE>
- --------------------------------------------------------------------------------
THE PFL ENDEAVOR VARIABLE ANNUITY ACCOUNT
BALANCE SHEET (AMOUNTS IN THOUSANDS)
December 31, 1996
<TABLE>
<CAPTION>
TCW
TCW MANAGED
MONEY ASSET
MARKET ALLOCATION
TOTAL SUBACCT. SUBACCT.
-------- -------- ----------
<S> <C> <C> <C>
ASSETS
Cash.............................................. $ 9 -- --
Investments in mutual funds, at current market
value (Note 2):
Endeavor Series Trust--TCW Money Market
Portfolio....................................... 30,542 30,542 --
Endeavor Series Trust--TCW Managed Asset
Allocation Portfolio............................ 229,142 -- 229,142
Endeavor Series Trust--T. Rowe Price
International Stock Portfolio................... 121,702 -- --
Endeavor Series Trust--Value Equity Portfolio.... 110,548 -- --
Endeavor Series Trust--Dreyfus Small Cap Value
Portfolio....................................... 76,482 -- --
Endeavor Series Trust--Dreyfus U.S. Government
Securities Portfolio............................ 19,823 -- --
Endeavor Series Trust--T. Rowe Price Equity
Income Portfolio................................ 64,935 -- --
Endeavor Series Trust--T. Rowe Price Growth Stock
Portfolio....................................... 48,731 -- --
Endeavor Series Trust--Opportunity Value
Portfolio....................................... 315 -- --
WRL Series Fund, Inc.--Growth Portfolio.......... 257,421 -- --
-------- ------ -------
Total investments in mutual funds................ 959,641 30,542 229,142
-------- ------ -------
Total Assets..................................... $959,650 30,542 229,142
======== ====== =======
LIABILITIES AND CONTRACT OWNERS' EQUITY
Liabilities:
Contract terminations payable.................... $ 2 -- 2
-------- ------ -------
Total Liabilities................................ 2 -- 2
Contract Owners' Equity:
Deferred annuity contracts terminable by owners
(Notes 3 and 6)................................. 959,648 30,542 229,140
-------- ------ -------
$959,650 30,542 229,142
======== ====== =======
</TABLE>
See accompanying Notes to Financial Statements.
17
<PAGE>
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
T. ROWE T. ROWE T. ROWE
PRICE DREYFUS DREYFUS U.S. PRICE PRICE
INT'L. VALUE SMALL CAP GOV'T. EQUITY GROWTH OPPORTUNITY
STOCK EQUITY VALUE SECURITIES INCOME STOCK VALUE GROWTH
SUBACCT. SUBACCT. SUBACCT. SUBACCT. SUBACCT. SUBACCT. SUBACCT. SUBACCT.
-------- -------- --------- ------------ -------- -------- ----------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
1 3 4 -- -- 1 -- --
-- -- -- -- -- -- -- --
-- -- -- -- -- -- -- --
121,702 -- -- -- -- -- -- --
-- 110,548 -- -- -- -- -- --
-- -- 76,482 -- -- -- -- --
-- -- -- 19,823 -- -- -- --
-- -- -- -- 64,935 -- -- --
-- -- -- -- -- 48,731 -- --
-- -- -- -- -- -- 315 --
-- -- -- -- -- -- -- 257,421
------- ------- ------ ------ ------ ------ --- -------
121,702 110,548 76,482 19,823 64,935 48,731 315 257,421
------- ------- ------ ------ ------ ------ --- -------
121,703 110,551 76,486 19,823 64,935 48,732 315 257,421
======= ======= ====== ====== ====== ====== === =======
-- -- -- -- -- -- -- --
------- ------- ------ ------ ------ ------ --- -------
-- -- -- -- -- -- -- --
121,703 110,551 76,486 19,823 64,935 48,732 315 257,421
------- ------- ------ ------ ------ ------ --- -------
121,703 110,551 76,486 19,823 64,935 48,732 315 257,421
======= ======= ====== ====== ====== ====== === =======
</TABLE>
18
<PAGE>
- --------------------------------------------------------------------------------
THE PFL ENDEAVOR VARIABLE ANNUITY ACCOUNT
STATEMENT OF OPERATIONS (AMOUNTS IN THOUSANDS)
Year Ended December 31, 1996, Except as Noted
<TABLE>
<CAPTION>
TCW
TCW MANAGED
MONEY ASSET
MARKET ALLOCATION
TOTAL SUBACCT. SUBACCT.
-------- -------- ----------
<S> <C> <C> <C>
NET INVESTMENT INCOME (LOSS)
Income:
Dividends........................................ $ 27,904 1,245 3,793
Expenses (Note 5):
Administrative fee............................... 443 10 122
Mortality and expense risk charge................ 11,237 365 2,943
-------- ------ ------
Net investment income (loss)................... 16,224 870 728
-------- ------ ------
NET REALIZED AND UNREALIZED CAPITAL GAIN FROM
INVESTMENTS
Net realized capital gain from sales of
investments:
Proceeds from sales.............................. 70,848 24,793 15,228
Cost of investments sold......................... 60,774 24,793 12,264
-------- ------ ------
Net realized capital gain from sales of
investments...................................... 10,074 -- 2,964
Net change in unrealized appreciation/depreciation
of investments:
Beginning of the period.......................... 78,863 -- 25,121
End of the period................................ 175,289 -- 52,892
-------- ------ ------
Net change in unrealized
appreciation/depreciation of investments...... 96,426 -- 27,771
-------- ------ ------
Net realized and unrealized capital gain from
investments................................... 106,500 -- 30,735
-------- ------ ------
INCREASE FROM OPERATIONS.......................... $122,724 870 31,463
======== ====== ======
</TABLE>
/1/Period from November 18, 1996 (commencement of operations) to December 31,
1996.
See accompanying Notes to Financial Statements.
19
<PAGE>
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
T. ROWE T. ROWE T. ROWE
PRICE DREYFUS DREYFUS U.S. PRICE PRICE
INT'L. VALUE SMALL CAP GOV'T. EQUITY GROWTH OPPORTUNITY
STOCK EQUITY VALUE SECURITIES INCOME STOCK VALUE GROWTH
SUBACCT. SUBACCT. SUBACCT. SUBACCT. SUBACCT. SUBACCT. SUBACCT./1/ SUBACCT.
- -------- -------- --------- ------------ -------- -------- ----------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
729 1,976 2,674 436 354 525 -- 16,172
66 42 31 5 15 13 -- 139
1,464 1,198 852 202 540 456 -- 3,217
------ ------ ------ ----- ----- ----- --- ------
(801) 736 1,791 229 (201) 56 -- 12,816
------ ------ ------ ----- ----- ----- --- ------
4,813 3,499 4,065 1,853 970 1,628 37 13,962
4,276 2,344 3,504 1,664 696 1,210 37 9,986
------ ------ ------ ----- ----- ----- --- ------
537 1,155 561 189 274 418 -- 3,976
2,636 12,562 4,426 563 2,266 1,913 -- 29,376
16,143 27,439 15,836 455 9,138 7,517 -- 45,869
------ ------ ------ ----- ----- ----- --- ------
13,507 14,877 11,410 (108) 6,872 5,604 -- 16,493
------ ------ ------ ----- ----- ----- --- ------
14,044 16,032 11,971 81 7,146 6,022 -- 20,469
------ ------ ------ ----- ----- ----- --- ------
13,243 16,768 13,762 310 6,945 6,078 -- 33,285
====== ====== ====== ===== ===== ===== === ======
</TABLE>
20
<PAGE>
- --------------------------------------------------------------------------------
THE PFL ENDEAVOR VARIABLE ANNUITY ACCOUNT
STATEMENTS OF CHANGES IN CONTRACT OWNERS' EQUITY (AMOUNTS IN THOUSANDS)
Years Ended December 31, 1996 and 1995, Except as Noted
<TABLE>
<CAPTION>
TCW TCW T. ROWE PRICE
MONEY MANAGED INTERNATIONAL
MARKET ASSET ALLOCATION STOCK
TOTAL SUBACCOUNT SUBACCOUNT SUBACCOUNT
----------------- --------------- ------------------ ---------------
1996 1995 1996 1995 1996 1995 1996 1995
-------- ------- ------- ------ -------- -------- ------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
OPERATIONS
Net investment income
(loss).................. $ 16,224 18,207 870 816 728 448 (801) 715
Net realized capital
gain.................... 10,074 5,077 -- -- 2,964 2,310 537 270
Net change in unrealized
appreciation/depreciation
of investments.......... 96,426 98,622 -- -- 27,771 31,591 13,507 6,070
-------- ------- ------- ------ -------- -------- ------- ------
Increase from
operations.............. 122,724 121,906 870 816 31,463 34,349 13,243 7,055
-------- ------- ------- ------ -------- -------- ------- ------
CONTRACT TRANSACTIONS
Net contract purchase
payments................ 150,050 88,212 12,211 5,842 13,250 12,410 16,257 9,185
Transfer payments from
(to) other subaccounts
or general account...... 78,317 11,541 5,680 1,552 2,506 (13,051) 10,431 (5,983)
Contract terminations,
withdrawals, and other
deductions.............. (52,551) (30,449) (11,765) (3,793) (12,118) (10,070) (6,132) (4,530)
-------- ------- ------- ------ -------- -------- ------- ------
Increase (decrease) from
contract transactions... 175,816 69,304 6,126 3,601 3,638 (10,711) 20,556 (1,328)
-------- ------- ------- ------ -------- -------- ------- ------
Net increase in contract
owners' equity.......... 298,540 191,210 6,996 4,417 35,101 23,638 33,799 5,727
-------- ------- ------- ------ -------- -------- ------- ------
CONTRACT OWNERS' EQUITY
Beginning of period...... 661,108 469,898 23,546 19,129 194,039 170,401 87,904 82,177
-------- ------- ------- ------ -------- -------- ------- ------
End of period............ $959,648 661,108 30,542 23,546 229,140 194,039 121,703 87,904
======== ======= ======= ====== ======== ======== ======= ======
</TABLE>
/1/Period from January 3, 1995 (commencement of operations) to December 31,
1995
/2/Period from November 18, 1996 (commencement of operations) to December 31,
1996
See accompanying Notes to Financial Statements.
21
<PAGE>
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Dreyfus Dreyfus U.s. T. Rowe Price T. Rowe Price
Value Small Cap Government Equity Growth Opportunity
Equity Value Securities Income Stock Value Growth
Subaccount Subaccount Subaccount Subaccount Subaccount Subaccount Subaccount
- --------------- -------------- ------------- --------------- --------------- ----------- ----------------
1996 1995 1996 1995 1996 1995 1996 1995/1/ 1996 1995/1/ 1996/2/ 1996 1995
- ------- ------ ------ ------ ------ ----- ------ ------- ------ ------- ----------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
736 (230) 1,791 314 229 (25) (201) (107) 56 (119) -- 12,816 16,395
1,155 972 561 184 189 106 274 71 418 322 -- 3,976 842
14,877 11,749 11,410 4,328 (108) 568 6,872 2,266 5,604 1,913 -- 16,493 40,137
- ------- ------ ------ ------ ------ ----- ------ ------ ------ ------ --- ------- -------
16,768 12,491 13,762 4,826 310 649 6,945 2,230 6,078 2,116 -- 33,285 57,374
- ------- ------ ------ ------ ------ ----- ------ ------ ------ ------ --- ------- -------
20,562 12,996 11,126 8,736 6,793 4,592 21,213 8,911 13,844 8,446 193 34,601 17,094
13,551 9,310 5,637 2,469 4,193 1,487 19,065 8,365 10,830 9,027 166 6,258 (1,635)
(4,444) (2,587) (3,080) (1,976) (980) (280) (1,524) (270) (1,233) (376) (44) (11,231) (6,567)
- ------- ------ ------ ------ ------ ----- ------ ------ ------ ------ --- ------- -------
29,669 19,719 13,683 9,229 10,006 5,799 38,754 17,006 23,441 17,097 315 29,628 8,892
- ------- ------ ------ ------ ------ ----- ------ ------ ------ ------ --- ------- -------
46,437 32,210 27,445 14,055 10,316 6,448 45,699 19,236 29,519 19,213 315 62,913 66,266
- ------- ------ ------ ------ ------ ----- ------ ------ ------ ------ --- ------- -------
64,114 31,904 49,041 34,986 9,507 3,059 19,236 -- 19,213 -- -- 194,508 128,242
- ------- ------ ------ ------ ------ ----- ------ ------ ------ ------ --- ------- -------
110,551 64,114 76,486 49,041 19,823 9,507 64,935 19,236 48,732 19,213 315 257,421 194,508
======= ====== ====== ====== ====== ===== ====== ====== ====== ====== === ======= =======
</TABLE>
22
<PAGE>
- --------------------------------------------------------------------------------
The PFL Endeavor Variable Annuity Account
Notes to Financial Statements (Amounts in Thousands, Except Where Noted)
December 31, 1996
1. Organization and Summary of Significant Accounting Policies
Organization -- The PFL Endeavor Variable Annuity Account ("Mutual Fund
Account") is a segregated investment account of PFL Life Insurance Company
("PFL Life"), an indirect, wholly-owned subsidiary of AEGON USA, Inc. ("AUSA"),
a holding company. AUSA is an indirect, wholly-owned subsidiary of AEGON nv, a
holding company organized under the laws of The Netherlands.
The Opportunity Value Subaccount commenced operations on November 18, 1996. The
T. Rowe Price Equity Income Subaccount and the T. Rowe Price Growth Stock
Subaccount commenced operations on January 3, 1995. Effective May 1, 1996, the
names of the Money Market, Managed Asset Allocation, Quest for Value Equity,
Quest for Value Small Cap and U.S. Government Securities Portfolios and
Subaccounts were changed to TCW Money Market, TCW Managed Asset Allocation,
Value Equity, Value Small Cap and Dreyfus U.S. Government Securities Portfolios
and Subaccounts, respectively. Effective October 29, 1996, the names of the
Value Small Cap Portfolio and Subaccount were changed to Dreyfus Small Cap
Value Portfolio and Dreyfus Small Cap Value Subaccount, respectively. Effective
March 25, 1995, the names of the Global Growth Portfolio and Subaccount were
changed to T. Rowe Price International Stock Portfolio and Subaccount,
respectively. The investment objective of the portfolio was changed from an
investment on a global basis to an investment on an international basis (i.e.
non-U.S. companies). The investment advisor of the Endeavor Series Trust is
Endeavor Investment Advisors, a general partnership between Endeavor Management
Co. and AUSA Financial Markets, Inc., an affiliate of PFL Life. The investment
advisor for the WRL Series Fund, Inc. is Western Reserve Life Assurance Co. of
Ohio, an affiliate of PFL Life.
The Mutual Fund Account is registered with the Securities and Exchange
Commission as a Unit Investment Trust pursuant to provisions of the Investment
Company Act of 1940.
Investments -- Net purchase payments received by the Mutual Fund Account are
invested in the portfolios of the Endeavor Series Trust, and the Growth
Portfolio of the WRL Series Fund, Inc. (collectively the "Series Funds"), as
selected by the contract owner. Investments are stated at the closing net asset
values per share on December 31, 1996.
Realized capital gains and losses from sale of shares in the Series Funds are
determined on the first-in, first-out basis. Investment transactions are
accounted for on the trade date (date the order to buy or sell is executed) and
dividend income is recorded on the ex-dividend date. Unrealized gains or losses
from investments in the Series Funds are credited or charged to contract
owners' equity.
Dividend Income -- Dividends received from the Series Funds investments are
reinvested to purchase additional mutual fund shares.
23
<PAGE>
- --------------------------------------------------------------------------------
2. Investments
A summary of the mutual fund investment at December 31, 1996 follows:
<TABLE>
<CAPTION>
Net Asset
Number Value
of Shares Per Share Market
Held (in Dollars) Value Cost
--------- ------------ -------- --------
<S> <C> <C> <C> <C>
Endeavor Series Trust
TCW Money Market Portfolio........... 30,542 $ 1.00 $ 30,542 $ 30,542
TCW Managed Asset Allocation
Portfolio........................... 12,163 18.84 229,142 176,250
T. Rowe Price International Stock
Portfolio........................... 8,724 13.95 121,702 105,559
Value Equity Portfolio............... 6,423 17.21 110,548 83,109
Dreyfus Small Cap Value Portfolio.... 5,203 14.70 76,482 60,646
Dreyfus U.S. Government Securities
Portfolio........................... 1,765 11.23 19,823 19,368
T. Rowe Price Equity Income
Portfolio........................... 4,192 15.49 64,935 55,797
T. Rowe Price Growth Stock
Portfolio........................... 2,991 16.29 48,731 41,214
Opportunity Value Portfolio.......... 31 10.06 315 315
WRL Series Fund, Inc.
Growth Portfolio..................... 7,355 35.001280 257,421 211,552
-------- --------
$959,641 $784,352
======== ========
</TABLE>
3. Contract Owners' Equity
Contract owners' equity at December 31, 1996 includes an amount of $2,954,
which represents the current value of PFL Life's capital contribution of
$1,900. A summary of deferred annuity contracts terminable by owners at
December 31, 1996 follows:
<TABLE>
<CAPTION>
Accumulation
Unit
Accumulation Value Total
Subaccount Units Owned (in Dollars) Contract Value
---------- ------------ ------------ --------------
<S> <C> <C> <C>
TCW Money Market...................... 26,461 $ 1.154219 $ 30,542
TCW Managed Asset Allocation.......... 124,999 1.833135 229,140
T. Rowe Price International Stock..... 91,462 1.330640 121,703
Value Equity.......................... 65,227 1.694854 110,551
Dreyfus Small Cap Value............... 51,125 1.496065 76,486
Dreyfus U.S. Government Securities.... 17,562 1.128769 19,823
T. Rowe Price Equity Income........... 42,673 1.521680 64,935
T. Rowe Price Growth Stock............ 30,238 1.611613 48,732
Opportunity Value..................... 314 1.004355 315
Growth................................ 15,174 16.964068 257,421
--------
$959,648
========
</TABLE>
24
<PAGE>
- --------------------------------------------------------------------------------
A summary of changes in contract owners' account units follows:
<TABLE>
<CAPTION>
TCW T. Rowe Dreyfus Dreyfus T. Rowe T. Rowe
TCW Managed Price Small U.S. Price Price
Money Asset Int'l. Value Cap Gov't. Equity Growth Opportunity
Market Allocation Stock Equity Value Securities Income Stock Value Growth
Subacct. Subacct. Subacct. Subacct. Subacct. Subacct. Subacct. Subacct. Subacct. Subacct.
-------- ---------- -------- -------- -------- ---------- -------- -------- ----------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Units outstanding at
1/1/95............... 17,837 130,910 76,518 30,512 32,607 3,103 -- -- -- 12,759
Units purchased....... 5,331 8,434 8,306 10,253 7,689 4,247 7,630 6,773 -- 1,344
Units redeemed and
transferred.......... (2,064) (16,369) (9,759) 5,430 340 1,107 7,313 7,424 -- (766)
------ ------- ------ ------ ------ ------ ------ ------ --- ------
Units outstanding at
12/31/95............. 21,104 122,975 75,065 46,195 40,636 8,457 14,943 14,197 -- 13,337
Units purchased....... 10,754 7,818 13,001 13,373 8,625 6,218 15,335 9,588 192 2,158
Units redeemed and
transferred.......... (5,397) (5,794) 3,396 5,659 1,864 2,887 12,395 6,453 122 (321)
------ ------- ------ ------ ------ ------ ------ ------ --- ------
Units outstanding at
12/31/96............. 26,461 124,999 91,462 65,227 51,125 17,562 42,673 30,238 314 15,174
====== ======= ====== ====== ====== ====== ====== ====== === ======
</TABLE>
4. Taxes
Operations of the Mutual Fund Account form a part of PFL Life, which is taxed
as a life insurance company under Subchapter L of the Internal Revenue Code of
1986, as amended (the "Code"). The operations of the Mutual Fund Account are
accounted for separately from other operations of PFL Life for purposes of
federal income taxation. The Mutual Fund Account is not separately taxable as a
regulated investment company under Subchapter M of the Code and is not
otherwise taxable as an entity separate from PFL Life. Under existing federal
income tax laws, the income of the Mutual Fund Account, to the extent applied
to increase reserves under the variable annuity contracts, is not taxable to
PFL Life.
5. Administrative, Mortality and Expense Risk Charge
Administrative charges include an annual charge of the lesser of 2% of the
policy value or $35 per contract which will commence on the first policy
anniversary of each contract owner's account. For policies issued on or after
May 1, 1995, the fee is waived if the sum of the premium payments less the sum
of all partial withdrawals is at least $50,000 on the policy anniversary.
Charges for administrative fees to the variable annuity contracts are an
expense of the Mutual Fund Account.
PFL Life deducts a daily charge equal to an annual rate of 1.25% of the value
of the contract owners' account as a charge for assuming certain mortality and
expense risks. PFL Life also deducts a daily charge equal to an annual rate of
.15% of the contract owners' account for administrative expenses.
6. Net Assets
At December 31, 1996 contract owners' equity was comprised of:
<TABLE>
<CAPTION>
TCW T. Rowe T. Rowe T. Rowe
TCW Managed Price Dreyfus Dreyfus U.S Price Price
Money Asset Int'l. Value Small Cap Gov't. Equity Growth Opportunity
Market Allocation Stock Equity Value Securities Income Stock Value Growth
Total Subacct. Subacct. Subacct. Subacct. Subacct. Subacct. Subacct. Subacct. Subacct. Subacct.
-------- -------- ---------- -------- -------- --------- ------------ -------- -------- ----------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Unit
transactions,
accumulated net
investment income
and realized
capital gains... $784,359 30,542 176,248 105,560 83,112 60,650 19,368 55,797 41,215 315 211,552
Adjustment for
appreciation/
depreciation to
market value.... 175,289 -- 52,892 16,143 27,439 15,836 455 9,138 7,517 -- 45,869
-------- ------ ------- ------- ------- ------ ------ ------ ------ --- -------
Total Contract
Owners' Equity.. $959,648 30,542 229,140 121,703 110,551 76,486 19,823 64,935 48,732 315 257,421
======== ====== ======= ======= ======= ====== ====== ====== ====== === =======
</TABLE>
25
<PAGE>
- --------------------------------------------------------------------------------
7. Purchases and Sales of Investment Securities
The aggregate cost of purchases and proceeds from sales of investments were as
follows:
<TABLE>
<CAPTION>
Year Ended December 31 or
Commencement of Operations to December 31
--------------------------------------------
1996 1995
---------------------- -------------------
Purchases Sales Purchases Sales
----------- --------- --------- -------
<S> <C> <C> <C> <C>
Endeavor Series Trust
TCW Money Market Portfolio........ $ 31,789 24,793 26,533 22,147
TCW Managed Asset Allocation
Port folio....................... 19,595 15,228 18,528 28,949
T. Rowe Price International Stock
Portfolio........................ 24,567 4,813 14,396 15,085
Value Equity Portfolio............ 33,901 3,499 25,078 5,610
Dreyfus Small Cap Value
Portfolio........................ 19,535 4,065 16,203 6,683
Dreyfus U.S. Government Securities
Portfolio........................ 12,087 1,853 7,759 1,988
T. Rowe Price Equity Income
Portfolio........................ 39,523 970 18,189 1,290
T. Rowe Price Growth Stock
Portfolio........................ 25,124 1,628 19,565 2,587
Opportunity Value Portfolio....... 352 37 -- --
WRL Series Fund, Inc.
Growth Portfolio.................. 56,406 13,962 38,417 13,226
----------- --------- ---------- ---------
$ 262,879 70,848 184,668 97,565
=========== ========= ========== =========
</TABLE>
26
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
PFL Life Insurance Company
We have audited the accompanying statutory-basis balance sheets of PFL Life
Insurance Company as of December 31, 1996 and 1995, and the related statutory-
basis statements of operations, changes in capital and surplus, and cash flows
for each of the three years in the period ended December 31, 1996. Our audits
also included the accompanying statutory-basis financial statement schedules
required by Article 7 of Regulation S-X. These financial statements and
schedules are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
As described in Note 1 to the financial statements, the Company presents its
financial statements in conformity with accounting practices prescribed or
permitted by the Insurance Division, Department of Commerce, of the State of
Iowa, which practices differ from generally accepted accounting principles.
The variances between such practices and generally accepted accounting
principles also are described in Note 1. The effects on the financial
statements of these variances are not reasonably determinable but are presumed
to be material.
In our opinion, because of the effects of the matters described in the
preceding paragraph, the financial statements referred to above do not present
fairly, in conformity with generally accepted accounting principles, the
financial position of PFL Life Insurance Company at December 31, 1996 and
1995, or the results of its operations or its cash flows for each of the three
years in the period ended December 31, 1996.
Also, in our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of PFL Life Insurance
Company at December 31, 1996 and 1995, and the results of its operations and
its cash flows for each of the three years in the period ended December 31,
1996 in conformity with accounting practices prescribed or permitted by the
Insurance Division, Department of Commerce, of the State of Iowa. Also, in our
opinion, the related financial statement schedules, when considered in
relation to the basic statutory-basis financial statements taken as a whole,
present fairly in all material respects the information set forth therein.
Ernst & Young L.L.P.
Des Moines, Iowa
February 21, 1997
27
<PAGE>
PFL LIFE INSURANCE COMPANY
STATEMENTS OF OPERATIONS--STATUTORY BASIS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------------------
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
Revenues:
Premiums and other considerations, net
of reinsurance:
Life.................................. $ 204,872 $ 114,704 $ 148,954
Annuity............................... 725,966 921,452 1,067,406
Accident and health................... 227,862 232,738 230,889
Net investment income................... 428,337 392,685 343,880
Amortization of interest maintenance
reserve................................ 2,434 4,341 2,871
Commissions and expense allowances on
reinsurance ceded...................... 73,931 77,071 94,635
---------- ---------- ----------
1,663,402 1,742,991 1,888,635
Benefits and expenses:
Benefits paid or provided for:
Life and accident and health
benefits............................. 147,024 146,346 141,632
Surrender benefits.................... 512,810 498,626 392,064
Other benefits........................ 101,288 88,607 73,306
Increase in aggregate reserves for
policies and contracts:
Life................................ 140,126 50,071 82,062
Annuity............................. 188,002 528,330 569,341
Accident and health................. 26,790 17,694 22,144
Other............................... 19,969 16,017 11,223
---------- ---------- ----------
1,136,009 1,345,691 1,291,772
Insurance expenses:
Commissions........................... 177,466 200,706 215,635
General insurance expenses............ 57,282 57,623 52,166
Taxes, licenses and fees.............. 13,889 15,700 15,368
Transfer to separate account.......... 171,785 42,981 243,806
Other expenses........................ 526 760 1,014
---------- ---------- ----------
420,948 317,770 527,989
---------- ---------- ----------
1,556,957 1,663,461 1,819,761
---------- ---------- ----------
Gain from operations before federal income
taxes and net realized capital losses on
investments.............................. 106,445 79,530 68,874
Federal income tax expense................ 41,177 33,335 23,858
---------- ---------- ----------
Gain from operations before net realized
capital losses on investments............ 65,268 46,195 45,016
Net realized capital losses on investments
(net of related federal income taxes and
amounts transferred to interest
maintenance reserve)..................... (3,503) (18,096) (3,624)
---------- ---------- ----------
Net income................................ $ 61,765 $ 28,099 $ 41,392
========== ========== ==========
</TABLE>
See accompanying notes.
28
<PAGE>
PFL LIFE INSURANCE COMPANY
BALANCE SHEETS--STATUTORY BASIS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
DECEMBER 31
---------------------
1996 1995
---------- ----------
<S> <C> <C>
ADMITTED ASSETS
Cash and invested assets:
Cash and short-term investments........................ $ 50,737 $ 79,852
Bonds.................................................. 4,773,433 4,613,334
Stocks:
Preferred............................................ 3,097 9,336
Common (cost: 1996--$23,212; 1995--$19,061).......... 32,038 24,866
Affiliated entities (cost: 1996--$14,893; 1995--
$14,661)............................................ 6,934 6,794
Mortgage loans on real estate.......................... 911,705 680,414
Real estate, at cost less accumulated depreciation
($11,338 in 1996; $12,493 in 1995):
Home office properties............................... 10,372 20,403
Properties acquired in satisfaction of debt.......... 12,260 2,648
Investment properties................................ 35,922 40,453
Policy loans........................................... 54,214 52,675
Other invested assets.................................. 16,343 13,557
---------- ----------
Total cash and invested assets......................... 5,907,055 5,544,332
Premiums deferred and uncollected........................ 16,345 17,026
Accrued investment income................................ 70,401 68,065
Receivable from affiliates............................... 53,900 79,913
Federal income taxes recoverable......................... 4,018 9,776
Transfers from separate accounts......................... 38,528 --
Other assets............................................. 31,215 32,803
Separate account assets.................................. 1,844,515 1,418,157
---------- ----------
Total admitted assets.................................. $7,965,977 $7,170,072
========== ==========
LIABILITIES AND CAPITAL AND SURPLUS
Liabilities:
Aggregate reserves for policies and contracts:
Life................................................. $ 736,100 $ 596,039
Annuity.............................................. 4,408,419 4,220,274
Accident and health.................................. 139,269 114,884
Policy and contract claim reserves:
Life................................................. 7,369 6,225
Accident and health.................................. 66,988 70,517
Other policyholders' funds............................. 126,672 105,371
Remittances and items not allocated.................... 64,064 123,710
Asset valuation reserve................................ 54,851 43,921
Interest maintenance reserve........................... 23,745 26,376
Other liabilities...................................... 70,663 67,070
Payable to affiliates.................................. 4,975 --
Separate account liabilities........................... 1,844,515 1,418,157
---------- ----------
Total liabilities...................................... 7,547,630 6,792,544
Commitments and contingencies
Capital and surplus:
Common stock, $10 par value, 500 shares authorized, 266
issued and outstanding................................ 2,660 2,660
Paid-in surplus........................................ 154,129 154,129
Unassigned surplus..................................... 261,558 220,739
---------- ----------
Total capital and surplus.............................. 418,347 377,528
---------- ----------
Total liabilities and capital and surplus.............. $7,965,977 $7,170,072
========== ==========
</TABLE>
See accompanying notes.
29
<PAGE>
PFL LIFE INSURANCE COMPANY
STATEMENTS OF CHANGES IN CAPITAL AND SURPLUS--STATUTORY BASIS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
TOTAL
COMMON PAID-IN UNASSIGNED CAPITAL AND
STOCK SURPLUS SURPLUS SURPLUS
------ -------- ---------- -----------
<S> <C> <C> <C> <C>
Balance at January 1, 1994.............. $2,660 $ 99,129 $212,982 $314,771
Capital contribution.................. -- 15,000 -- 15,000
Net income for 1994................... -- -- 41,392 41,392
Net unrealized capital losses......... -- -- (25,350) (25,350)
Increase in non-admitted assets....... -- -- (248) (248)
Decrease in asset valuation reserve... -- -- 6,040 6,040
Dividend to stockholder............... -- -- (20,900) (20,900)
Surplus effect of ceding commissions
associated with the sale of a
division............................. -- -- 184 184
Amendment of reinsurance agreement.... -- -- 391 391
Decrease in liability for reinsurance
in unauthorized companies............ -- -- 505 505
Prior period adjustment............... -- -- (3,444) (3,444)
------ -------- -------- --------
Balance at December 31, 1994............ 2,660 114,129 211,552 328,341
Capital contribution.................. -- 40,000 -- 40,000
Net income for 1995................... -- -- 28,099 28,099
Net unrealized capital losses......... -- -- (7,574) (7,574)
Decrease in non-admitted assets....... -- -- 50 50
Increase in asset valuation reserve... -- -- (5,946) (5,946)
Surplus effect of ceding commissions
associated with the sale of a
division............................. -- -- 35 35
Cancellation of reinsurance
agreement............................ -- -- 585 585
Amendment of reinsurance agreement.... -- -- 419 419
Transfer of subsidiary investment to
stockholder.......................... -- -- (3,250) (3,250)
Change in reserve valuation
methodology.......................... -- -- (501) (501)
Increase in liability for reinsurance
in unauthorized companies............ -- -- (2,730) (2,730)
------ -------- -------- --------
Balance at December 31, 1995............ 2,660 154,129 220,739 377,528
Net income for 1996................... -- -- 61,765 61,765
Net unrealized capital gains.......... -- -- 2,351 2,351
Increase in non-admitted assets....... -- -- (148) (148)
Increase in asset valuation reserve... -- -- (10,930) (10,930)
Dividend to stockholder............... -- -- (20,000) (20,000)
Prior period adjustment............... -- -- 5,025 5,025
Surplus effect of sale of a division.. -- -- (384) (384)
Surplus effect of ceding commissions
associated with the sale of a
division............................. -- -- 29 29
Amendment of reinsurance agreement.... -- -- 421 421
Decrease in liability for reinsurance
in unauthorized companies............ -- -- 2,690 2,690
------ -------- -------- --------
Balance at December 31, 1996............ $2,660 $154,129 $261,558 $418,347
====== ======== ======== ========
</TABLE>
See accompanying notes.
30
<PAGE>
PFL LIFE INSURANCE COMPANY
STATEMENTS OF CASH FLOWS--STATUTORY BASIS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------------------
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
SOURCES OF CASH
Premiums and other considerations, net of
reinsurance.............................. $1,240,748 $1,353,407 $1,548,030
Net investment income..................... 431,456 398,051 339,856
---------- ---------- ----------
1,672,204 1,751,458 1,887,886
Life and accident and health claims....... (147,556) (140,798) (137,602)
Surrender benefits and other fund
withdrawals.............................. (512,810) (498,626) (392,064)
Other benefits to policyholders........... (101,254) (88,519) (73,237)
Commissions, other expenses and other
taxes.................................... (248,321) (278,241) (288,384)
Net transfers to separate accounts........ (210,312) (42,981) (243,806)
Dividends to policyholders................ (844) (940) (1,155)
Federal income taxes, excluding tax on
capital gains and IRS settlements........ (35,551) (32,905) (39,864)
---------- ---------- ----------
Net cash provided by operations........... 415,556 668,448 711,774
Proceeds from investments sold, matured or
repaid:
Bonds and preferred stocks.............. 2,112,831 1,757,229 1,430,339
Common stocks........................... 27,214 20,338 12,941
Mortgage loans on real estate........... 74,351 36,550 43,495
Real estate............................. 18,077 23,203 9,536
Other proceeds.......................... 22,567 381 189
---------- ---------- ----------
Total cash from investments............... 2,255,040 1,837,701 1,496,500
Capital contribution...................... -- 40,000 15,000
Dividend from subsidiary.................. -- -- 10,000
Cash received from ceding commissions
associated with the sale of a division... 45 55 284
Increase in remittances and items not
allocated................................ -- 88,295 16,177
Other sources............................. 19,381 12,758 24,855
---------- ---------- ----------
Total sources of cash..................... 2,690,022 2,647,257 2,274,590
APPLICATIONS OF CASH
Cost of investments acquired:
Bonds and preferred stocks.............. $2,270,105 $2,294,195 $2,043,615
Common stocks........................... 29,799 23,284 11,228
Mortgage loans on real estate........... 324,381 192,292 160,068
Net increase in policy loans............ 1,539 877 3,202
Real estate............................. 222 10,188 14,801
Other invested assets................... 5,169 2,670 664
---------- ---------- ----------
Total investments acquired................ 2,631,215 2,523,506 2,233,578
Dividends to stockholder.................. 20,000 -- 20,900
Cash paid associated with the sale of a
division................................. 539 -- --
Repayment of intercompany notes and
receivables, net......................... -- 48,070 365
Cash paid in conjunction with an amendment
of a reinsurance agreement............... 5,812 -- --
Decrease in remittances and items not
allocated................................ 59,646 -- --
Cash paid in conjunction with sales of a
division................................. 123 -- --
Other applications, net................... 1,802 29,887 3,820
---------- ---------- ----------
Total applications of cash................ 2,719,137 2,601,463 2,258,663
---------- ---------- ----------
Net change in cash and short-term
investments.............................. (29,115) 45,790 15,927
Cash and short-term investments at
beginning of year........................ 79,852 34,062 18,135
---------- ---------- ----------
Cash and short-term investments at end of
year..................................... $ 50,737 $ 79,852 $ 34,062
========== ========== ==========
</TABLE>
See accompanying notes.
31
<PAGE>
PFL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS--STATUTORY BASIS
(DOLLARS IN THOUSANDS)
DECEMBER 31, 1996
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
PFL Life Insurance Company ("the Company") is a stock life insurance company
and is a wholly-owned subsidiary of First AUSA Life Insurance Company ("First
AUSA"), which, in turn, is a wholly-owned subsidiary of AEGON USA, Inc.
("AEGON"). AEGON is a wholly-owned subsidiary of AEGON nv, a holding company
organized under the laws of The Netherlands. Effective June 1, 1995, the
Company transferred the common stock of its wholly-owned subsidiary, Equity
National Life Insurance Company ("Equity National"), to its stockholder, First
AUSA. Equity National was then merged with Life Investors Insurance Company of
America, a subsidiary of First AUSA. The financial statements presented herein
are prepared on the statutory accounting principles basis for the Company
only; as such, the accounts of the Company's subsidiary, Equity National, are
not consolidated with those of the Company.
In connection with the sale of certain affiliated companies, the Company has
assumed various blocks of business from these former affiliates through
mergers. In addition, the Company has canceled or entered into several
coinsurance and reinsurance agreements with affiliates and non-affiliates. The
following is a description of those transactions:
During 1996, the Company sold its North Richland Hills, Texas health
administrative operations known as The Insurance Center. The transaction
resulted in the transfer of substantially all employees and office
facilities to United Insurance Companies, Inc. ("UICI"). All inforce
business will continue to be shared by UICI and the Company and its
affiliates through the existing coinsurance agreements. After a short
transition period, all new business produced by United Group Association,
an independent insurance agency, will be written by the insurance
subsidiaries of UICI and will not be shared with the Company and its
affiliates through coinsurance arrangements. As a result of the sale, the
Company transferred $123 in assets, substantially all of which was cash,
and $70 of liabilities. The difference between the assets and liabilities
of $(53) plus a tax credit of $19 was charged directly to unassigned
surplus.
Effective December 31, 1995, the Company canceled a coinsurance agreement
with its parent, First AUSA. As a result of the cancellation, the Company
transferred $825 of assets and $1,712 of liabilities. The difference
between the assets and liabilities, net of a tax effect of $302 was
credited directly to unassigned surplus.
On January 1, 1994, the Company entered into an agreement with a non-
affiliate reinsurer to increase the reinsurance ceded by 2 1/2% each year
(primarily group health business). As a result, the Company transferred
$3,881 in assets and $4,080 in liabilities during 1994. The difference
between the assets and liabilities of $199, plus a tax credit of $192, was
credited directly to unassigned surplus. During 1995, the Company
transferred $4,303 in assets and liabilities of $4,467. The difference
between the assets and liabilities of $164, plus a tax credit of $255, was
credited directly to unassigned surplus. During 1996, the Company
transferred $5,991 in assets, including $5,812 of cash and short-term
investments and liabilities of $6,146. The difference between the assets
and liabilities of $155, plus a tax credit of $266 was credited directly to
unassigned surplus.
During 1993, the Company sold the Oakbrook Division (primarily group
health business). The initial transfer of risk occurred through an
indemnity reinsurance agreement. The
32
<PAGE>
PFL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS--STATUTORY BASIS (CONTINUED)
(DOLLARS IN THOUSANDS)
policies will then be assumed by the reinsurer by novation as state
regulatory and policyholder approvals are received. In addition, the
Company will receive from the third party administrator a ceding commission
of one percent of the premiums collected between January 1, 1994 and
December 31, 1996. As a result of the sale, in 1994, the Company received
$284 for ceding commissions; the commissions net of the related tax effect
of $100 was credited directly to unassigned surplus. During 1995, the
Company received $55 for ceding commissions; the commissions net of the
related tax effect of $20 was credited directly to unassigned surplus.
During 1996, the Company received $45 for ceding commissions; the
commissions net of the related tax effect of $(16) was charged directly to
unassigned surplus. During 1996, the Company paid $539 in association with
this sale; the proceeds, net of a tax credit of $189, were charged directly
to unassigned surplus.
Nature of Business
The Company sells individual non-participating whole life, endowment and
term contracts, as well as a broad line of single fixed and flexible premium
annuity products. In addition, the Company offers group life, universal life,
and individual and specialty health coverages. The Company is licensed in 49
states and the District of Columbia. Sales of the Company's products are
primarily through an independent insurance agency of The Insurance Center, the
Company's agents, and financial institutions.
Basis of Presentation
The preparation of financial statements of insurance companies requires
management to make estimates and assumptions that affect amounts reported in
the financial statements and accompanying notes. Actual results could differ
from those estimates.
Significant estimates and assumptions are utilized in the calculation of
aggregate policy reserves, policy and contract claim reserves, guaranty fund
assessment accruals and valuation allowances on investments. It is reasonably
possible that actual experience could differ from the estimates and
assumptions utilized which could have a material impact on the financial
statements.
The accompanying financial statements have been prepared on the basis of
accounting practices prescribed or permitted by the Insurance Division,
Department of Commerce, of the State of Iowa, which practices differ in some
respects from generally accepted accounting principles. The more significant
of these differences are as follows: (a) bonds are generally reported at
amortized cost rather than segregating the portfolio into held-to-maturity
(reported at amortized cost), available-for-sale (reported at fair value), and
trading (reported at fair value) classifications; (b) acquisition costs of
acquiring new business are charged to current operations as incurred rather
than deferred and amortized over the life of the policies; (c) policy reserves
on traditional life products are based on statutory mortality rates and
interest which may differ from reserves based on reasonable assumptions of
expected mortality, interest, and withdrawals which include a provision for
possible unfavorable deviation from such assumptions; (d) policy reserves on
certain investment products use discounting methodologies utilizing statutory
interest rates rather than full account values; (e) reinsurance amounts are
netted against the corresponding asset or liability rather than shown as gross
amounts on the balance sheet; (f) deferred income taxes are not provided for
the difference between the financial statement and income tax bases of assets
and liabilities; (g) net realized gains or losses attributed to changes in the
level of interest
33
<PAGE>
PFL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS--STATUTORY BASIS (CONTINUED)
(DOLLARS IN THOUSANDS)
rates in the market are deferred and amortized over the remaining life of the
bond or mortgage loan, rather than recognized as gains or losses in the
statement of operations when the sale is completed; (h) declines in the
estimated realizable value of investments are provided for through the
establishment of a formula-determined statutory investment reserve (carried as
a liability) changes to which are charged directly to surplus, rather than
through recognition in the statement of operations for declines in value, when
such declines are judged to be other than temporary; (i) certain assets
designated as "non-admitted assets" have been charged to surplus rather than
being reported as assets; (j) revenues for universal life and investment
products consist of premiums received rather than policy charges for the cost
of insurance, policy administration charges, amortization of policy initiation
fees and surrender charges assessed; (k) pension expense is recorded as
amounts are paid; (l) adjustments to federal income taxes of prior years are
charged or credited directly to unassigned surplus, rather than reported as a
component of expense in the statement of operations; (m) gains or losses on
dispositions of business are charged or credited directly to unassigned
surplus rather than being reported in the statement of operations; and (n) a
liability is established for "unauthorized reinsurers" and changes in this
liability are charged or credited directly to unassigned surplus. The effects
of these variances have not been determined by the Company.
The National Association of Insurance Commissioners (NAIC) currently is in
the process of recodifying statutory accounting practices, the result of which
is expected to constitute the only source of "prescribed" statutory accounting
practices. Accordingly, that project, which is expected to be completed in
1997, will likely change, to some extent, prescribed statutory accounting
practices and may result in changes to the accounting practices that the
Company uses to prepare its statutory-basis financial statements.
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all
highly liquid investments with remaining maturity of one year or less when
purchased to be cash equivalents.
Investments
Investments in bonds (except those to which the Securities Valuation Office
of the NAIC has ascribed a value), mortgage loans on real estate and short-
term investments are reported at cost adjusted for amortization of premiums
and accrual of discounts. Amortization is computed using methods which result
in a level yield over the expected life of the security. The Company reviews
its prepayment assumptions on mortgage and other asset backed securities at
regular intervals and adjusts amortization rates prospectively when such
assumptions are changed due to experience and/or expected future patterns.
Investments in preferred stocks in good standing are reported at cost.
Investments in preferred stocks not in good standing are reported at the lower
of cost or market. Common stocks of affiliated and unaffiliated companies,
which may include shares of mutual funds (money market and other), are carried
at market. Real estate is reported at cost less allowances for depreciation.
Depreciation is computed principally by the straight-line method. Policy loans
are reported at unpaid principal. Other invested assets consist principally of
investments in various joint ventures and are recorded at equity in underlying
net assets. Other "admitted assets" are valued, principally at cost, as
required or permitted by Iowa Insurance Laws.
34
<PAGE>
PFL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS--STATUTORY BASIS (CONTINUED)
(DOLLARS IN THOUSANDS)
Realized capital gains and losses are determined on the basis of specific
identification and are recorded net of related federal income taxes. The Asset
Valuation Reserve (AVR) is established by the Company to provide for
anticipated losses in the event of default by issuers of certain invested
assets. These amounts are determined using a formula prescribed by the NAIC
and are reported as a liability. The formula for the AVR provides for a
corresponding adjustment for realized gains and losses, net of amounts
attributed to changes in the general level of interest rates. Under a formula
prescribed by the NAIC, the Company defers, in the Interest Maintenance
Reserve (IMR), the portion of realized gains and losses on sales of fixed
income investments, principally bonds and mortgage loans, attributable to
changes in the general level of interest rates and amortizes those deferrals
over the remaining period to maturity of the security.
Interest income is recognized on an accrual basis. The Company does not
accrue income on bonds in default, mortgage loans on real estate in default
and/or foreclosure or which are delinquent more than twelve months, or real
estate where rent is in arrears for more than three months. Further, income is
not accrued when collection is uncertain. At December 31, 1996, 1995 and 1994,
the Company excluded investment income due and accrued of $1,541, $2,272 and
$4,622, respectively, with respect to such practices.
The Company entered into an interest-rate cap agreement on Five Year
Constant Maturities Treasury futures to hedge the exposure of increasing
interest rates. The cash flows from the interest rate cap will help offset
losses that might occur from disintermediation resulting from a rise in
interest rates. The Company paid a one-time premium to receive the difference
between the reference rate and the strike rate after a two-year delay. The
cost is included in interest expense ratably during the life of the agreement.
Income received as a result of the cap agreement will be recognized in
investment income as earned. Unamortized cost of the agreements is included in
other assets.
Aggregate Policy Reserves
Life, annuity and accident and health benefit reserves are developed by
actuarial methods and are determined based on published tables using
statutorily specified interest rates and valuation methods that will provide,
in the aggregate, reserves that are greater than or equal to the minimum
required by law.
The aggregate policy reserves for life insurance policies are based
principally upon the 1941, 1958 and 1980 Commissioners' Standard Ordinary
Mortality and American Experience Mortality Tables. The reserves are
calculated using interest rates ranging from 2.00 to 6.00 percent and are
computed principally on the Net Level Premium Valuation and the Commissioners'
Reserve Valuation Methods. Reserves for universal life policies are based on
account balances adjusted for the Commissioners' Reserve Valuation Method.
Deferred annuity reserves are calculated according to the Commissioners'
Annuity Reserve Valuation Method including excess interest reserves to cover
situations where the future interest guarantees plus the decrease in surrender
charges are in excess of the maximum valuation rates of interest. Reserves for
immediate annuities and supplementary contracts with and without life
contingencies are equal to the present value of future payments assuming
interest rates ranging from 2.50 to 11.25 percent and mortality rates, where
appropriate, from a variety of tables.
35
<PAGE>
PFL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS--STATUTORY BASIS (CONTINUED)
(DOLLARS IN THOUSANDS)
Accident and health policy reserves are equal to the greater of the gross
unearned premiums or any required midterminal reserves plus net unearned
premiums and the present value of amounts not yet due on both reported and
unreported claims.
Policy and Contract Claim Reserves
Claim reserves represent the estimated accrued liability for claims reported
to the Company and claims incurred but not yet reported through the statement
date. These reserves are estimated using either individual case-basis
valuations or statistical analysis techniques. These estimates are subject to
the effects of trends in claim severity and frequency. The estimates are
continually reviewed and adjusted as necessary as experience develops or new
information becomes available.
Separate Account
Assets held in trust for purchases of variable annuity contracts and the
Company's corresponding obligation to the contract owners are shown separately
in the balance sheets. The assets in the separate account are valued at
market. Income and gains and losses with respect to the assets in the separate
account accrue to the benefit of the policyholders. The Company received
variable contract premiums of $227,864, $133,386 and $308,305 in 1996, 1995
and 1994, respectively. All variable account contracts are subject to
discretionary withdrawal by the policyholder at the market value of the
underlying assets less the current surrender charge.
Reclassifications
Certain reclassifications have been made to the 1995 and 1994 financial
statements to conform to the 1996 presentation.
2. FAIR VALUES OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, Disclosures about Fair
Value of Financial Instruments, requires disclosure of fair value information
about financial instruments, whether or not recognized in the statutory-basis
balance sheet, for which it is practicable to estimate that value. SFAS No.
119, Disclosures about Derivative Financial Instruments and Fair Value of
Financial Instruments, requires additional disclosure about derivatives. In
cases where quoted market prices are not available, fair values are based on
estimates using present value or other valuation techniques. Those techniques
are significantly affected by the assumptions used, including the discount
rate and estimates of future cash flows. In that regard, the derived fair
value estimates cannot be substantiated by comparisons to independent markets
and, in many cases, could not be realized in immediate settlement of the
instrument. Statement of Financial Accounting Standards No. 107 and No. 119
exclude certain financial instruments and all nonfinancial instruments from
their disclosure requirements and allow companies to forego the disclosures
when those estimates can only be made at excessive cost. Accordingly, the
aggregate fair value amounts presented do not represent the underlying value
of the Company.
The following methods and assumptions were used by the Company in estimating
its fair value disclosures for financial instruments:
Cash and short-term investments: The carrying amounts reported in the
balance sheet for these instruments approximate their fair values.
36
<PAGE>
PFL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS--STATUTORY BASIS (CONTINUED)
(DOLLARS IN THOUSANDS)
Investment securities: Fair values for fixed maturity securities
(including redeemable preferred stocks) are based on quoted market prices,
where available. For fixed maturity securities not actively traded, fair
values are estimated using values obtained from independent pricing
services or, in the case of private placements, are estimated by
discounting expected future cash flows using a current market rate
applicable to the yield, credit quality, and maturity of the investments.
The fair values for equity securities other than insurance subsidiaries are
based on quoted market prices. Fair value for the Company's insurance
subsidiary is the statutory net book value of that subsidiary.
Mortgage loans and policy loans: The fair values for mortgage loans are
estimated utilizing discounted cash flow analyses, using interest rates
reflective of current market conditions and the risk characteristics of the
loans. The fair value of policy loans are assumed to equal their carrying
value.
Investment contracts: Fair values for the Company's liabilities under
investment-type insurance contracts are estimated using discounted cash
flow calculations, based on interest rates currently being offered for
similar contracts with maturities consistent with those remaining for the
contracts being valued.
Interest rate cap: Estimated fair value of the interest rate cap is based
upon the latest quoted market price.
Fair values for the Company's insurance contracts other than investment
contracts are not required to be disclosed. However, the fair values of
liabilities under all insurance contracts are taken into consideration in the
Company's overall management of interest rate risk, which minimizes exposure
to changing interest rates through the matching of investment maturities with
amounts due under insurance contracts.
The following sets forth a comparison of the fair values and carrying values
of the Company's financial instruments subject to the provisions of Statement
of Financial Accounting Standards No. 107 and No. 119:
<TABLE>
<CAPTION>
DECEMBER 31
-------------------------------------------
1996 1995
--------------------- ---------------------
CARRYING CARRYING
VALUE FAIR VALUE VALUE FAIR VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
ADMITTED ASSETS
Bonds.......................... $4,773,433 $4,867,770 $4,613,334 $4,824,635
Preferred stocks............... 3,097 7,133 9,336 12,275
Common stocks.................. 32,038 32,038 24,866 24,866
Affiliated common and preferred
stock......................... 6,934 6,934 6,794 6,794
Mortgage loans on real estate.. 911,705 922,010 680,414 714,399
Policy loans................... 54,214 54,214 52,675 52,675
Cash and short-term
investments................... 50,737 50,737 79,852 79,852
Interest rate cap.............. 6,797 6,975 7,971 7,250
Separate account assets........ 1,844,515 1,844,515 1,418,157 1,418,157
LIABILITIES
Investment contract
liabilities................... 4,532,568 4,398,630 4,323,188 4,310,505
Separate account annuities..... 1,803,057 1,803,057 1,417,842 1,417,842
</TABLE>
37
<PAGE>
PFL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS--STATUTORY BASIS (CONTINUED)
(DOLLARS IN THOUSANDS)
3. INVESTMENTS
The carrying value and estimated fair value of investments in debt
securities were as follows:
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
CARRYING UNREALIZED UNREALIZED FAIR
VALUE GAINS LOSSES VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
DECEMBER 31, 1996
Bonds:
United States Government and
agencies.................... $ 136,450 $ 3,301 $ 180 $ 139,571
State, municipal and other
government.................. 59,644 1,906 177 61,373
Public utilities............. 147,918 5,616 1,020 152,514
Industrial and
miscellaneous............... 1,958,681 64,710 8,105 2,015,286
Mortgage-backed securities... 2,470,740 43,896 15,610 2,499,026
---------- -------- ------- ----------
4,773,433 119,429 25,092 4,867,770
Preferred stocks............... 3,097 4,036 -- 7,133
---------- -------- ------- ----------
$4,776,530 $123,465 $25,092 $4,874,903
========== ======== ======= ==========
DECEMBER 31, 1995
Bonds:
United States Government and
agencies.................... $ 117,054 $ 5,808 $ 135 $ 122,727
State, municipal and other
government.................. 46,236 3,109 2 49,343
Public utilities............. 156,342 9,578 1,092 164,828
Industrial and
miscellaneous............... 1,781,149 112,074 7,146 1,886,077
Mortgage-backed securities... 2,512,553 93,420 4,313 2,601,660
---------- -------- ------- ----------
4,613,334 223,989 12,688 4,824,635
Preferred stocks............... 9,336 3,348 409 12,275
---------- -------- ------- ----------
$4,622,670 $227,337 $13,097 $4,836,910
========== ======== ======= ==========
</TABLE>
The carrying value and estimated fair value of bonds at December 31, 1996,
by contractual maturity, are shown below. Expected maturities may differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
CARRYING ESTIMATED FAIR
VALUE VALUE
---------- --------------
<S> <C> <C>
Due in one year or less............................ $ 202,775 $ 204,980
Due after one year through five years.............. 896,912 921,711
Due after five years through ten years............. 954,555 977,421
Due after ten years................................ 248,451 264,632
---------- ----------
2,302,693 2,368,744
Mortgage and other asset-backed securities......... 2,470,740 2,499,026
---------- ----------
$4,773,433 $4,867,770
========== ==========
</TABLE>
38
<PAGE>
PFL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS--STATUTORY BASIS (CONTINUED)
(DOLLARS IN THOUSANDS)
A detail of net investment income is presented below:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Interest on bonds and notes...................... $364,356 $342,182 $294,145
Dividends on equity investments.................. 1,436 1,822 12,091
Interest on mortgage loans....................... 69,418 52,702 42,385
Rental income on real estate..................... 9,526 10,443 9,360
Interest on policy loans......................... 3,273 3,112 3,182
Other investment income.......................... 1,799 1,803 282
-------- -------- --------
Gross investment income.......................... 449,808 412,064 361,445
Investment expenses.............................. 21,471 19,379 17,565
-------- -------- --------
Net investment income............................ $428,337 $392,685 $343,880
======== ======== ========
</TABLE>
Proceeds from sales and maturities of debt securities and related gross
realized gains and losses were as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------------------
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
Proceeds................................ $2,112,831 $1,757,229 $1,430,339
========== ========== ==========
Gross realized gains.................... $ 19,876 $ 19,721 $ 15,411
Gross realized losses................... (19,634) (34,399) (33,044)
---------- ---------- ----------
Net realized gains (losses)............. $ 242 $ (14,678) $ (17,633)
========== ========== ==========
</TABLE>
At December 31, 1996, investments with an aggregate carrying value of
$5,825,802 were on deposit with regulatory authorities or were restrictively
held in bank custodial accounts for the benefit of such regulatory authorities
as required by statute.
Realized investment gains (losses) and changes in unrealized gains (losses)
for investments are summarized below:
<TABLE>
<CAPTION>
REALIZED
---------------------------
YEAR ENDED DECEMBER 31
---------------------------
1996 1995 1994
------- -------- --------
<S> <C> <C> <C>
Debt securities................................ $ 242 $(14,678) $(17,633)
Short-term investments......................... (197) 24 (309)
Equity securities.............................. 1,798 504 1,322
Mortgage loans on real estate.................. (5,530) (1,053) (2,186)
Real estate.................................... 1,210 (1,908) (2,858)
Other invested assets.......................... 12 (970) 14
------- -------- --------
(2,465) (18,081) (21,650)
Tax effect..................................... (1,235) 7,878 7,236
Transfer to interest maintenance reserve....... 197 (7,891) 10,790
------- -------- --------
Net realized losses............................ $(3,503) $(18,096) $ (3,624)
======= ======== ========
</TABLE>
39
<PAGE>
PFL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS--STATUTORY BASIS (CONTINUED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
CHANGE IN UNREALIZED
------------------------------
YEAR ENDED DECEMBER 31
------------------------------
1996 1995 1994
--------- -------- ---------
<S> <C> <C> <C>
Debt securities............................ $(115,867) $355,560 $(322,346)
Equity securities.......................... 2,929 (16,379) (23,202)
--------- -------- ---------
Change in unrealized appreciation
(depreciation)............................ $(112,938) $339,181 $(345,548)
========= ======== =========
</TABLE>
Gross unrealized gains and gross unrealized losses on equity securities were
as follows:
<TABLE>
<CAPTION>
DECEMBER 31
-------------------------
1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
Unrealized gains.................................. $ 9,590 $ 6,833 $20,244
Unrealized losses................................. (8,723) (8,895) (5,927)
------- ------- -------
Net unrealized gains (losses)..................... $ 867 $(2,062) $14,317
======= ======= =======
</TABLE>
During 1996, the Company issued mortgage loans with interest rates ranging
from 6.83% to 8.75%. The maximum percentage of any one mortgage loan to the
value of the underlying real estate at origination was 85%. Mortgage loans
with a carrying value of $4,027 were non-income producing for the previous
twelve months. Accrued interest of $852 related to these mortgage loans was
excluded from investment income. The Company requires all mortgage loans to
carry fire insurance equal to the value of the underlying property.
During 1996, 1995 and 1994, mortgage loans of $13,163, $1,644 and $799,
respectively, were foreclosed and transferred to real estate. At December 31,
1996 and 1995, the Company held a mortgage loan loss reserve in the asset
valuation reserve of $5,432 and $6,168, respectively. The mortgage loan
portfolio is diversified by geographic region and specific collateral property
type as follows:
<TABLE>
<CAPTION>
GEOGRAPHIC DISTRIBUTION
- -------------------------------------
DECEMBER 31
------------
1996 1995
----- -----
<S> <C> <C>
South Atlantic.......... 26% 26%
Mountain................ 10 12
W. South Central........ 12 14
Pacific................. 13 17
E. North Central........ 15 13
E. South Central........ 9 5
W. North Central........ 6 6
Middle Atlantic......... 6 3
New England............. 3 4
</TABLE>
<TABLE>
<CAPTION>
PROPERTY TYPE DISTRIBUTION
- -------------------------------------
DECEMBER 31
------------
1996 1995
----- -----
<S> <C> <C>
Retail.................. 37% 31%
Apartment............... 14 20
Office.................. 34 29
Industrial.............. 3 4
Other................... 12 16
</TABLE>
40
<PAGE>
PFL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS--STATUTORY BASIS (CONTINUED)
(DOLLARS IN THOUSANDS)
At December 31, 1996, the Company had the following investments (excluding
U. S. Government guaranteed or insured issues) which individually represented
more than ten percent of capital and surplus and the asset valuation reserve:
<TABLE>
<CAPTION>
DESCRIPTION OF SECURITY OR ISSUER CARRYING VALUE
--------------------------------- --------------
<S> <C>
Bonds:
Citibank.................................................... 70,661
</TABLE>
4. REINSURANCE
The Company reinsures portions of risk on certain insurance policies which
exceed its established limits, thereby providing a greater diversification of
risk and minimizing exposure on larger risks. The Company remains contingently
liable with respect to any insurance ceded, and this would become an actual
liability in the event that the assuming insurance company became unable to
meet its obligation under the reinsurance treaty.
Reinsurance assumption and cession treaties are transacted primarily with
affiliates. Premiums earned reflect the following reinsurance assumed and
ceded amounts:
<TABLE>
<CAPTION>
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
Direct premiums.......................... $1,457,450 $1,591,531 $1,857,446
Reinsurance assumed...................... 1,796 2,356 1,832
Reinsurance ceded........................ (300,546) (324,993) (412,029)
---------- ---------- ----------
Net premiums earned...................... $1,158,700 $1,268,894 $1,447,249
========== ========== ==========
</TABLE>
The Company received reinsurance recoveries in the amount of $168,155,
$167,287 and $148,414 during 1996, 1995 and 1994, respectively. At December
31, 1996 and 1995, estimated amounts recoverable from reinsurers that have
been deducted from policy and contract claim reserves totaled $63,226 and
$65,503, respectively. The aggregate reserves for policies and contracts were
reduced for reserve credits for reinsurance ceded at December 31, 1996 and
1995 of $2,737,441 and $2,920,034, respectively.
At December 31, 1996, amounts recoverable from unauthorized reinsurers of
$73,434 (1995--$70,516) and reserve credits for reinsurance ceded of $55,035
(1995--$48,992) were associated with a single reinsurer and its affiliates.
The Company holds collateral under these reinsurance agreements in the form of
trust agreements totaling $120,477 at December 31, 1996 that can be drawn on
for amounts that remain unpaid for more than 120 days.
5. INCOME TAXES
For federal income tax purposes, the Company joins in a consolidated tax
return filing with certain affiliated companies. Under the terms of a tax-
sharing agreement between the Company and its affiliates, the Company computes
federal income tax expense as if it were filing a separate income tax return,
except that tax credits and net operating loss carryforwards are determined on
the basis of the consolidated group. Additionally, the alternative minimum tax
is computed for the consolidated group and the resulting tax, if any, is
allocated back to the separate companies on the basis of the separate
companies' alternative minimum taxable income.
41
<PAGE>
PFL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS--STATUTORY BASIS (CONTINUED)
(DOLLARS IN THOUSANDS)
Federal income tax expense differs from the amount computed by applying the
statutory federal income tax rate to gain from operations before taxes and
realized capital losses for the following reasons:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
-------------------------
1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
Computed tax at federal statutory rate (35%)..... $37,256 $27,835 $24,106
Tax reserve adjustment........................... 2,211 2,405 1,150
Excess tax depreciation.......................... (384) (365) (406)
Deferred acquisition costs--tax basis............ 5,583 4,581 7,378
Prior year over accrual.......................... (499) (306) (644)
Dividend received deduction...................... (454) (56) (3,513)
Charitable contribution.......................... -- -- (3,935)
Other items--net................................. (2,536) (759) (278)
------- ------- -------
Federal income tax expense....................... $41,177 $33,335 $23,858
======= ======= =======
</TABLE>
Prior to 1984, as provided for under the Life Insurance Company Tax Act of
1959, a portion of statutory income was not subject to current taxation but
was accumulated for income tax purposes in a memorandum account referred to as
the policyholders' surplus account. No federal income taxes have been provided
for in the financial statements on income deferred in the policyholders'
surplus account ($20,387 at December 31, 1996). To the extent dividends are
paid from the amount accumulated in the policyholders' surplus account, net
earnings would be reduced by the amount of tax required to be paid. Should the
entire amount in the policyholders' surplus account become taxable, the tax
thereon computed at current rates would amount to approximately $7,135.
The Company's federal income tax returns have been examined and closing
agreements have been executed with the Internal Revenue Service through 1987.
During 1996, there was a $5,025 prior period adjustment to the tax accrual.
This included a $2,100 writeoff of an intangible asset for tax purposes, and a
federal income tax refund of $1,829 for tax years 1984-1986 and related
interest of $1,686, net of a tax effect of $590. An examination is underway
for years 1988 through 1995.
6. POLICY AND CONTRACT ATTRIBUTES
Participating life insurance policies are issued by the Company which
entitle policyholders to a share in the earnings of the participating
policies, provided that a dividend distribution, which is determined annually
based on mortality and persistency experience of the participating policies,
is authorized by the Company. Participating insurance constituted
approximately 1.0% and 1.2% of ordinary life insurance in force at December
31, 1996 and 1995, respectively.
A portion of the Company's policy reserves and other policyholders' funds
(including separate account liabilities) relate to liabilities established on
a variety of the Company's products that are not subject to significant
mortality or morbidity risk; however, there may be certain restrictions placed
upon the amount of funds that can be withdrawn without penalty. The amount of
reserves on these products, by withdrawal characteristics are summarized as
follows:
42
<PAGE>
PFL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS--STATUTORY BASIS (CONTINUED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31
---------------------------------------
1996 1995
------------------- -------------------
PERCENT PERCENT
AMOUNT OF TOTAL AMOUNT OF TOTAL
---------- -------- ---------- --------
<S> <C> <C> <C> <C>
Subject to discretionary withdrawal
with market value adjustment....... $ 20,800 0% $ 699 --%
Subject to discretionary withdrawal
at book value less surrender
charge............................. 794,881 9 733,796 8%
Subject to discretionary withdrawal
at market value.................... 1,803,057 20 1,390,156 16%
Subject to discretionary withdrawal
at book value (minimal or no
charges or adjustments)............ 6,284,876 69 6,395,719 74%
Not subject to discretionary
withdrawal provision............... 174,416 2 139,330 2%
---------- --- ---------- ---
9,078,030 100 8,659,700 100%
Less reinsurance ceded.............. 2,677,432 2,866,160
---------- ----------
Total policy reserves on annuities
and deposit fund liabilities....... $6,400,598 $5,793,540
========== ==========
</TABLE>
A reconciliation of the amounts transferred to and from the separate
accounts is presented below:
<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Transfers as reported in the summary of
operations of the separate accounts statement:
Transfers to separate accounts................. $227,864 $133,386 $308,305
Transfers from separate accounts............... 75,172 104,219 76,133
-------- -------- --------
Net transfers to separate accounts............... 152,692 29,167 232,172
Reconciling adjustments--charges for investment
management, administration fees and contract
guarantees...................................... 19,093 13,814 11,634
-------- -------- --------
Transfers as reported in the summary of
operations of the life, accident and health
annual statement................................ $171,785 $ 42,981 $243,806
======== ======== ========
</TABLE>
43
<PAGE>
PFL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS--STATUTORY BASIS (CONTINUED)
(DOLLARS IN THOUSANDS)
Reserves on the Company's traditional life products are computed using mean
reserving methodologies. These methodologies result in the establishment of
assets for the amount of the net valuation premiums that are anticipated to be
received between the policy's paid-through date to the policy's next
anniversary date. At December 31, 1996 and 1995, these assets (which are
reported as premiums deferred and uncollected) and the amounts of the related
gross premiums and loadings, are as follows:
<TABLE>
<CAPTION>
GROSS LOADING NET
------- ------- -------
<S> <C> <C> <C>
DECEMBER 31, 1996
Life and annuity:
Ordinary direct first year business............. $ 2,657 $ 1,865 $ 792
Ordinary direct renewal business................ 23,307 7,180 16,127
Group life direct business...................... 1,788 1,195 593
Reinsurance ceded............................... (1,706) (438) (1,268)
------- ------- -------
26,046 9,802 16,244
Accident and health:
Direct.......................................... 104 -- 104
Reinsurance ceded............................... (3) -- (3)
------- ------- -------
Total accident and health......................... 101 -- 101
------- ------- -------
$26,147 $ 9,802 $16,345
======= ======= =======
DECEMBER 31, 1995
Life and annuity:
Ordinary direct first year business............. $ 3,151 $ 2,223 $ 928
Ordinary direct renewal business................ 24,250 7,792 16,458
Group life direct business...................... 1,537 779 758
Reinsurance ceded............................... (1,362) (141) (1,221)
------- ------- -------
27,576 10,653 16,923
Accident and health:
Direct.......................................... 1,296 -- 1,296
Reinsurance ceded............................... (1,193) -- (1,193)
------- ------- -------
Total accident and health......................... 103 -- 103
------- ------- -------
$27,679 $10,653 $17,026
======= ======= =======
</TABLE>
At December 31, 1996 and 1995, the Company had insurance in force
aggregating $69,251 and $87,010, respectively, in which the gross premiums are
less than the net premiums required by the standard valuation standards
established by the Insurance Division, Department of Commerce, of the State of
Iowa. The Company established policy reserves of $1,252 and $1,417 to cover
these deficiencies at December 31, 1996 and 1995, respectively.
In 1994, the NAIC enacted a guideline to clarify reserving methodologies for
contracts that require immediate payment of claims upon proof of death of the
insured. Companies were allowed to grade the effects of the change in
reserving methodologies over five years. A direct charge to surplus of $501
was made for the year ended December 31, 1995, related to the change in
reserve methodology.
44
<PAGE>
PFL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS--STATUTORY BASIS (CONTINUED)
(DOLLARS IN THOUSANDS)
7. DIVIDEND RESTRICTIONS
Generally, an insurance company's ability to pay dividends is limited to the
amount that their net assets, as determined in accordance with statutory
accounting practices, exceed minimum statutory capital requirements. However,
payment of such amounts as dividends may be subject to approval by regulatory
authorities.
The Company paid dividends to its parent of $20,000 and $20,900 in 1996 and
1994, respectively. No dividends were paid in 1995.
8. RETIREMENT AND COMPENSATION PLANS
The Company's employees participate in a qualified benefit pension plan
sponsored by AEGON. The Company has no legal obligation for the plan. The
Company recognizes pension expense equal to its allocation from AEGON. The
pension expense is allocated among the participating companies based on the
FASB No. 87 expense as a percent of salaries. The benefits are based on years
of service and the employee's compensation during the highest five consecutive
years of employment. Pension expense aggregated $1,056, $942 and $966 for the
years ended December 31, 1996, 1995 and 1994, respectively. The plan is
subject to the reporting and disclosure requirements of the Employee
Retirement and Income Security Act of 1974.
The Company's employees also participate in a contributory defined
contribution plan sponsored by AEGON which is qualified under Section 401(k)
of the Internal Revenue Service Code. Employees of the Company who customarily
work at least 1,000 hours during each calendar year and meet the other
eligibility requirements, are participants of the plan. Participants may elect
to contribute up to fifteen percent of their salary to the plan. The Company
will match an amount up to three percent of the participant's salary.
Participants may direct all of their contributions and plan balances to be
invested in a variety of investment options. The plan is subject to the
reporting and disclosure requirements of the Employee Retirement and Income
Security Act of 1974. Expense related to this plan was $297, $465 and $411 for
the years ended December 31, 1996, 1995 and 1994, respectively.
AEGON sponsors supplemental retirement plans to provide the Company's senior
management with benefits in excess of normal pension benefits. The plans are
noncontributory and benefits are based on years of service and the employee's
compensation level. The plans are unfunded and nonqualified under the Internal
Revenue Service Code. In addition, AEGON has established incentive deferred
compensation plans for certain key employees of the Company. AEGON also
sponsors an employee stock option plan for individuals employed at least three
years and a stock purchase plan for its producers, with the participating
affiliated companies establishing their own eligibility criteria, producer
contribution limits and company matching formula. These plans have been
accrued or funded as deemed appropriate by management of AEGON and the
Company.
In addition to pension benefits, the Company participates in plans sponsored
by AEGON that provide postretirement medical, dental and life insurance
benefits to employees meeting certain eligibility requirements. Portions of
the medical and dental plans are contributory. The expenses of the
postretirement plans calculated on the pay-as-you-go basis are charged to
affiliates in accordance with an intercompany cost sharing arrangement. The
Company expensed $184, $164 and $169 for the years ended December 31, 1996,
1995 and 1994, respectively.
45
<PAGE>
PFL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS--STATUTORY BASIS (CONTINUED)
(DOLLARS IN THOUSANDS)
9. RELATED PARTY TRANSACTIONS
The Company shares certain offices, employees and general expenses with
affiliated companies.
The Company receives data processing, investment advisory and management,
marketing and administration services from certain affiliates. During 1996,
1995 and 1994, the Company paid $17,028, $14,214 and $11,820, respectively,
for these services, which approximates their costs to the affiliates.
Payable to affiliates and intercompany borrowings bear interest at the
thirty-day commercial paper rate of 5.5% at December 31, 1996. During 1996,
1995 and 1994, the Company paid net interest of $174, $71 and $23,
respectively, to affiliates.
During 1995 and 1994, the Company received capital contributions of $40,000
and $15,000, respectively, in cash from its parent and during 1994 received a
dividend of $10,000 from its subsidiary, Equity National, which was included
in net investment income.
During 1995, the Company sold real estate with a book value of approximately
$13,270 to an affiliated entity in exchange for a short-term note receivable.
No gain was recognized on this sale. This note accrued interest at 5.65% and
matured during 1996.
During the year ended December 31, 1995, the Company restructured demand
notes and accrued interest of $13,250 and $745, respectively, related to an
affiliate. The Company received 9,750 shares of preferred stock from the
affiliate for satisfaction of debt. The Company realized a loss of $8,695
related to this transaction. At December 31, 1996 and 1995, the preferred
stock related to this affiliate was deemed to have no value and an unrealized
loss of $4,555 was recognized in 1995.
10. COMMITMENTS AND CONTINGENCIES
The Company is a party to legal proceedings incidental to its business.
Although such litigation sometimes includes substantial demands for
compensatory and punitive damages, in addition to contract liability, it is
management's opinion, after consultation with counsel and a review of
available facts, that damages arising from such demands will not be material
to the Company's financial position.
The Company is subject to insurance guaranty laws in the states in which it
writes business. These laws provide for assessments against insurance
companies for the benefit of policyholders and claimants in the event of
insolvency of other insurance companies. Assessments are charged to operations
when received by the Company except where right of offset against other taxes
paid is allowed by law; amounts available for future offsets are recorded as
an asset on the Company's balance sheet. Potential future obligations for
unknown insolvencies are not determinable by the Company. The future
obligation has been based on the most recent information available from the
National Organization of Life and Health Insurance Guaranty Associations
(NOLHGA). The Company has established a reserve of $21,774 and $21,747 and an
offsetting premium tax benefit of $8,752 and $9,457 at December 31, 1996 and
1995, respectively, for its estimated share of future guaranty fund
assessments related to several major insurer insolvencies. During 1994, $3,444
was charged to surplus as prior period adjustments to provide for this net
reserve plus certain assessments paid that related to several major insurer
insolvencies prior to 1992. The guaranty fund expense was $2,617, $5,859 and
$4,054 for December 31, 1996, 1995 and 1994, respectively.
46
<PAGE>
SCHEDULE I
PFL LIFE INSURANCE COMPANY
SUMMARY OF INVESTMENTS--OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 1996
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
AMOUNT AT WHICH
MARKET SHOWN IN THE
TYPE OF INVESTMENT COST (1) VALUE BALANCE SHEET (2)
------------------ ---------- ---------- -----------------
<S> <C> <C> <C>
FIXED MATURITIES
Bonds:
United States Government and
government agencies and
authorities......................... $1,533,581 $1,554,339 $1,533,510
States, municipalities and political
subdivisions........................ 4,918 5,360 4,919
Foreign governments.................. 55,633 56,013 54,725
Public utilities..................... 150,346 152,514 147,918
All other corporate bonds............ 3,046,090 3,099,544 3,032,361
Redeemable preferred stock............. 3,097 7,133 3,097
---------- ---------- ----------
Total fixed maturities................. 4,793,665 4,874,903 4,776,530
EQUITY SECURITIES
Common stocks:
Banks, trust and insurance........... 7,120 9,777 9,777
Industrial, miscellaneous and all
other............................... 16,092 22,261 22,261
---------- ---------- ----------
Total equity securities................ 23,212 32,038 32,038
Mortgage loans on real estate.......... 911,705 911,705
Real estate............................ 46,294 46,294
Real estate acquired in satisfaction of
debt.................................. 12,260 12,260
Policy loans........................... 54,214 54,214
Other long-term investments............ 9,546 9,546
Cash and short-term investments........ 50,737 50,737
---------- ----------
Total investments...................... $5,901,633 $5,893,324
========== ==========
</TABLE>
- --------
(1) Original cost of equity securities and, as to fixed maturities, original
cost reduced by repayments.
(2) Amount differs from cost as certain bonds have been adjusted to reflect
other than temporary decline in value charged to surplus, as prescribed by
the NAIC.
47
<PAGE>
SCHEDULE III
PFL LIFE INSURANCE COMPANY
SUPPLEMENTARY INSURANCE INFORMATION
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
FUTURE POLICY POLICY AND
BENEFITS AND UNEARNED CONTRACT
EXPENSES PREMIUMS LIABILITIES
------------- -------- -----------
<S> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1996
Individual life.............................. $ 734,350 $ -- $ 7,240
Individual health............................ 39,219 8,680 13,631
Group life and health........................ 78,418 14,702 53,486
Annuity...................................... 4,408,419 -- --
---------- ------- -------
$5,260,406 $23,382 $74,357
========== ======= =======
YEAR ENDED DECEMBER 31, 1995
Individual life.............................. $ 594,274 $ -- $ 6,066
Individual health............................ 24,225 7,768 11,863
Group life and health........................ 67,994 16,662 58,813
Annuity...................................... 4,220,274 -- --
---------- ------- -------
$4,906,767 $24,430 $76,742
========== ======= =======
YEAR ENDED DECEMBER 31, 1994
Individual life.............................. $ 544,087 $ -- $ 7,298
Individual health............................ 16,649 6,487 8,643
Group life and health........................ 60,207 17,680 57,959
Annuity...................................... 3,693,388 -- --
---------- ------- -------
$4,314,331 $24,167 $73,900
========== ======= =======
</TABLE>
48
<PAGE>
<TABLE>
<CAPTION>
NET INVESTMENT BENEFITS, CLAIMS LOSSES OTHER OPERATING
PREMIUM REVENUE INCOME* AND SETTLEMENT EXPENSES EXPENSES* PREMIUMS WRITTEN
- --------------- -------------- ----------------------- --------------- ----------------
<S> <C> <C> <C> <C>
$ 202,082 $ 66,538 $ 197,526 $ 38,067 --
55,871 5,263 32,903 29,511 $ 55,678
174,781 12,877 105,459 122,953 171,320
725,966 343,659 800,121 230,417 --
- ---------- -------- ---------- --------
$1,158,700 $428,337 $1,136,009 $420,948
========== ======== ========== ========
$111,918 $ 49,929 $ 97,065 $ 37,933 --
47,692 4,091 25,793 26,033 $ 47,690
187,832 11,665 106,065 139,640 184,545
921,452 327,000 1,116,768 114,164 --
- ---------- -------- ---------- --------
$1,268,894 $392,685 $1,345,691 $317,770
========== ======== ========== ========
$146,328 $ 43,025 $ 124,736 $ 42,309 --
38,811 3,983 22,323 22,707 $ 38,797
194,704 10,531 108,400 143,645 192,034
1,067,406 286,341 1,036,313 319,328 --
- ---------- -------- ---------- --------
$1,447,249 $343,880 $1,291,772 $527,989
========== ======== ========== ========
</TABLE>
- --------
* Allocations of net investment income and other operating expenses are based
on a number of assumptions and estimates, and the results would change if
different methods were applied.
49
<PAGE>
SCHEDULE IV
PFL LIFE INSURANCE COMPANY
REINSURANCE
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
ASSUMED PERCENTAGE
CEDED TO FROM OF AMOUNT
GROSS OTHER OTHER NET ASSUMED
AMOUNT COMPANIES COMPANIES AMOUNT TO NET
---------- --------- --------- ---------- ----------
<S> <C> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31,
1996
Life insurance in force.. $4,863,416 $477,112 $ 30,685 $4,416,989 .7%
========== ======== ======== ========== ===
Premiums:
Individual life........ $ 204,144 $ 3,858 $ 1,796 $ 202,082 .9%
Individual health...... 68,699 12,828 -- 55,871 --
Group life and health.. 390,296 215,515 -- 174,781 --
Annuity................ 794,311 68,345 -- 725,966 --
---------- -------- -------- ---------- ---
$1,457,450 $300,546 $ 1,796 $1,158,700 .2%
========== ======== ======== ========== ===
YEAR ENDED DECEMBER 31,
1995
Life insurance in force.. $4,594,434 $468,811 $ 22,936 $4,148,559 .6%
========== ======== ======== ========== ===
Premiums:
Individual life........ $ 113,934 $ 3,841 $ 1,825 $ 111,918 1.6%
Individual health...... 60,309 12,617 -- 47,692 --
Group life and health.. 408,097 220,265 -- 187,832 --
Annuity................ 1,009,191 88,270 531 921,452 .05%
---------- -------- -------- ---------- ---
$1,591,531 $324,993 $ 2,356 $1,268,894 .2%
========== ======== ======== ========== ===
YEAR ENDED DECEMBER 31,
1994
Life insurance in force.. $4,713,817 $468,811 $112,054 $4,357,060 2.6%
========== ======== ======== ========== ===
Premiums:
Individual life........ $ 148,702 $ 3,639 $ 1,265 $ 146,328 .9%
Individual health...... 50,303 11,492 -- 38,811 --
Group life and health.. 412,200 217,496 -- 194,704 --
Annuity................ 1,246,241 179,402 567 1,067,406 .05%
---------- -------- -------- ---------- ---
$1,857,446 $412,029 $ 1,832 $1,447,249 .1%
========== ======== ======== ========== ===
</TABLE>
50
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
ENDEAVOR SERIES TRUST
This Statement of Additional Information is not a prospectus and should be
read in conjunction with the Prospectus for the TCW Money Market Portfolio
(formerly, the Money Market Portfolio), the TCW Managed Asset Allocation
Portfolio (formerly, the Managed Asset Allocation Portfolio), the T. Rowe Price
International Stock Portfolio (formerly, the Global Growth Portfolio), the Value
Equity Portfolio (formerly, the Quest for Value Equity Portfolio), the Dreyfus
Small Cap Value Portfolio (formerly, the Value Small Cap Portfolio and prior to
that the Quest for Value Small Cap Portfolio), the Dreyfus U.S. Government
Securities Portfolio (formerly, the U.S. Government Securities Portfolio), the
T. Rowe Price Equity Income Portfolio, the T. Rowe Price Growth Stock Portfolio,
the Opportunity Value Portfolio and the Enhanced Index Portfolio of Endeavor
Series Trust (the "Fund"), dated May 1, 1997, which may be obtained by writing
the Fund at 2101 East Coast Highway, Suite 300, Corona del Mar, California 92625
or by telephoning (800) 854-8393. Unless otherwise defined herein, capitalized
terms have the meanings given to them in the Prospectus.
-1-
<PAGE>
TABLE OF CONTENTS
Page
----
Investment Objectives and Policies................ 3
Options and Futures Strategies............... 3
Foreign Currency Transactions................ 9
Repurchase Agreements........................ 13
Forward Commitments.......................... 14
Securities Loans............................. 14
Lower Rated Bonds ........................... 14
Interest Rate Transactions................... 16
Dollar Roll Transactions..................... 17
Portfolio Turnover........................... 18
Investment Restrictions........................... 19
Other Policies............................... 22
Performance Information........................... 23
Total Return................................. 24
Yield........................................ 26
Non-Standardized Performance................. 27
Portfolio Transactions............................ 27
Management of the Fund............................ 32
Trustees and Officers........................ 32
The Manager.................................. 38
The Advisers................................. 40
Redemption of Shares.............................. 44
Net Asset Value................................... 44
Taxes............................................. 47
Federal Income Taxes......................... 47
Organization and Capitalization of the Fund....... 48
Legal Matters..................................... 51
Custodian......................................... 51
Financial Statements.............................. 51
Appendix.......................................... A-1
______________________
No person has been authorized to give any information or to make any
representation not contained in this Statement of Additional Information or in
the Prospectus and, if given or made, such information or representation must
not be relied upon as having been authorized. This Statement of Additional
Information does not constitute an offering of any securities other than the
registered securities to which it relates or an offer to any person in any state
or other jurisdiction of the United States or any country where such offer would
be unlawful.
The date of this Statement of Additional Information is May 1, 1997.
-2-
<PAGE>
INVESTMENT OBJECTIVES AND POLICIES
The following information supplements the discussion of the investment
objectives and policies of the Portfolios in the Prospectus of the Fund. The
Fund is managed by Endeavor Investment Advisers. The Manager has selected TCW
Funds Management, Inc. as investment adviser for the TCW Money Market Portfolio
and the TCW Managed Asset Allocation Portfolio, Rowe Price-Fleming
International, Inc. as investment adviser for the T. Rowe Price International
Stock Portfolio, OpCap Advisors (formerly, Quest for Value Advisors) as
investment adviser for the Value Equity Portfolio and Opportunity Value
Portfolio, The Dreyfus Corporation as investment adviser for the Dreyfus U.S.
Government Securities Portfolio and Dreyfus Small Cap Value Portfolio, T. Rowe
Price Associates, Inc. as investment adviser for the T. Rowe Price Equity Income
Portfolio and T. Rowe Price Growth Stock Portfolio and J.P. Morgan Investment
Management Inc. as investment adviser for the Enhanced Index Portfolio.
Options and Futures Strategies (All Portfolios except TCW Money Market
Portfolio)
A Portfolio may seek to increase the current return on its investments by
writing covered call or covered put options. In addition, a Portfolio may at
times seek to hedge against either a decline in the value of its portfolio
securities or an increase in the price of securities which its Adviser plans to
purchase through the writing and purchase of options including options on stock
indices and the purchase and sale of futures contracts and related options. A
Portfolio may utilize options or futures contracts and related options for other
than hedging purposes to the extent that the aggregate initial margins and
premiums do not exceed 5% of the Portfolio's net asset value. The Adviser to the
TCW Managed Asset Allocation Portfolio does not presently intend to utilize
options or futures contracts and related options but may do so in the future.
The Advisers to the Dreyfus Small Cap Value Portfolio and the Opportunity Value
Portfolio do not currently intend to write covered put and call options or
engage in transactions in futures contracts and related options, but may do so
in the future. Expenses and losses incurred as a result of such hedging
strategies will reduce a Portfolio's current return.
The ability of a Portfolio to engage in the options and futures strategies
described below will depend on the availability of liquid markets in such
instruments. Markets in options and futures with respect to stock indices and
U.S. government securities are relatively new and still developing. It is
impossible to predict the amount of trading interest that may
-3-
<PAGE>
exist in various types of options or futures. Therefore no assurance can be
given that a Portfolio will be able to utilize these instruments effectively for
the purposes stated below.
Writing Covered Options on Securities. A Portfolio may write covered call
-------------------------------------
options and covered put options on optionable securities of the types in which
it is permitted to invest from time to time as its Adviser determines is
appropriate in seeking to attain the Portfolio's investment objective. Call
options written by a Portfolio give the holder the right to buy the underlying
security from the Portfolio at a stated exercise price; put options give the
holder the right to sell the underlying security to the Portfolio at a stated
price.
A Portfolio may only write call options on a covered basis or for cross-
hedging purposes and will only write covered put options. A put option would be
considered "covered" if the Portfolio owns an option to sell the underlying
security subject to the option having an exercise price equal to or greater than
the exercise price of the "covered" option at all times while the put option is
outstanding. A call option is covered if the Portfolio owns or has the right to
acquire the underlying securities subject to the call option (or comparable
securities satisfying the cover requirements of securities exchanges) at all
times during the option period. A call option is for cross-hedging purposes if
it is not covered, but is designed to provide a hedge against another security
which the Portfolio owns or has the right to acquire. In the case of a call
written for cross-hedging purposes or a put option, the Portfolio will maintain
in a segregated account at the Fund's custodian bank cash or short-term U.S.
government securities with a value equal to or greater than the Portfolio's
obligation under the option. A Portfolio may also write combinations of covered
puts and covered calls on the same underlying security.
A Portfolio will receive a premium from writing an option, which increases
the Portfolio's return in the event the option expires unexercised or is
terminated at a profit. The amount of the premium will reflect, among other
things, the relationship of the market price of the underlying security to the
exercise price of the option, the term of the option, and the volatility of the
market price of the underlying security. By writing a call option, a Portfolio
will limit its opportunity to profit from any increase in the market value of
the underlying security above the exercise price of the option. By writing a put
option, a Portfolio will assume the risk that it may be required to purchase the
underlying security for an exercise price higher than its then current market
price, resulting in a potential
-4-
<PAGE>
capital loss if the purchase price exceeds the market price plus the amount of
the premium received.
A Portfolio may terminate an option which it has written prior to its
expiration by entering into a closing purchase transaction in which it purchases
an option having the same terms as the option written. The Portfolio will
realize a profit (or loss) from such transaction if the cost of such transaction
is less (or more) than the premium received from the writing of the option.
Because increases in the market price of a call option will generally reflect
increases in the market price of the underlying security, any loss resulting
from the repurchase of a call option may be offset in whole or in part by
unrealized appreciation of the underlying security owned by the Portfolio.
Purchasing Put and Call Options on Securities. A Portfolio may purchase put
---------------------------------------------
options to protect its portfolio holdings in an underlying security against a
decline in market value. This protection is provided during the life of the put
option since the Portfolio, as holder of the put, is able to sell the underlying
security at the exercise price regardless of any decline in the underlying
security's market price. For the purchase of a put option to be profitable, the
market price of the underlying security must decline sufficiently below the
exercise price to cover the premium and transaction costs. By using put options
in this manner, any profit which the Portfolio might otherwise have realized on
the underlying security will be reduced by the premium paid for the put option
and by transaction costs.
A Portfolio may also purchase a call option to hedge against an increase in
price of a security that it intends to purchase. This protection is provided
during the life of the call option since the Portfolio, as holder of the call,
is able to buy the underlying security at the exercise price regardless of any
increase in the underlying security's market price. For the purchase of a call
option to be profitable, the market price of the underlying security must rise
sufficiently above the exercise price to cover the premium and transaction
costs. By using call options in this manner, any profit which the Portfolio
might have realized had it bought the underlying security at the time it
purchased the call option will be reduced by the premium paid for the call
option and by transaction costs.
No Portfolio intends to purchase put or call options if, as a result of any
such transaction, the aggregate cost of options held by the Portfolio at the
time of such transaction would exceed 5% of its total assets.
-5-
<PAGE>
Purchase and Sale of Options and Futures on Stock Indices. A Portfolio may
---------------------------------------------------------
purchase and sell options on stock indices and stock index futures contracts
either as a hedge against movements in the equity markets or for other
investment purposes.
Options on stock indices are similar to options on specific securities
except that, rather than the right to take or make delivery of the specific
security at a specific price, an option on a stock index gives the holder the
right to receive, upon exercise of the option, an amount of cash if the closing
level of that stock index is greater than, in the case of a call, or less than,
in the case of a put, the exercise price of the option. This amount of cash is
equal to such difference between the closing price of the index and the exercise
price of the option expressed in dollars times a specified multiple. The writer
of the option is obligated, in return for the premium received, to make delivery
of this amount. Unlike options on specific securities, all settlements of
options on stock indices are in cash and gain or loss depends on general
movements in the stocks included in the index rather than price movements in
particular stocks. Currently options traded include the Standard & Poor's 500
Composite Stock Price Index, the NYSE Composite Index, the AMEX Market Value
Index, the National Over-The-Counter Index, the Nikkei 225 Stock Average Index,
the Financial Times Stock Exchange 100 Index and other standard broadly based
stock market indices. Options are also traded in certain industry or market
segment indices such as the Pharmaceutical Index.
A stock index futures contract is an agreement in which one party agrees to
deliver to the other an amount of cash equal to a specific dollar amount times
the difference between the value of a specific stock index at the close of the
last trading day of the contract and the price at which the agreement is made.
No physical delivery of securities is made.
If a Portfolio's Adviser expects general stock market prices to rise, it
might purchase a call option on a stock index or a futures contract on that
index as a hedge against an increase in prices of particular equity securities
it wants ultimately to buy for the Portfolio. If in fact the stock index does
rise, the price of the particular equity securities intended to be purchased may
also increase, but that increase would be offset in part by the increase in the
value of the Portfolio's index option or futures contract resulting from the
increase in the index. If, on the other hand, the Portfolio's Adviser expects
general stock market prices to decline, it might purchase a put option or sell a
futures contract on the index. If that index does in fact decline, the value of
some or all of the equity securities held
-6-
<PAGE>
by the Portfolio may also be expected to decline, but that decrease would be
offset in part by the increase in the value of the Portfolio's position in such
put option or futures contract.
Purchase and Sale of Interest Rate Futures. A Portfolio may purchase and
------------------------------------------
sell interest rate futures contracts on U.S. Treasury bills, notes and bonds and
Government National Mortgage Association ("GNMA") certificates either for the
purpose of hedging its portfolio securities against the adverse effects of
anticipated movements in interest rates or for other investment purposes.
A Portfolio may sell interest rate futures contracts in anticipation of an
increase in the general level of interest rates. Generally, as interest rates
rise, the market value of the securities held by a Portfolio will fall, thus
reducing the net asset value of the Portfolio. This interest rate risk can be
reduced without employing futures as a hedge by selling such securities and
either reinvesting the proceeds in securities with shorter maturities or by
holding assets in cash. However, this strategy entails increased transaction
costs in the form of dealer spreads and brokerage commissions and would
typically reduce the Portfolio's average yield as a result of the shortening of
maturities.
The sale of interest rate futures contracts provides a means of hedging
against rising interest rates. As rates increase, the value of a Portfolio's
short position in the futures contracts will also tend to increase thus
offsetting all or a portion of the depreciation in the market value of the
Portfolio's investments that are being hedged. While the Portfolio will incur
commission expenses in selling and closing out futures positions (which is done
by taking an opposite position in the futures contract), commissions on futures
transactions are lower than transaction costs incurred in the purchase and sale
of portfolio securities.
A Portfolio may purchase interest rate futures contracts in anticipation of
a decline in interest rates when it is not fully invested. As such purchases are
made, it is expected that an equivalent amount of futures contracts will be
closed out.
A Portfolio will enter into futures contracts which are traded on national
or foreign futures exchanges, and are standardized as to maturity date and the
underlying financial instrument. Futures exchanges and trading in the United
States are regulated under the Commodity Exchange Act by the Commodity Futures
Trading Commission ("CFTC"). Futures are traded in
-7-
<PAGE>
London at the London International Financial Futures Exchange, in Paris, at the
MATIF, and in Tokyo at the Tokyo Stock Exchange.
Options on Futures Contracts. A Portfolio may purchase and write call and
----------------------------
put options on stock index and interest rate futures contracts. A Portfolio may
use such options on futures contracts in connection with its hedging strategies
in lieu of purchasing and writing options directly on the underlying securities
or stock indices or purchasing or selling the underlying futures. For example, a
Portfolio may purchase put options or write call options on stock index futures
or interest rate futures, rather than selling futures contracts, in anticipation
of a decline in general stock market prices or rise in interest rates,
respectively, or purchase call options or write put options on stock index or
interest rate futures, rather than purchasing such futures, to hedge against
possible increases in the price of equity securities or debt securities,
respectively, which the Portfolio intends to purchase.
In connection with transactions in stock index options, stock index
futures, interest rate futures and related options on such futures, a Portfolio
will be required to deposit as "initial margin" an amount of cash and short-term
U.S. government securities. The current initial margin requirement per contract
is approximately 2% of the contract amount. Thereafter, subsequent payments
(referred to as "variation margin") are made to and from the broker to reflect
changes in the value of the futures contract. Brokers may establish deposit
requirements higher than exchange minimums.
Limitations. A Portfolio will not purchase or sell futures contracts or
-----------
options on futures contracts or stock indices for non-hedging purposes if, as a
result, the sum of the initial margin deposits on its existing futures contracts
and related options positions and premiums paid for options on futures contracts
or stock indices would exceed 5% of the net assets of the Portfolio unless the
transaction meets certain "bona fide hedging" criteria.
Risks of Options and Futures Strategies. The effective use of options and
---------------------------------------
futures strategies depends, among other things, on a Portfolio's ability to
terminate options and futures positions at times when its Adviser deems it
desirable to do so. Although a Portfolio will not enter into an option or
futures position unless its Adviser believes that a liquid market exists for
such option or future, there can be no assurance that a Portfolio will be able
to effect closing transactions at any particular time or at an acceptable price.
The Advisers generally expect that
-8-
<PAGE>
options and futures transactions for the Portfolios will be conducted on
recognized exchanges. In certain instances, however, a Portfolio may purchase
and sell options in the over-the-counter market. The staff of the Securities and
Exchange Commission considers over-the-counter options to be illiquid. A
Portfolio's ability to terminate option positions established in the over-the-
counter market may be more limited than in the case of exchange traded options
and may also involve the risk that securities dealers participating in such
transactions would fail to meet their obligations to the Portfolio.
The use of options and futures involves the risk of imperfect correlation
between movements in options and futures prices and movements in the price of
the securities that are the subject of the hedge. The successful use of these
strategies also depends on the ability of a Portfolio's Adviser to forecast
correctly interest rate movements and general stock market price movements. This
risk increases as the composition of the securities held by the Portfolio
diverges from the composition of the relevant option or futures contract.
Foreign Currency Transactions (Dreyfus U.S. Government Securities, T. Rowe Price
Equity Income, T. Rowe Price Growth Stock, T. Rowe Price International Stock,
Opportunity Value and Enhanced Index Portfolios)
Foreign Currency Exchange Transactions. The Dreyfus U.S. Government
--------------------------------------
Securities, T. Rowe Price Equity Income, T. Rowe Price Growth Stock, T. Rowe
Price International Stock, Opportunity Value and Enhanced Index Portfolios may
engage in foreign currency exchange transactions to protect against uncertainty
in the level of future exchange rates. The Adviser to a Portfolio may engage in
foreign currency exchange transactions in connection with the purchase and sale
of portfolio securities ("transaction hedging"), and to protect the value of
specific portfolio positions ("position hedging").
A Portfolio may engage in "transaction hedging" to protect against a change
in the foreign currency exchange rate between the date on which the Portfolio
contracts to purchase or sell the security and the settlement date, or to "lock
in" the U.S. dollar equivalent of a dividend or interest payment in a foreign
currency. For that purpose, a Portfolio may purchase or sell a foreign currency
on a spot (or cash) basis at the prevailing spot rate in connection with the
settlement of transactions in portfolio securities denominated in that foreign
currency.
-9-
<PAGE>
If conditions warrant, a Portfolio may also enter into contracts to
purchase or sell foreign currencies at a future date ("forward contracts") and
purchase and sell foreign currency futures contracts as a hedge against changes
in foreign currency exchange rates between the trade and settlement dates on
particular transactions and not for speculation. A foreign currency forward
contract is a negotiated agreement to exchange currency at a future time at a
rate or rates that may be higher or lower than the spot rate. Foreign currency
futures contracts are standardized exchange-traded contracts and have margin
requirements.
For transaction hedging purposes, a Portfolio may also purchase exchange-
listed and over-the-counter call and put options on foreign currency futures
contracts and on foreign currencies. A put option on a futures contract gives a
Portfolio the right to assume a short position in the futures contract until
expiration of the option. A put option on currency gives a Portfolio the right
to sell a currency at an exercise price until the expiration of the option. A
call option on a futures contract gives a Portfolio the right to assume a long
position in the futures contract until the expiration of the option. A call
option on currency gives a Portfolio the right to purchase a currency at the
exercise price until the expiration of the option.
A Portfolio may engage in "position hedging" to protect against a decline
in the value relative to the U.S. dollar of the currencies in which its
portfolio securities are denominated or quoted (or an increase in the value of
currency for securities which the Portfolio intends to buy, when it holds cash
reserves and short-term investments). For position hedging purposes, a Portfolio
may purchase or sell foreign currency futures contracts and foreign currency
forward contracts, and may purchase put or call options on foreign currency
futures contracts and on foreign currencies on exchanges or over-the-counter
markets. In connection with position hedging, a Portfolio may also purchase or
sell foreign currency on a spot basis.
The precise matching of the amounts of foreign currency exchange
transactions and the value of the portfolio securities involved will not
generally be possible since the future value of such securities in foreign
currencies will change as a consequence of market movements in the value of
those securities between the dates the currency exchange transactions are
entered into and the dates they mature.
-10-
<PAGE>
It is impossible to forecast with precision the market value of portfolio
securities at the expiration or maturity of a forward or futures contract.
Accordingly, it may be necessary for a Portfolio to purchase additional foreign
currency on the spot market (and bear the expense of such purchase) if the
market value of the security or securities being hedged is less than the amount
of foreign currency the Portfolio is obligated to deliver and if a decision is
made to sell the security or securities and make delivery of the foreign
currency. Conversely, it may be necessary to sell on the spot market some of the
foreign currency received upon the sale of the portfolio security or securities
if the market value of such security or securities exceeds the amount of foreign
currency the Portfolio is obligated to deliver.
Hedging transactions involve costs and may result in losses. A Portfolio
may write covered call options on foreign currencies to offset some of the costs
of hedging those currencies. A Portfolio will engage in over-the-counter
transactions only when appropriate exchange-traded transactions are unavailable
and when, in the opinion of the Portfolio's Adviser, the pricing mechanism and
liquidity are satisfactory and the participants are responsible parties likely
to meet their contractual obligations. A Portfolio's ability to engage in
hedging and related option transactions may be limited by tax considerations.
Transaction and position hedging do not eliminate fluctuations in the
underlying prices of the securities which a Portfolio owns or intends to
purchase or sell. They simply establish a rate of exchange which one can achieve
at some future point in time. Additionally, although these techniques tend to
minimize the risk of loss due to a decline in the value of the hedged currency,
they tend to limit any potential gain which might result from the increase in
the value of such currency.
Currency Forward and Futures Contracts. A forward foreign currency exchange
--------------------------------------
contract involves an obligation to purchase or sell a specific currency at a
future date, which may be any fixed number of days from the date of the contract
as agreed by the parties, at a price set at the time of the contract. In the
case of a cancelable forward contract, the holder has the unilateral right to
cancel the contract at maturity by paying a specified fee. The contracts are
traded in the interbank market conducted directly between currency traders
(usually large commercial banks) and their customers. A forward contract
generally has no deposit requirement, and no commissions are charged at any
stage for trades. A foreign currency futures contract is a standardized contract
for the future delivery of a specified amount of a foreign currency at a future
date at a price set at the time of
-11-
<PAGE>
the contract. Foreign currency futures contracts traded in the United States are
designed by and traded on exchanges regulated by the CFTC, such as the New York
Mercantile Exchange. A Portfolio would enter into foreign currency futures
contracts solely for hedging or other appropriate investment purposes as defined
in CFTC regulations.
Forward foreign currency exchange contracts differ from foreign currency
futures contracts in certain respects. For example, the maturity date of a
forward contract may be any fixed number of days from the date of the contract
agreed upon by the parties, rather than a predetermined date in any given month.
Forward contracts may be in any amounts agreed upon by the parties rather than
predetermined amounts. Also, forward foreign exchange contracts are traded
directly between currency traders so that no intermediary is required. A forward
contract generally requires no margin or other deposit.
At the maturity of a forward or futures contract, a Portfolio may either
accept or make delivery of the currency specified in the contract, or at or
prior to maturity enter into a closing transaction involving the purchase or
sale of an offsetting contract. Closing transactions with respect to forward
contracts are usually effected with the currency trader who is a party to the
original forward contract. Closing transactions with respect to futures
contracts are effected on a commodities exchange; a clearing corporation
associated with the exchange assumes responsibility for closing out such
contracts.
Positions in foreign currency futures contracts may be closed out only on
an exchange or board of trade which provides a secondary market in such
contracts. Although a Portfolio intends to purchase or sell foreign currency
futures contracts only on exchanges or boards of trade where there appears to be
an active secondary market, there can be no assurance that a secondary market on
an exchange or board of trade will exist for any particular contract or at any
particular time. In such event, it may not be possible to close a futures
position and, in the event of adverse price movements, a Portfolio would
continue to be required to make daily cash payments of variation margin.
Foreign Currency Options. Options on foreign currencies operate similarly
------------------------
to options on securities, and are traded primarily in the over-the-counter
market, although options on foreign currencies have recently been listed on
several exchanges. Such options will be purchased or written only when a
Portfolio's Adviser believes that a liquid secondary market exists for such
options. There can be no assurance that a liquid
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<PAGE>
secondary market will exist for a particular option at any specific time.
Options on foreign currencies are affected by all of those factors which
influence foreign exchange rates and investments generally.
The value of a foreign currency option is dependent upon the value of the
foreign currency and the U.S. dollar, and may have no relationship to the
investment merits of a foreign security. Because foreign currency transactions
occurring in the interbank market involve substantially larger amounts than
those that may be involved in the use of foreign currency options, investors may
be disadvantaged by having to deal in an odd lot market (generally consisting of
transactions of less than $1 million) for the underlying foreign currencies at
prices that are less favorable than for round lots.
There is no systematic reporting of last sale information for foreign
currencies and there is no regulatory requirement that quotations available
through dealers or other market sources be firm or revised on a timely basis.
Available quotation information is generally representative of very large
transactions in the interbank market and thus may not reflect relatively smaller
transactions (less than $1 million) where rates may be less favorable. The
interbank market in foreign currencies is a global, around-the-clock market. To
the extent that the U.S. options markets are closed while the markets for the
underlying currencies remain open, significant price and rate movements may take
place in the underlying markets that cannot be reflected in the options markets.
Foreign Currency Conversion. Although foreign exchange dealers do not
---------------------------
charge a fee for currency conversion, they do realize a profit based on the
difference (the "spread") between prices at which they are buying and selling
various currencies. Thus, a dealer may offer to sell a foreign currency to a
Portfolio at one rate, while offering a lesser rate of exchange should a
Portfolio desire to resell that currency to the dealer.
Repurchase Agreements (All Portfolios)
Each of the Portfolios may enter into repurchase agreements with a bank,
broker-dealer, or other financial institution but no Portfolio may invest more
than 10% (15% with respect to each of the T. Rowe Price Equity Income, T. Rowe
Price Growth Stock, T. Rowe Price International Stock, Dreyfus Small Cap Value,
Opportunity Value and Enhanced Index Portfolios) of its net assets in repurchase
agreements having maturities of greater than seven days. A Portfolio may enter
into repurchase agreements,
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<PAGE>
provided the Fund's custodian always has possession of securities serving as
collateral whose market value at least equals the amount of the repurchase
obligation. To minimize the risk of loss a Portfolio will enter into repurchase
agreements only with financial institutions which are considered by its Adviser
to be creditworthy under guidelines adopted by the Trustees of the Fund. If an
institution enters an insolvency proceeding, the resulting delay in liquidation
of the securities serving as collateral could cause a Portfolio some loss, as
well as legal expense, if the value of the securities declines prior to
liquidation.
Forward Commitments (All Portfolios)
Each of the Portfolios may enter into forward commitments to purchase
securities. An amount of cash or short-term U.S. government securities equal to
the Portfolio's commitment will be deposited in a segregated account at the
Fund's custodian bank to secure the Portfolio's obligation. Although a Portfolio
will generally enter into forward commitments to purchase securities with the
intention of actually acquiring the securities for its portfolio (or for
delivery pursuant to options contracts it has entered into), the Portfolio may
dispose of a security prior to settlement if its Adviser deems it advisable to
do so. The Portfolio may realize short-term gains or losses in connection with
such sales.
Securities Loans (All Portfolios)
Each of the Portfolios may pay reasonable finders', administrative and
custodial fees in connection with loans of its portfolio securities. Although
voting rights or the right to consent accompanying loaned securities pass to the
borrower, a Portfolio retains the right to call the loan at any time on
reasonable notice, and will do so in order that the securities may be voted by
the Portfolio with respect to matters materially affecting the investment. A
Portfolio may also call a loan in order to sell the securities involved. Loans
of portfolio securities will only be made to borrowers considered by a
Portfolio's Adviser to be creditworthy under guidelines adopted by the Trustees
of the Fund.
Lower Rated Bonds (Value Equity, Dreyfus U.S. Government Securities, Opportunity
Value and T. Rowe Price Equity Income Portfolios)
The Value Equity Portfolio and Opportunity Value Portfolio may invest up to
5% of their assets, the T. Rowe Price Equity
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<PAGE>
Income Portfolio may invest up to 10% of its assets, and the Dreyfus U.S.
Government Securities Portfolio may invest up to 25% of its assets in bonds
rated below Baa3 by Moody's Investors Service Inc. ("Moody's") or BBB by
Standard & Poor's Ratings Service, a division of McGraw-Hill Companies, Inc.
("Standard & Poor's") (commonly known as "junk bonds"). Securities rated less
than Baa by Moody's or BBB by Standard & Poor's are classified as non-investment
grade securities and are considered speculative by those rating agencies. It is
each Portfolio Adviser's policy not to rely exclusively on ratings issued by
credit rating agencies but to supplement such ratings with the Adviser's own
independent and ongoing review of credit quality. Junk bonds may be issued as a
consequence of corporate restructurings, such as leveraged buyouts, mergers,
acquisitions, debt recapitalizations, or similar events or by smaller or highly
leveraged companies. When economic conditions appear to be deteriorating, junk
bonds may decline in market value due to investors' heightened concern over
credit quality, regardless of prevailing interest rates. Although the growth of
the high yield securities market in the 1980s had paralleled a long economic
expansion, in the past many issuers have been affected by adverse economic and
market conditions. It should be recognized that an economic downturn or increase
in interest rates is likely to have a negative effect on (i) the high yield bond
market, (ii) the value of high yield securities and (iii) the ability of the
securities' issuers to service their principal and interest payment obligations,
to meet their projected business goals or to obtain additional financing. The
market for junk bonds, especially during periods of deteriorating economic
conditions, may be less liquid than the market for investment grade bonds. In
periods of reduced market liquidity, junk bond prices may become more volatile
and may experience sudden and substantial price declines. Also, there may be
significant disparities in the prices quoted for junk bonds by various dealers.
Under such conditions, a Portfolio may find it difficult to value its junk bonds
accurately. Under such conditions, a Portfolio may have to use subjective rather
than objective criteria to value its junk bond investments accurately and rely
more heavily on the judgment of the Fund's Board of Trustees. Prices for junk
bonds also may be affected by legislative and regulatory developments. For
example, recent federal rules require that savings and loans gradually reduce
their holdings of high-yield securities. Also, from time to time, Congress has
considered legislation to restrict or eliminate the corporate tax deduction for
interest payments or to regulate corporate restructurings such as takeovers,
mergers or leveraged buyouts. Such legislation, if enacted, could depress the
prices of outstanding junk bonds.
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<PAGE>
Interest Rate Transactions (Dreyfus U.S. Government Securities Portfolio)
Among the strategic transactions into which the Dreyfus U.S. Government
Securities Portfolio may enter are interest rate swaps and the purchase or sale
of related caps and floors. The Portfolio expects to enter into these
transactions primarily to preserve a return or spread on a particular investment
or portion of its portfolio, to protect against currency fluctuations, as a
duration management technique or to protect against any increase in the price of
securities the Portfolio anticipates purchasing at a later date. The Portfolio
intends to use these transactions as hedges and not as speculative investments
and will not sell interest rate caps or floors where it does not own securities
or other instruments providing the income stream the Portfolio may be obligated
to pay. Interest rate swaps involve the exchange by the Portfolio with another
party of their respective commitments to pay or receive interest, e.g., an
exchange of floating rate payments for fixed rate payments with respect to a
notional amount of principal. A currency swap is an agreement to exchange cash
flows on a notional amount of two or more currencies based on the relative value
differential among them and an index swap is an agreement to swap cash flows on
a notional amount based on changes in the values of the reference indices. The
purchase of a cap entitles the purchaser, to the extent that a specific index
exceeds a predetermined interest rate, to receive payments of interest on a
notional principal amount from the party selling such cap. The purchase of a
floor entitles the purchaser to receive payments on a notional principal amount
from the party selling such floor to the extent that a specified index falls
below a predetermined interest rate or amount.
The Portfolio will usually enter into swaps on a net basis, i.e., the
two payment streams are netted out in a cash settlement on the payment date or
dates specified in the instrument, with the Portfolio receiving or paying, as
the case may be, only the net amount of the two payments. Inasmuch as these
swaps, caps and floors are entered into for good faith hedging purposes, the
Adviser to the Portfolio and the Fund believe such obligations do not constitute
senior securities under the Investment Company Act of 1940 (the "1940 Act") and,
accordingly, will not treat them as being subject to its borrowing restrictions.
The Portfolio will not enter into any swap, cap and floor transaction unless, at
the time of entering into such transaction, the unsecured long-term debt of the
counterparty, combined with any credit enhancements, is rated at least "A" by
Standard & Poor's or Moody's or has an equivalent rating from a nationally
recognized statistical rating organization ("NRSRO") or is determined to be of
equivalent
-16-
<PAGE>
credit quality by the Adviser. For a description of the NRSROs and their
ratings, see the Appendix. If there is a default by the counterparty, the
Portfolio may have contractual remedies pursuant to the agreements related to
the transaction. The swap market has grown substantially in recent years with a
large number of banks and investment banking firms acting both as principals and
as agents utilizing standardized swap documentation. As a result, the swap
market has become relatively liquid. Caps and floors are more recent innovations
for which standardized documentation has not yet been fully developed and,
accordingly, they are less liquid than swaps.
With respect to swaps, the Portfolio will accrue the net amount of the
excess, if any, of its obligations over its entitlements with respect to each
swap on a daily basis and will segregate an amount of cash or liquid high grade
securities having a value equal to the accrued excess. Caps and floors require
segregation of assets with a value equal to the Portfolio's net obligations, if
any.
Dollar Roll Transactions (Dreyfus U.S. Government Securities Portfolio)
The Dreyfus U.S. Government Securities Portfolio may enter into "dollar
roll" transactions, which consist of the sale by the Portfolio to a bank or
broker-dealer (the "counterparty") of GNMA certificates or other mortgage-backed
securities together with a commitment to purchase from the counterparty similar,
but not identical, securities at a future date. The counterparty receives all
principal and interest payments, including prepayments, made on the security
while it is the holder. The Portfolio receives a fee from the counterparty as
consideration for entering into the commitment to purchase. Dollar rolls may be
renewed over a period of several months with a different repurchase price and a
cash settlement made at each renewal without physical delivery of securities.
Moreover, the transaction may be preceded by a firm commitment agreement
pursuant to which the Portfolio agrees to buy a security on a future date.
The Portfolio will not use such transactions for leveraging purposes
and, accordingly, will segregate cash, U.S. government securities or other high
grade debt obligations in an amount sufficient to meet its purchase obligations
under the transactions. The Portfolio will also maintain asset coverage of at
least 300% for all outstanding firm commitments, dollar rolls and other
borrowings.
-17-
<PAGE>
Dollar rolls are treated for purposes of the 1940 Act as borrowings of the
Portfolio because they involve the sale of a security coupled with an agreement
to repurchase. Like all borrowings, a dollar roll involves costs to the
Portfolio. For example, while the Portfolio receives a fee as consideration for
agreeing to repurchase the security, the Portfolio forgoes the right to receive
all principal and interest payments while the counterparty holds the security.
These payments to the counterparty may exceed the fee received by the Portfolio,
thereby effectively charging the Portfolio interest on its borrowing. Further,
although the Portfolio can estimate the amount of expected principal prepayment
over the term of the dollar roll, a variation in the actual amount of prepayment
could increase or decrease the cost of the Portfolio's borrowing.
The entry into dollar rolls involves potential risks of loss that are
different from those related to the securities underlying the transactions. For
example, if the counterparty becomes insolvent, the Portfolio's right to
purchase from the counterparty might be restricted. Additionally, the value of
such securities may change adversely before the Portfolio is able to purchase
them. Similarly, the Portfolio may be required to purchase securities in
connection with a dollar roll at a higher price than may otherwise be available
on the open market. Since, as noted above, the counterparty is required to
deliver a similar, but not identical, security to the Portfolio, the security
that the Portfolio is required to buy under the dollar roll may be worth less
than an identical security. Finally, there can be no assurance that the
Portfolio's use of the cash that it receives from a dollar roll will provide a
return that exceeds borrowing costs.
Portfolio Turnover
While it is impossible to predict portfolio turnover rates, the Advisers
to the Portfolios other than the Dreyfus U.S. Government Securities Portfolio,
Dreyfus Small Cap Value Portfolio and the TCW Money Market Portfolio anticipate
that portfolio turnover will generally not exceed 100% per year. The Adviser to
the Dreyfus U.S. Government Securities Portfolio anticipates that portfolio
turnover may exceed 200% per year, exclusive of dollar roll transactions. The
Adviser to the Dreyfus Small Cap Value Portfolio anticipates that the
Portfolio's portfolio turnover rate will generally not exceed 175%. With respect
to the TCW Money Market Portfolio, although the Portfolio intends normally to
hold its investments to maturity, the short maturities of these investments are
expected by the Portfolio's Adviser to result in a relatively high rate of
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<PAGE>
portfolio turnover. Higher portfolio turnover rates usually generate additional
brokerage commissions and expenses.
For the fiscal year ended December 31, 1996, the portfolio turnover rate
for the Dreyfus Small Cap Value Portfolio was 171% as compared with a turnover
rate of 75%% for the fiscal year ended December 31, 1995. The increase in
portfolio turnover rate was in connection with the change of the Portfolio's
investment adviser in September, 1996.
For the fiscal year ended December 31, 1996, the portfolio turnover rate
for the Dreyfus U.S. Government Securities Portfolio was 222% as compared with a
turnover rate of 161% for the period ended December 31, 1995. The increase in
portfolio turnover rate was due to an increased number of market-related
investment opportunities for the Portfolio.
INVESTMENT RESTRICTIONS
Except for restriction numbers 2, 3, 4, 11 and 12 with respect to the T.
Rowe Price Equity Income, T. Rowe Price Growth Stock, Opportunity Value and
Enhanced Index Portfolios and restriction number 11 with respect to the T. Rowe
Price International Stock and Dreyfus Small Cap Value Portfolios (which
restrictions are not fundamental policies), the following investment
restrictions (numbers 1 through 12) are fundamental policies, which may not be
changed without the approval of a majority of the outstanding shares of the
Portfolio, and apply to each of the Portfolios except as otherwise indicated. As
provided in the 1940 Act, a vote of a majority of the outstanding shares
necessary to amend a fundamental policy means the affirmative vote of the lesser
of (1) 67% or more of the shares present at a meeting, if the holders of more
than 50% of the outstanding shares of the Portfolio are present or represented
by proxy, or (2) more than 50% of the outstanding shares of the Portfolio.
A Portfolio may not:
1. Borrow money or issue senior securities (as defined in the 1940 Act),
provided that a Portfolio may borrow amounts not exceeding 5% of the value of
its total assets (not including the amount borrowed) for temporary purposes,
except that the Dreyfus U.S. Government Securities Portfolio may borrow from
banks or through reverse repurchase agreements or dollar roll transactions in an
amount equal to up to 33 1/3% of the value of its total assets (calculated when
the loan is made) for temporary, extraordinary or emergency purposes and to take
advantage of investment opportunities and may pledge up to 33 1/3% of the
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<PAGE>
value of its total assets to secure those borrowings; except that the T. Rowe
Price Equity Income Portfolio, the T. Rowe Price Growth Stock Portfolio and T.
Rowe Price International Stock Portfolio may (i) borrow for non-leveraging,
temporary or emergency purposes and (ii) engage in reverse repurchase agreements
and make other investments or engage in other transactions, which may involve a
borrowing, in a manner consistent with each Portfolio's investment objective and
program, provided that the combination of (i) and (ii) shall not exceed 33 1/3%
of the value of each Portfolios's total assets (including the amount borrowed)
less liabilities (other than borrowings) and may pledge up to 33 1/3% of the
value of its total assets to secure those borrowings; except that the
Opportunity Value Portfolio may borrow money from banks or through reverse
repurchase agreements for temporary or emergency purposes in amounts up to 10%
of its total assets; and except that the Enhanced Index Portfolio may borrow
money from banks for temporary or emergency purposes or through reverse
repurchase agreements in amounts up to 10% of its total assets.
2. Pledge, hypothecate, mortgage or otherwise encumber its assets, except to
secure borrowings permitted by restriction 1 above. Collateral arrangements with
respect to margin for futures contracts and options are not deemed to be pledges
or other encumbrances for purposes of this restriction.
3. Purchase securities on margin, except a Portfolio may obtain such short-
term credits as may be necessary for the clearance of securities transactions
and may make margin deposits in connection with transactions in options, futures
contracts and options on such contracts.
4. Make short sales of securities or maintain a short position for the account
of the Portfolio, unless at all times when a short position is open the
Portfolio owns an equal amount of such securities or owns securities which,
without payment of any further consideration, are convertible or exchangeable
for securities of the same issue as, and in equal amounts to, the securities
sold short.
5. Underwrite securities issued by other persons, except to the extent that
in connection with the disposition of its portfolio investments it may be deemed
to be an underwriter under federal securities laws.
6. Purchase or sell real estate, although a Portfolio may purchase securities
of issuers which deal in real estate,
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<PAGE>
securities which are secured by interests in real estate and securities
representing interests in real estate.
7. Purchase or sell commodities or commodity contracts, except that all
Portfolios other than the TCW Money Market Portfolio may purchase or sell
financial futures contracts and related options. For purposes of this
restriction, currency contracts or hybrid investments shall not be considered
commodities.
8. Make loans, except by purchase of debt obligations in which the Portfolio
may invest consistently with its investment policies, by entering into
repurchase agreements or through the lending of its portfolio securities.
9. Invest in the securities of any issuer if, immediately after such
investment, more than 5% of the total assets of the Portfolio (taken at current
value) would be invested in the securities of such issuer or acquire more than
10% of the outstanding voting securities of any issuer, provided that this
limitation does not apply to obligations issued or guaranteed as to principal
and interest by the U.S. government or its agencies and instrumentalities or to
repurchase agreements secured by such obligations and that up to 25% of the
Portfolio's total assets (taken at current value) may be invested without regard
to this limitation.
10. Invest more than 25% of the value of its total assets in any one industry,
provided that this limitation does not apply to obligations issued or guaranteed
as to interest and principal by the U.S. government, its agencies and
instrumentalities, and repurchase agreements secured by such obligations, and in
the case of the TCW Money Market Portfolio obligations of domestic branches of
United States banks.
11. Invest more than 10% (15% with respect to the T. Rowe Price Equity Income
Portfolio, the T. Rowe Price Growth Stock Portfolio, the T. Rowe Price
International Stock Portfolio, the Dreyfus Small Cap Value Portfolio, the
Opportunity Value Portfolio and the Enhanced Index Portfolio) of its net assets
(taken at current value at the time of each purchase) in illiquid securities
including repurchase agreements maturing in more than seven days.
12. Purchase securities of any issuer for the purpose of exercising control or
management.
All percentage limitations on investments will apply at the time of the
making of an investment and shall not be considered
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<PAGE>
violated unless an excess or deficiency occurs or exists immediately after and
as a result of such investment.
Other Policies
The TCW Money Market Portfolio may not invest in the securities of any one
issuer if, immediately after such investment, more than 5% of the total assets
of the Portfolio (taken at current value) would be invested in the securities of
such issuer, provided that this limitation does not apply to obligations issued
or guaranteed as to principal and interest by the U.S. government or its
agencies and instrumentalities or to repurchase agreements secured by such
obligations and that with respect to 25% of the Portfolio's total assets more
than 5% may be invested in securities of any one issuer for three business days
after the purchase thereof if the securities have been assigned the highest
quality rating by NRSROs, or if not rated, have been determined to be of
comparable quality. These limitations apply to time deposits, including
certificates of deposit, bankers' acceptances, letters of credit and similar
instruments; they do not apply to demand deposit accounts. For a description of
the NRSROs' ratings, see the Appendix.
In addition, the TCW Money Market Portfolio may not purchase any security
that matures more than thirteen months (397 days) from the date of purchase or
which has an implied maturity of more than thirteen months (397 days) except as
provided in (1) below. For the purposes of satisfying this requirement, the
maturity of a portfolio instrument shall be deemed to be the period remaining
until the date noted on the face of the instrument as the date on which the
principal amount must be paid, or in the case of an instrument called for
redemption, the date on which the redemption payment must be made, except that:
1. An instrument that is issued or guaranteed by the U.S. government or any
agency thereof which has a variable rate of interest readjusted no less
frequently than every 25 months (762 days) may be deemed to have a maturity
equal to the period remaining until the next readjustment of the interest rate.
2. A variable rate instrument, the principal amount of which is scheduled on
the face of the instrument to be paid in thirteen months (397 days) or less, may
be deemed to have a maturity equal to the period remaining until the next
readjustment of the interest rate.
3. A variable rate instrument that is subject to a demand feature may be
deemed to have a maturity equal to the longer of
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<PAGE>
the period remaining until the next readjustment of the interest rate or the
period remaining until the principal amount can be recovered through demand.
4. A floating rate instrument that is subject to a demand feature may be
deemed to have a maturity equal to the period remaining until the principal
amount can be recovered through demand.
5. A repurchase agreement may be deemed to have a maturity equal to the period
remaining until the date on which the repurchase of the underlying securities is
scheduled to occur, or where no date is specified, but the agreement is subject
to demand, the notice period applicable to a demand for the repurchase of the
securities.
6. A portfolio lending agreement may be treated as having a maturity equal to
the period remaining until the date on which the loaned securities are scheduled
to be returned, or where no date is specified, but the agreement is subject to
demand, the notice period applicable to a demand for the return of the loaned
securities.
Each of the Value Equity and Dreyfus Small Cap Value Portfolios may not
invest more than 5% of the value of its total assets in warrants not listed on
either the New York or American Stock Exchange. Each of the Opportunity Value
and Enhanced Index Portfolios will not invest in warrants if, as a result
thereof, more than 2% of the value of the total assets of the Portfolio would be
invested in warrants which are not listed on the New York Stock Exchange, the
American Stock Exchange, or a recognized foreign exchange, or more than 5% of
the value of the total assets of the Portfolio would be invested in warrants
whether or not so listed. However, the acquisition of warrants attached to other
securities is not subject to this restriction. Each of the T. Rowe Price Equity
Income, T. Rowe Price Growth Stock and T. Rowe Price International Stock
Portfolios will not invest in warrants if, as a result thereof, the Portfolio
will have more than 5% of the value of its total assets invested in warrants;
provided that this restriction does not apply to warrants acquired as a result
of the purchase of another security.
PERFORMANCE INFORMATION
Total return and yield will be computed as described below.
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<PAGE>
Total Return
Each Portfolio's "average annual total return" figures described and shown
in the Prospectus are computed according to a formula prescribed by the
Securities and Exchange Commission. The formula can be expressed as follows:
P(1+T)n = ERV
Where: P = a hypothetical initial payment of $1000
T = average annual total return
n = number of years
ERV = Ending Redeemable Value of a hypothetical $1000 payment made at the
beginning of the 1, 5, or 10 years (or other) periods at the end of the 1, 5, or
10 years (or other) periods (or fractional portion thereof)
The table below shows the average annual total return for the TCW Managed
Asset Allocation, Value Equity, Dreyfus Small Cap Value, Dreyfus U.S. Government
Securities, T. Rowe Price Equity Income, T. Rowe Price Growth Stock and
Opportunity Value Portfolios for the specific periods.
With respect to the T. Rowe Price International Stock Portfolio which
commenced operation April 8, 1991, effective January 1, 1995, the Portfolio's
Adviser was changed to Rowe Price-Fleming International, Inc. ("Price-Fleming").
Prior to March 24, 1995, the Portfolio was known as the Global Growth Portfolio.
Subsequent to such time, the Portfolio's investment objective was changed from
investments in small capitalization companies on a global basis to investments
in a broad range of established companies on an international basis (i.e., non-
U.S. companies). Because of the change of the Portfolio's Adviser, performance
information for the period from inception to December 31, 1995 is not presented.
Such information is not reflective of Price- Fleming's ability to manage the
Portfolio. Information with respect to the Portfolio's per share income and
capital changes from inception through December 31, 1996 is set forth in the
Prospectus. Average annual total return information for the period from
inception to December 31, 1994 is available upon written request to the Fund.
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<PAGE>
<TABLE>
<CAPTION>
For Period
For the One For the Five From Incep-
Year Period Year Period tion (1) to
Ended December Ended December December 31,
31, 1996 31, 1996 1996
-------------- -------------- --------------
<S> <C> <C> <C>
TCW Managed Asset
Allocation(2)...... 17.82%/17.82%* 12.66%/12.39%* 12.72%/12.41%*
T. Rowe Price
International
Stock.............. 15.23%/15.23%* N/A 12.77%/12.77%*
Value Equity(3)....... 23.84%/23.84%* N/A 17.46%/17.29%*
Dreyfus Small
Cap Value(4)....... 25.63%/25.63%* N/A 13.19%/13.07%*
T. Rowe Price
Equity Income(5)... 19.88%/19.88%* N/A 25.19%/25.19%*
T. Rowe Price Growth
Stock(5)............ 20.77%/20.77%* N/A 28.85%/28.85%*
Dreyfus U.S.
Government
Securities(6)...... 1.81%/1.81%* N/A 6.23%/6.08%*
Opportunity Value(7).. N/A N/A .60%/ .20%*
</TABLE>
________________________
* The figure shows what the Portfolio's performance would have been in the
absence of fee waivers and/or reimbursement of other expenses, if any.
(1) With respect to T. Rowe Price International Stock Portfolio, period
commenced on January 1, 1995.
(2) The Portfolio commenced operations on April 8, 1991.
(3) The Portfolio commenced operations on May 27, 1993.
(4) The Portfolio commenced operations on May 4, 1993.
(5) The Portfolio commenced operations on January 3, 1995.
(6) The Portfolio commenced operations on May 13, 1994.
(7) The Portfolio commenced operations on November 18, 1996.
________________________
The calculations of total return assume the reinvestment of all dividends
and capital gains distributions on the reinvestment dates during the period and
the deduction of all recurring expenses that were charged to shareholders
accounts. The above
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<PAGE>
table does not reflect charges and deductions which are, or may be, imposed
under the Contracts.
The performance of each Portfolio will vary from time to time in response
to fluctuations in market conditions, interest rates, the composition of the
Portfolio's investments and expenses. Consequently, a Portfolio's performance
figures are historical and should not be considered representative of the
performance of the Portfolio for any future period.
Yield
From time to time, the Fund may quote the TCW Money Market Portfolio's and
the Dreyfus U.S. Government Securities Portfolio's yield and effective yield in
advertisements or in reports or other communications to shareholders. Yield
quotations are expressed in annualized terms and may be quoted on a compounded
basis.
The annualized current yield for the TCW Money Market Portfolio is computed
by: (a) determining the net change in the value of a hypothetical pre-existing
account in the Portfolio having a balance of one share at the beginning of a
seven calendar day period for which yield is to be quoted; (b) dividing the net
change by the value of the account at the beginning of the period to obtain the
base period return; and (c) annualizing the results (i.e., multiplying the base
period return by 365/7). The net change in the value of the account reflects the
value of additional shares purchased with dividends declared on the original
share and any such additional shares, but does not include realized gains and
losses or unrealized appreciation and depreciation. In addition, the TCW Money
Market Portfolio may calculate a compound effective annualized yield by adding 1
to the base period return (calculated as described above), raising the sum to a
power equal to 365/7 and subtracting 1.
The Dreyfus U.S. Government Securities Portfolio's 30-day yield will be
calculated according to a formula prescribed by the Securities and Exchange
Commission. The formula can be expressed as follows:
YIELD = 2[(a-b+1)6-1]
---
cd
Where: a = dividends and interest earned during the period
b = expenses accrued for the period (net of
reimbursement)
-26-
<PAGE>
c = the average daily number of shares outstanding
during the period that were entitled to receive
dividends
d = the net asset value per share on the last day of
the period
For the purpose of determining the interest earned (variable "a" in the formula)
on debt obligations that were purchased by the Portfolio at a discount or
premium, the formula generally calls for amortization of the discount or
premium; the amortization schedule will be adjusted monthly to reflect changes
in the market values of the debt obligations.
Yield information is useful in reviewing a Portfolio's performance, but
because yields fluctuate, such information cannot necessarily be used to compare
an investment in a Portfolio's shares with bank deposits, savings accounts and
similar investment alternatives which often provide an agreed or guaranteed
fixed yield for a stated period of time. Shareholders should remember that yield
is a function of the kind and quality of the instruments in the Portfolios'
investment portfolios, portfolio maturity, operating expenses and market
conditions.
It should be recognized that in periods of declining interest rates the
yields will tend to be somewhat higher than prevailing market rates, and in
periods of rising interest rates the yields will tend to be somewhat lower.
Also, when interest rates are falling, the inflow of net new money to a
Portfolio from the continuous sale of its shares will likely be invested in
instruments producing lower yields than the balance of the Portfolio's
investments, thereby reducing the current yield of the Portfolio. In periods of
rising interest rates, the opposite can be expected to occur.
Non-Standardized Performance
In addition to the performance information described above, the Fund may
provide total return information with respect to the Portfolios for designated
periods, such as for the most recent six months or most recent twelve months.
This total return information is computed as described under "Total Return"
above except that no annualization is made.
PORTFOLIO TRANSACTIONS
Subject to the supervision and control of the Manager and the Trustees of
the Fund, each Portfolio's Adviser is responsible
-27-
<PAGE>
for decisions to buy and sell securities for its account and for the placement
of its portfolio business and the negotiation of commissions, if any, paid on
such transactions. Brokerage commissions are paid on transactions in equity
securities traded on a securities exchange and on options, futures contracts and
options thereon. Fixed income securities and certain equity securities in which
the Portfolios invest are traded in the over-the-counter market. These
securities are generally traded on a net basis with dealers acting as principal
for their own account without a stated commission, although prices of such
securities usually include a profit to the dealer. In over-the-counter
transactions, orders are placed directly with a principal market maker unless a
better price and execution can be obtained by using a broker. In underwritten
offerings, securities are usually purchased at a fixed price which includes an
amount of compensation to the underwriter generally referred to as the
underwriter's concession or discount. Certain money market securities may be
purchased directly from an issuer, in which case no commissions or discounts are
paid. U.S. government securities are generally purchased from underwriters or
dealers, although certain newly-issued U.S. government securities may be
purchased directly from the U.S. Treasury or from the issuing agency or
instrumentality. Each Portfolio's Adviser is responsible for effecting its
portfolio transactions and will do so in a manner deemed fair and reasonable to
the Portfolio and not according to any formula. The primary consideration in all
portfolio transactions will be prompt execution of orders in an efficient manner
at a favorable price. In selecting broker-dealers and negotiating commissions,
an Adviser considers the firm's reliability, the quality of its execution
services on a continuing basis and its financial condition. When more than one
firm is believed to meet these criteria, preference may be given to brokers that
provide the Portfolios or their Advisers with brokerage and research services
within the meaning of Section 28(e) of the Securities Exchange Act of 1934. Each
Portfolio's Adviser is of the opinion that, because this material must be
analyzed and reviewed, its receipt and use does not tend to reduce expenses but
may benefit the Portfolio by supplementing the Adviser's research. In seeking
the most favorable price and execution available, an Adviser may, if permitted
by law, consider sales of the Contracts as described in the Prospectus a factor
in the selection of broker-dealers.
The Board of Trustees of the Fund has authorized the Manager and the
Advisers to enter into arrangements with brokers who execute brokerage
transactions for the Portfolios whereby a portion of the commissions earned by
such brokers will be shared with a broker-dealer affiliate of the Manager. The
affiliated
-28-
<PAGE>
broker will act as an "introducing broker" in the transaction. Subject to the
requirements of applicable law including seeking best price and execution of
orders, commissions paid to executing brokers will not exceed ordinary and
customary brokerage commissions.
The Board of Trustees has determined that the Fund's brokerage commissions
should be utilized for the Fund's benefit to the extent possible. After
reviewing various alternatives, the Board concluded that commissions received by
the broker-dealer affiliate of the Manager can be used to promote the
distribution of the Fund's shares including payments to broker-dealers who sell
the Contracts, the costs of training and educating such broker-dealers with
respect to the Contracts and other bona-fide distribution costs payable to
unaffiliated persons. Other than incidental costs related to establishing the
broker-dealer affiliate as an "introducing broker", no portion of the
commissions received by the broker-dealer affiliate of the Manager will be
retained for its or any affiliate's benefit. On a quarterly basis, the Manager
will report to the Board of Trustees the aggregate commissions received by its
broker-dealer affiliate and the distribution expenses paid from such
commissions. The Board of Trustees will periodically review the extent to which
the foregoing arrangement reduces distribution expenses currently being incurred
by the Manager or its affiliates on behalf of the Fund. The Board of Trustees
may determine from time to time other appropriate uses for the Fund from the
commissions it pays to executing brokers.
The Manager will not implement this program until any required exemptive or
no-action relief is obtained from the Securities and Exchange Commission.
An Adviser may effect portfolio transactions for other investment companies
and advisory accounts. Research services furnished by broker-dealers through
which a Portfolio effects its securities transactions may be used by the
Portfolio's Adviser in servicing all of its accounts; not all such services may
be used in connection with the Portfolio. In the opinion of each Adviser, it is
not possible to measure separately the benefits from research services to each
of its accounts, including a Portfolio. Whenever concurrent decisions are made
to purchase or sell securities by a Portfolio and another account, the
Portfolio's Adviser will attempt to allocate equitably portfolio transactions
among the Portfolio and other accounts. In making such allocations between the
Portfolio and other accounts, the main factors to be considered are the
respective investment objectives, the relative size of portfolio holdings of the
same
-29-
<PAGE>
or comparable securities, the availability of cash for investment, the size of
investment commitments generally held, and the opinions of the persons
responsible for recommending investments to the Portfolio and the other
accounts. In some cases this procedure could have an adverse effect on a
Portfolio. In the opinion of each Adviser, however, the results of such
procedures will, on the whole, be in the best interest of each of the accounts.
The Adviser to the Value Equity and Opportunity Value Portfolios may
execute brokerage transactions through Oppenheimer & Co. Inc. ("Opco"), an
affiliated broker-dealer of the Adviser, acting as agent in accordance with
procedures established by the Fund's Board of Trustees, but will not purchase
any securities from or sell any securities to Opco acting as principal for its
own account.
The Adviser to the T. Rowe Price International Stock, T. Rowe Price Equity
Income and T. Rowe Price Growth Stock Portfolios may execute portfolio
transactions through certain affiliates of Robert Fleming Holdings Limited and
Jardine Fleming Group Limited, persons indirectly related to the Adviser, acting
as agent in accordance with procedures established by the Fund's Board of
Trustees, but will not purchase any securities from or sell any securities to
any such affiliate acting as principal for its own account.
The Adviser to the Enhanced Index Portfolio may execute portfolio
transactions through certain of its affiliated brokers, acting as agent in
accordance with the procedures established by the Fund's Board of Trustees, but
will not purchase any securities from or sell any securities to such affiliate
acting as principal for its own account.
For the year ended December 31, 1994, the TCW Money Market Portfolio did
not pay any brokerage commissions, while the TCW Managed Asset Allocation
Portfolio and T. Rowe Price International Stock Portfolio paid $175,548 and
$554,048, respectively, in brokerage commissions. For the year ended December
31, 1994, the Value Equity Portfolio and Dreyfus Small Cap Value Portfolio paid
$58,472 and $100,262, respectively, in brokerage commissions, of which $32,796
(78.29%) with respect to the Value Equity Portfolio and $58,028 (72.78%) with
respect to the Dreyfus Small Cap Value Portfolio was paid to Opco. For the
fiscal period ended December 31, 1994, the Dreyfus U.S. Government Securities
Portfolio paid no brokerage commissions. For the year ended December 31, 1995,
the TCW Money Market Portfolio and the Dreyfus U.S. Government Securities
Portfolio
-30-
<PAGE>
did not pay any brokerage commissions, while the TCW Managed Asset Allocation
Portfolio paid $187,103 in brokerage commissions. For the year ended December
31, 1995, the T. Rowe Price International Stock Portfolio, the Value Equity
Portfolio and the Dreyfus Small Cap Value Portfolio paid $395,753, $57,800, and
$101,885, respectively, in brokerage commissions of which $33,338 (8.42%),
$15,101 (3.82%) and $673 (.17%) with respect to the T. Rowe Price International
Stock Portfolio was paid to Robert Fleming Holdings Limited and Jardine Fleming
Group Limited, Ord Minnett and OpCo, respectively, $29,271 (50.64%) with respect
to the Value Equity Portfolio and $36,216 (35.55%) with respect to the Dreyfus
Small Cap Value Portfolio was paid to OpCo. For the fiscal period ended December
31, 1995, the T. Rowe Price Equity Income Portfolio and the T. Rowe Price Growth
Stock Portfolio paid $18,059 and $39,447, respectively in brokerage commissions
of which $10 (0.06%) with respect to the T. Rowe Price Equity Income Portfolio
was paid to OpCo and $536 (1.36%), $507 (1.29%) and $23 (0.06%) with respect to
the T. Rowe Price Growth Stock Portfolio was paid to Boston Safe Deposit and
Trust Company, Jardine Fleming Group Limited and OpCo, respectively. For the
year ended December 31, 1996, the Dreyfus U.S. Government Securities Portfolio
did not pay any brokerage commissions, while the TCW Money Market Portfolio and
the TCW Managed Asset Allocation Portfolio paid $2,724 and $93,009 in brokerage
commissions, respectively. For the year ended December 31, 1996, the T. Rowe
Price International Stock Portfolio, the Value Equity Portfolio and the Dreyfus
Small Cap Value Portfolio paid $136,536, $90,589, and $398,554, respectively, in
brokerage commissions of which $4,462 (3.27%), $2,908 (2.13%) and $906 (.66%)
with respect to the T. Rowe Price International Stock Portfolio was paid to
Robert Fleming Holdings Limited and Jardine Fleming Group Limited, Ord Minnett
and OpCo, respectively, $35,624 (39.32%) with respect to the Value Equity
Portfolio and $34,511 (8.66%) with respect to the Dreyfus Small Cap Value
Portfolio was paid to OpCo. For the fiscal year ended December 31, 1996, the T.
Rowe Price Equity Income Portfolio and the T. Rowe Price Growth Stock Portfolio
paid $55,261 and $69,409, respectively in brokerage commissions of which $120
(.22%) with respect to the T. Rowe Price Equity Income Portfolio was paid to
OpCo and $3,037 (4.38%) and $63 (.09%) with respect to the T. Rowe Price Growth
Stock Portfolio was paid to Robert Flemings Holdings Limited and OpCo,
respectively. For the fiscal period ended December 31, 1996, the Opportunity
Value Portfolio paid $291 in brokerage commissions.
-31-
<PAGE>
MANAGEMENT OF THE FUND
Trustees and Officers
The Trustees and executive officers of the Trust, their ages and their
principal occupations during the past five years are set forth below. Unless
otherwise indicated, the business address of each is 2101 East Coast Highway,
Suite 300, Corona del Mar, California 92625.
Principal
Positions Occupation(s)
Held with During Past
Name, Age and Address Registrant 5 Years
- --------------------- ---------- -------------
James R. McInnis (49) President President of Endeavor
Group (broker-dealer)
since June, 1991;
President of McGuinness &
Associates (insurance
marketing) from March,
1983 to June, 1991.
*Vincent J. McGuinness (62) Trustee Chairman, Chief Executive
Officer and Director of
McGuinness & Associates,
Endeavor Group, VJM
Corporation (oil and gas),
until July, 1996
McGuinness Group
(insurance marketing) and
until January, 1994 Swift
Energy Marketing Company
and since September, 1988
Endeavor Management Co.;
President of VJM
Corporation, Endeavor
Management Co. and, since
February, 1996, McGuinness
& Associates.
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<PAGE>
Principal
Positions Occupation(s)
Held with During Past
Name, Age and Address Registrant 5 Years
- --------------------- ---------- -------------
Timothy A. Devine (62) Trustee Prior to September, 1993,
1424 Dolphin Terrace President and Chief
Corona del Mar, California Executive Officer, Devine
92625 Properties, Inc. Since
September, 1993, Vice
President, Plant Control,
Inc. (landscape
contracting and
maintenance).
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<PAGE>
Principal
Positions Occupation(s)
Held with During Past
Name, Age and Address Registrant 5 Years
- --------------------- ---------- -------------
Thomas J. Hawekotte (62) Trustee President, Thomas J.
1200 Lake Shore Drive Hawekotte, P.C. (law
Chicago, Illinois 60610 practice).
Steven L. Klosterman (45) Trustee Since July, 1995,
462 Stevens Avenue President of Klosterman
Suite 206 Capital Corporation
Solana Beach, California (investment adviser);
92075 Investment Counselor,
Robert J. Metcalf &
Associates, Inc.
(investment adviser) from
August, 1990 to June,
1995.
*Halbert D. Lindquist (51) Trustee President, Lindquist
1650 E. Fort Lowell Road Enterprises, Inc.
Tucson, Arizona 85719-2324 (financial services) and
since December, 1987
Tucson Asset Management,
Inc. (financial services),
and since November, 1987,
Presidio Government
Securities, Incorporated
(broker-dealer).
R. Daniel Olmstead, Jr. (66) Trustee Rancher until January,
2661 Point Del Mar 1997. Since January,
Corona Del Mar, California 1997, real estate
92625 consultant.
Norman Ridley (51) Vice Since 1985, Senior Vice
865 S. Figueroa Street President President, TCW Asset
Suite 1800 Management Company and
Los Angeles, California Trust Company of the West.
90017
-34-
<PAGE>
Principal
Positions Occupation(s)
Held with During Past
Name, Age and Address Registrant 5 Years
- --------------------- ---------- -------------
Ronald E. Robison (58) Vice Since November, 1987,
865 S. Figueroa Street President Managing Director and
Suite 1800 Chief Operating Officer,
Los Angeles, California TCW Funds Management Inc.;
90017 since March, 1990,
Managing Director, Trust
Company of the West and
TCW Asset Management
Company.
James M. Goldberg (51) Vice Since June, 1984, Managing
865 S. Figueroa Street President Director, TCW Asset
Suite 1800 Management Company and
Los Angeles, California Trust Company of the West
90017 and since January, 1987
Managing Director, TCW
Funds Management, Inc.
Eileen Rominger (42) Vice Since May, 1994, Managing
One World Financial Center President Director, Oppenheimer
New York, New York 10281 Capital, prior thereto
Senior Vice President,
Oppenheimer Capital;
Portfolio Manager,
Oppenheimer Quest Value
Fund, Inc., OCC
Accumulation Trust,
Enterprise Accumulation
Trust and Penn Series
Fund, open-end investment
companies.
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<PAGE>
Principal
Positions Occupation(s)
Held with During Past
Name, Age and Address Registrant 5 Years
- --------------------- ---------- -------------
**Vincent J. McGuinness, Jr. Chief Since September, 1996,
(32) Financial Chief Financial Officer
Officer and since May, 1996,
(Treasurer) Director of Endeavor
Management Co.; since
August, 1996, Chief
Financial officer of VJM
Corporation; since May,
1996, Executive Vice
President and Director of
Sales, Western Division of
Endeavor Group; Chief
Financial Officer of
McGuinness & Associates;
since March, 1996,
Director of McGuinness
Group. From July, 1993 to
August, 1995 Rocky
Mountain Regional
Marketing Director for
Endeavor Group. MBA
graduate student from
September, 1991 to May,
1993.
-36-
<PAGE>
Principal
Positions Occupation(s)
Held with During Past
Name, Age and Address Registrant 5 Years
- --------------------- ---------- -------------
Pamela A. Shelton (48) Secretary Since October, 1993,
Executive Secretary to
Chairman of the Board and
Chief Executive Officer
of, and since April, 1996,
Secretary of McGuinness &
Associates, Endeavor
Group, VJM Corporation,
McGuinness Group (until
July, 1996) and Endeavor
Management Co.; from July,
1992 to October, 1993,
Administrative Secretary,
Mayor and City Council,
City of Laguna Niguel,
California; and from
November, 1986 to July,
1992, Executive Secretary
to Chairman of the Board
and Chief Executive
Officer of, and from
October, 1990 to July,
1992, Secretary of
McGuinness & Associates,
Endeavor Group, VJM
Corporation, McGuinness
Group, Endeavor Management
Co. and Swift Energy
Marketing Company.
* An "interested person" of the Fund as defined in the 1940 Act.
** Vincent J. McGuinness, Jr. is the son of Vincent J. McGuinness.
No remuneration will be paid by the Fund to any Trustee or officer of the
Fund who is affiliated with the Manager or the Advisers. Each Trustee who is not
an affiliated person of the Fund will be reimbursed for out-of-pocket expenses
and receives an annual fee of $2,500 and $500 for attendance at each regularly
scheduled Trustees' meeting. Set forth below for each of the Trustees of the
Fund is the aggregate compensation paid to such Trustees for the fiscal year
ended December 31, 1996.
-37-
<PAGE>
COMPENSATION TABLE
<TABLE>
<CAPTION>
Total
Compensation
From Fund
Aggregate and Fund
Name of Compensation Complex
Person From Fund Paid to Trustees
- ------- ------------ ----------------
<S> <C> <C>
Vincent J. McGuinness $ - $ -
Timothy A. Devine 4,500 4,500
Thomas J. Hawekotte 4,500 4,500
Steven L. Klosterman 4,500 4,500
Halbert D. Lindquist 3,500 3,500
R. Daniel Olmstead 4,500 4,500
</TABLE>
The Agreement and Declaration of Trust of the Fund provides that the Fund
will indemnify its Trustees and officers against liabilities and expenses
incurred in connection with litigation in which they may be involved because of
their offices with the Fund, except if it is determined in the manner specified
in the Agreement and Declaration of Trust that they have not acted in good faith
in the reasonable belief that their actions were in the best interests of the
Fund or that such indemnification would relieve any officer or Trustee of any
liability to the Fund or its shareholders by reason of willful misfeasance, bad
faith, gross negligence or reckless disregard of his duties. The Fund, at its
expense, provides liability insurance for the benefit of its Trustees and
officers.
As of the date of this Statement of Additional Information, the officers
and Trustees of the Fund as a group owned less than 1% of the outstanding shares
of the Fund.
The Manager
The Management Agreement between the Fund and the Manager with respect to
the TCW Money Market, TCW Managed Asset Allocation and T. Rowe Price
International Stock Portfolios was approved by the Trustees of the Fund
(including all of the Trustees who are not "interested persons" [as defined in
the 1940 Act] of the Manager) on July 20, 1992, and by the shareholders of the
Fund on November 23, 1992. With respect to the Value Equity and Dreyfus Small
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<PAGE>
Cap Value Portfolios, the Management Agreement was approved by the Trustees of
the Fund (including all of the Trustees who are not "interested persons" of the
Manager) on April 19, 1993 and by PFL Life Insurance Company, the sole
shareholder of the Value Equity and Dreyfus Small Cap Value Portfolios, on April
19, 1993. With respect to the Dreyfus U.S. Government Securities Portfolio, the
Management Agreement was approved by the Trustees of the Fund (including all of
the Trustees who are not "interested persons" of the Manager) on January 24,
1994 and by PFL Life Insurance Company, the sole shareholder of the Dreyfus U.S.
Government Securities Portfolio, on March 7, 1994. With respect to the T. Rowe
Price Equity Income and T. Rowe Price Growth Stock Portfolios, the Management
Agreement was approved by the Trustees of the Fund (including all of the
Trustees who are not "interested persons" of the Manager) on October 24, 1994
and by PFL Life Insurance Company, the sole shareholder of the T. Rowe Price
Equity Income and T. Rowe Price Growth Stock Portfolios, on November 1, 1994.
With respect to the Opportunity Value and Enhanced Index Portfolios, the
Management Agreement was approved by the Trustees of the Fund (including all of
the Trustees who are not "interested persons" of the Manager) on August 13, 1996
and by PFL Life Insurance Company, the sole shareholder of the Opportunity Value
and Enhanced Index Portfolios, on August 26, 1996. See "Organization and
Capitalization of the Fund." The Management Agreement will continue in force for
two years from its date, November 23, 1992 with respect to the TCW Money Market,
TCW Managed Asset Allocation and T. Rowe Price International Stock Portfolios,
April 19, 1993 with respect to the Value Equity and Dreyfus Small Cap Value
Portfolios, March 25, 1994 with respect to the Dreyfus U.S. Government
Securities Portfolio, December 28, 1994 with respect to the T. Rowe Price Equity
Income and T. Rowe Price Growth Stock Portfolios, August 26, 1996 with respect
to the Opportunity Value and Enhanced Index Portfolios and from year to year
thereafter, but only so long as its continuation as to each Portfolio is
specifically approved at least annually (i) by the Trustees or by the vote of a
majority of the outstanding voting securities of the Portfolio, and (ii) by the
vote of a majority of the Trustees who are not parties to the Management
Agreement or "interested persons" of any such party, by votes cast in person at
a meeting called for the purpose of voting on such approval. The Management
Agreement provides that it shall terminate automatically if assigned, and that
it may be terminated as to any Portfolio without penalty by the Trustees of the
Fund or by vote of a majority of the outstanding voting securities of the
Portfolio upon 60 days' prior written notice to the Manager, or by the Manager
upon 90 days' prior written notice to the Fund, or upon such shorter notice as
may be mutually agreed upon. In the event the Manager ceases to be the Manager
of the Fund, the right of the Fund to use the identifying name of "Endeavor" may
be withdrawn.
-39-
<PAGE>
The Advisers
The Investment Advisory Agreements between the Manager and TCW Funds
Management, Inc. were approved by the Trustees of the Fund (including all the
Trustees who are not "interested persons" of the Manager or of the Adviser) on
July 20, 1992, and by the shareholders of the Fund on November 23, 1992. The
Investment Advisory Agreements between the Manager and OpCap Advisors (formerly
known as Quest for Value Advisors) were initially approved by the Trustees of
the Fund (including all of the Trustees who are not "interested persons" of the
Manager or of the Adviser) on April 19, 1993 with respect to the Value Equity
Portfolio and August 13, 1996 with respect to the Opportunity Value Portfolio
and by PFL Life Insurance Company as sole shareholder of the Value Equity and
Opportunity Value Portfolios on April 19, 1993 and August 26, 1996,
respectively. As described in the Prospectus, a transaction is pending whereby
the ownership of OpCap Advisors is being transferred which, under the 1940 Act,
will result in the automatic termination of the Investment Advisory Agreement
between the Manager and OpCap Advisors. On April 8, 1997 the Trustees of the
Fund (including all of the Trustees who are not "interested persons" of the
Manager or the Adviser) approved new Investment Advisory Agreements between the
Manager and OpCap Advisors. Approval of the new Investment Advisory Agreements
will be submitted to the shareholders of the Value Equity and Opportunity Value
Portfolios for approval.
The Investment Advisory Agreement between the Manager and The Boston
Company Asset Management, Inc. was approved by the Trustees of the Fund
(including all of the Trustees who are not "interested persons" of the Manager
or of the Adviser) on January 24, 1994 and by PFL Life Insurance Company as sole
shareholder of the Dreyfus U.S. Government Securities Portfolio on March 7,
1994. The Investment Advisory Agreement was transferred to The Dreyfus
Corporation effective May 1, 1996. The Investment Advisory Agreements between
the Manager and T. Rowe Price Associates, Inc. were approved by the Trustees of
the Fund (including all of the Trustees who are not "interested persons" of the
Manager or of the Adviser) on October 24, 1994 and by PFL Life Insurance Company
as sole shareholder of the T. Rowe Price Equity Income and T. Rowe Price Growth
Stock Portfolios on November 1, 1994. The Investment Advisory Agreement between
the Manager and J.P. Morgan Investment Management Inc. was approved by the
Trustees of the Fund (including all of the Trustees who are not "interested
-40-
<PAGE>
persons" of the Manager or of the Adviser) on August 13, 1996 and by PFL Life
Insurance Company as sole shareholder of the Enhanced Index Portfolio on August
26, 1996. Effective January 1, 1995, Price-Fleming became the Adviser of the T.
Rowe Price International Stock Portfolio. The Investment Advisory Agreement with
Price-Fleming for the T. Rowe Price International Stock Portfolio was approved
by the Trustees of the Fund (including all of the Trustees who are not
"interested persons" of the Manager or of the Adviser) on December 19, 1994 and
by shareholders of the Portfolio on March 24, 1995. Effective September 16,
1996, The Dreyfus Corporation became the Adviser of the Dreyfus Small Cap Value
Portfolio. The Investment Advisory Agreement with The Dreyfus Corporation was
approved by the Trustees of the Fund (including all of the Trustees who are not
"interested persons" of the Manager or of the Adviser) on August 13, 1996 and by
the shareholders of the Portfolio on October 29, 1996. See "Organization and
Capitalization of the Fund."
Each agreement will continue in force for two years from its date, November
23, 1992 with respect to the TCW Money Market and TCW Managed Asset Allocation
Portfolios, April 19, 1993 with respect to the Value Equity Portfolio, March 25,
1994 with respect to the Dreyfus U.S. Government Securities Portfolio, December
28, 1994 with respect to the T. Rowe Price Equity Income and T. Rowe Price
Growth Stock Portfolios, January 1, 1995 with respect to the T. Rowe Price
International Stock Portfolio, September 16, 1996 with respect to the Dreyfus
Small Cap Value Portfolio, November 4, 1996 with respect to the Opportunity
Value Portfolio and April 30, 1997 with respect to the Enhanced Index Portfolio,
and from year to year thereafter, but only so long as its continuation as to a
Portfolio is specifically approved at least annually (i) by the Trustees or by
the vote of a majority of the outstanding voting securities of the Portfolio,
and (ii) by the vote of a majority of the Trustees who are not parties to the
agreement or "interested persons" of any such party, by votes cast in person at
a meeting called for the purpose of voting on such approval. Each Investment
Advisory Agreement provides that it shall terminate automatically if assigned or
if the Management Agreement with respect to the related Portfolio terminates,
and that it may be terminated as to a Portfolio without penalty by the Manager,
by the Trustees of the Fund or by vote of a majority of the outstanding voting
securities of the Portfolio on not less than 60 days' (90 days' with respect to
the Enhanced Index Portfolio) prior written notice to the Adviser or by the
Adviser on not less than 150 days' prior written notice to the Manager, or upon
such shorter notice as may be mutually agreed upon.
-41-
<PAGE>
The following table shows the fees paid by each of the Portfolios and any
fee waivers or reimbursements during the fiscal years ended December 31, 1994,
December 31, 1995 and December 31, 1996.
<TABLE>
<CAPTION>
1996
---------------------------------------
Investment Investment
Management Management Other
Fee Fee Expenses
Paid Waived Reimbursed
---------- ---------- ----------
<S> <C> <C> <C>
TCW Money Market
Portfolio....... $ 165,212 $ -- --
TCW Managed Asset
Allocation
Portfolio....... 1,639,338 -- --
T. Rowe Price
International
Stock Portfolio. 1,015,179 -- --
Value Equity
Portfolio....... 768,579 -- --
Dreyfus Small
Cap Value
Portfolio....... 535,895 -- --
Dreyfus U.S.
Government
Securities
Portfolio....... 122,058 -- --
T. Rowe Price
Equity Income
Portfolio....... 369,356 -- --
T. Rowe Price
Growth Stock
Portfolio....... 313,356 -- --
Opportunity Value
Portfolio*...... 197 -- 2,802
</TABLE>
-42-
<PAGE>
<TABLE>
<CAPTION>
1995**
---------------------------------------
Investment Investment
Management Management Other
Fee Fee Expenses
Paid Waived Reimbursed
---------- ---------- ----------
<S> <C> <C> <C>
TCW Money Market
Portfolio....... $ 117,465 $ --- ---
TCW Managed Asset
Allocation
Portfolio....... 1,388,652 --- ---
T. Rowe Price
International
Stock Portfolio. 759,830 --- ---
Value Equity
Portfolio....... 395,205 --- ---
Dreyfus Small Cap
Value Portfolio. 339,672 --- ---
Dreyfus U.S.
Government
Securities
Portfolio....... 42,531 --- ---
T. Rowe Price
Equity Income
Portfolio....... 70,664 --- ---
T. Rowe Price
Growth Stock
Portfolio....... 75,681 --- ---
</TABLE>
<TABLE>
<CAPTION>
1994
---------------------------------------
Investment
Management Investment Other
Fee Management Expenses
Paid Fee Waived Reimbursed
---------- ---------- ----------
<S> <C> <C> <C>
TCW Money Market
Portfolio....... $ 111,100 $ --- $ ---
TCW Managed Asset
Allocation
Portfolio....... 1,151,688 --- ---
T. Rowe Price
International
Stock Portfolio. 696,732 --- ---
Value Equity
Portfolio....... 191,316 --- ---
Dreyfus Small
Cap Value
Portfolio....... 214,198 --- ---
Dreyfus U.S.
Government
Securities
Portfolio***.... 8,087 8,087 4,955
</TABLE>
- ---------------
-43-
<PAGE>
* The information presented with respect to the Opportunity Value Portfolio
is for the period from November 18, 1996 (commencement of operations) to
December 31, 1996.
** The information presented for the T. Rowe Price Equity Income and T. Rowe
Price Growth Stock Portfolios is for the period from January 3, 1995
(commencement of operations) to December 31, 1995.
*** The information presented with respect to the Dreyfus U.S. Government
Securities Portfolio is for the period from May 13, 1994 (commencement of
operations) to December 31, 1994.
___________________________
Each Investment Advisory Agreement provides that the Adviser shall not be
subject to any liability to the Fund or the Manager for any act or omission in
the course of or connected with rendering services thereunder in the absence of
willful misfeasance, bad faith, gross negligence or reckless disregard of its
duties on the part of the Adviser.
REDEMPTION OF SHARES
The Fund may suspend redemption privileges or postpone the date of payment
on shares of the Portfolios for more than seven days during any period (1) when
the New York Stock Exchange is closed or trading on the Exchange is restricted
as determined by the Securities and Exchange Commission, (2) when an emergency
exists, as defined by the Securities and Exchange Commission, which makes it not
reasonably practicable for a Portfolio to dispose of securities owned by it or
fairly to determine the value of its assets, or (3) as the Securities and
Exchange Commission may otherwise permit.
The value of the shares on redemption may be more or less than the
shareholder's cost, depending upon the market value of the portfolio securities
at the time of redemption.
NET ASSET VALUE
The net asset value per share of each Portfolio is determined as of the
close of regular trading of the New York Stock Exchange (currently 4:00 p.m.,
New York City time), Monday through Friday, exclusive of national business
holidays. The Fund will be closed on the following national business holidays:
New Year's Day, Presidents' Day, Good Friday, Memorial Day, Independence Day,
Labor Day, Thanksgiving Day and Christmas Day. Portfolio securities for which
-44-
<PAGE>
the primary market is on a domestic or foreign exchange or which are traded
over-the-counter and quoted on the NASDAQ System will be valued at the last sale
price on the day of valuation or, if there was no sale that day, at the last
reported bid price, using prices as of the close of trading. Portfolio
securities not quoted on the NASDAQ System that are actively traded in the over-
the-counter market, including listed securities for which the primary market is
believed to be over-the-counter, will be valued at the most recently quoted bid
price provided by the principal market makers.
In the case of any securities which are not actively traded, reliable
market quotations may not be considered to be readily available. These
investments are stated at fair value as determined under the direction of the
Trustees. Such fair value is expected to be determined by utilizing information
furnished by a pricing service which determines valuations for normal,
institutional-size trading units of such securities using methods based on
market transactions for comparable securities and various relationships between
securities which are generally recognized by institutional traders.
If any securities held by a Portfolio are restricted as to resale, their
fair value will be determined following procedures approved by the Trustees. The
fair value of such securities is generally determined as the amount which the
Portfolio could reasonably expect to realize from an orderly disposition of such
securities over a reasonable period of time. The valuation procedures applied in
any specific instance are likely to vary from case to case. However,
consideration is generally given to the financial position of the issuer and
other fundamental analytical data relating to the investment and to the nature
of the restrictions on disposition of the securities (including any registration
expenses that might be borne by the Portfolio in connection with such
disposition). In addition, specific factors are also generally considered, such
as the cost of the investment, the market value of any unrestricted securities
of the same class (both at the time of purchase and at the time of valuation),
the size of the holding, the prices of any recent transactions or offers with
respect to such securities and any available analysts' reports regarding the
issuer.
Notwithstanding the foregoing, short-term debt securities with maturities
of 60 days or less will be valued at amortized cost.
-45-
<PAGE>
The TCW Money Market Portfolio's investment policies and method of
securities valuation are intended to permit the Portfolio generally to maintain
a constant net asset value of $1.00 per share by computing the net asset value
per share to the nearest $.01 per share. The Portfolio is permitted to use the
amortized cost method of valuation for its portfolio securities pursuant to
regulations of the Securities and Exchange Commission. This method may result in
periods during which value, as determined by amortized cost, is higher or lower
than the price the Portfolio would receive if it sold the instrument. The net
asset value per share would be subject to fluctuation upon any significant
changes in the value of the Portfolio's securities. The value of debt
securities, such as those in the Portfolio, usually reflects yields generally
available on securities of similar yield, quality and duration. When such yields
decline, the value of a portfolio holding such securities can be expected to
decline. Although the Portfolio seeks to maintain the net asset value per share
of the Portfolio at $1.00, there can be no assurance that net asset value will
not vary.
The Trustees of the Fund have undertaken to establish procedures reasonably
designed, taking into account current market conditions and the Portfolio's
investment objective, to stabilize the net asset value per share for purposes of
sales and redemptions at $1.00. These procedures include the determination, at
such intervals as the Trustees deem appropriate, of the extent, if any, to which
the net asset value per share calculated by using available market quotations
deviates from $1.00 per share. In the event such deviation exceeds one half of
one percent, the Trustees are required to promptly consider what action, if any,
should be initiated.
With respect to the Portfolios other than the TCW Money Market Portfolio,
foreign securities traded outside the United States are generally valued as of
the time their trading is complete, which is usually different from the close of
the New York Stock Exchange. Occasionally, events affecting the value of such
securities may occur between such times and the close of the New York Stock
Exchange that will not be reflected in the computation of the Portfolio's net
asset value. If events materially affecting the value of such securities occur
during such period, these securities will be valued at their fair value
according to procedures decided upon in good faith by the Fund's Board of
Trustees. All securities and other assets of a Portfolio initially expressed in
foreign currencies will be converted to U.S. dollar values at the mean of the
bid and offer prices of such currencies against U.S. dollars last quoted on a
valuation date by any recognized dealer.
-46-
<PAGE>
TAXES
Federal Income Taxes
Each Portfolio intends to qualify each year as a "regulated investment
company" under the Internal Revenue Code of 1986, as amended (the "Code"). By so
qualifying, a Portfolio will not be subject to federal income taxes to the
extent that its net investment income and net realized capital gains are
distributed.
In order to so qualify, a Portfolio must, among other things, (1) derive at
least 90% of its gross income in each taxable year from dividends, interest,
payments with respect to securities loans, gains from the sale or other
disposition of stocks or securities or foreign currencies, or other income
(including but not limited to gains from options, futures or forward contracts)
derived with respect to its business of investing in such stocks or securities;
(2) derive less than 30% of its gross income in each taxable year from the sale
or other disposition of stocks or securities held less than three months (the
Portfolio's transactions in future transactions, straddles and options may be
restricted in order to comply with this requirement); and (3) diversify its
holdings so that, at the end of each quarter of the Portfolio's taxable year,
(a) at least 50% of the market value of the Portfolio's assets is represented by
cash, government securities and other securities limited in respect of any one
issuer to 5% of the value of the Portfolio's assets and to not more than 10% of
the voting securities of such issuer, and (b) not more than 25% of the value of
its assets is invested in securities of any one issuer (other than government
securities).
As a regulated investment company, a Portfolio will not be subject to
federal income tax on net investment income and capital gains (short- and long-
term), if any, that it distributes to its shareholders if at least 90% of its
net investment income and net short-term capital gains for the taxable year are
distributed, but will be subject to tax at regular corporate rates on any income
or gains that are not distributed. In general, dividends will be treated as paid
when actually distributed, except that dividends declared in October, November
or December and made payable to shareholders of record in such a month will be
treated as having been paid by the Portfolio (and received by shareholders) on
December 31, provided the dividend is paid in the following January. Each
Portfolio intends to satisfy the distribution requirement in each taxable year.
-47-
<PAGE>
The Portfolios will not be subject to the 4% federal excise tax imposed on
registered investment companies that do not distribute all of their income and
gains each calendar year because such tax does not apply to a registered
investment company whose only shareholders are segregated asset accounts of life
insurance companies held in connection with variable annuity and/or variable
life insurance policies.
The Fund intends to comply with section 817(h) of the Code and the
regulations issued thereunder. As required by regulations under that section,
the only shareholders of the Fund and its Portfolios will be life insurance
company segregated asset accounts (also referred to as separate accounts) that
fund variable life insurance or annuity contracts and the general account of PFL
Life Insurance Company which provided the initial capital for the Portfolios of
the Fund. See the prospectus or other material for the Contracts for additional
discussion of the taxation of segregated asset accounts and of the owner of the
particular Contract described therein.
Section 817(h) of the Code and Treasury Department regulations thereunder
impose certain diversification requirements on the segregated asset accounts
investing in the Portfolios of the Fund. These requirements, which are in
addition to the diversification requirements applicable to the Fund under the
1940 Act and under the regulated investment company provisions of the Code, may
limit the types and amounts of securities in which the Portfolios may invest.
Failure to meet the requirements of section 817(h) could result in current
taxation of the owner of the Contract on the income of the Contract.
The Fund may therefore find it necessary to take action to ensure that a
Contract continues to qualify as a Contract under federal tax laws. The Fund,
for example, may be required to alter the investment objectives of a Portfolio
or substitute the shares of one Portfolio for those of another. No such change
of investment objectives or substitution of securities will take place without
notice to the shareholders of the affected Portfolio and the approval of a
majority of such shareholders and without prior approval of the Securities and
Exchange Commission, to the extent legally required.
ORGANIZATION AND CAPITALIZATION OF THE FUND
The Fund is a Massachusetts business trust organized on November 18, 1988.
A copy of the Fund's Agreement and Declaration of Trust, as amended, which is
governed by Massachusetts law, is on file with the Secretary of State of The
Commonwealth of Massachusetts.
-48-
<PAGE>
The Trustees of the Fund have authority to issue an unlimited number of
shares of beneficial interest without par value of one or more series.
Currently, the Trustees have established and designated ten series. Each series
of shares represents the beneficial interest in a separate Portfolio of assets
of the Fund, which is separately managed and has its own investment objective
and policies. The Trustees of the Fund have authority, without the necessity of
a shareholder vote, to establish additional portfolios and series of shares. The
shares outstanding are, and those offered hereby when issued will be, fully paid
and nonassessable by the Fund. The shares have no preemptive, conversion or
subscription rights and are fully transferable.
The assets received from the sale of shares of a Portfolio, and all income,
earnings, profits and proceeds thereof, subject only to the rights of creditors,
constitute the underlying assets of the Portfolio. The underlying assets of a
Portfolio are required to be segregated on the Fund's books of account and are
to be charged with the expenses with respect to that Portfolio. Any general
expenses of the Fund not readily attributable to a Portfolio will be allocated
by or under the direction of the Trustees in such manner as the Trustees
determine to be fair and equitable, taking into consideration, among other
things, the nature and type of expense and the relative sizes of the Portfolio
and the other Portfolios.
Each share has one vote, with fractional shares voting proportionately.
Shareholders of a Portfolio are not entitled to vote on any matter that requires
a separate vote of the shares of another Portfolio but which does not affect the
Portfolio. The Agreement and Declaration of Trust does not require the Fund to
hold annual meetings of shareholders. Thus, there will ordinarily be no annual
shareholder meetings, unless otherwise required by the 1940 Act. The Trustees of
the Fund may appoint their successors until fewer than a majority of the
Trustees have been elected by shareholders, at which time a meeting of
shareholders will be called to elect Trustees. Under the Agreement and
Declaration of Trust, any Trustee may be removed by vote of two-thirds of the
outstanding shares of the Fund, and holders of 10% or more of the outstanding
shares can require the Trustees to call a meeting of shareholders for the
purpose of voting on the removal of one or more Trustees. If ten or more
shareholders who have been such for at least six months and who hold in the
aggregate shares with a net asset value of at least $25,000 inform the Trustees
that they wish to communicate with other shareholders, the Trustees either will
give such shareholders access to the shareholder lists or will inform them of
the cost involved if the Fund forwards materials to the shareholders on their
behalf. If the Trustees object to mailing such materials, they must inform the
Securities and Exchange Commission and thereafter comply with the requirements
of the 1940 Act.
-49-
<PAGE>
PFL will vote shares of the Fund as described under the caption "Voting
Rights" in the prospectus or other material for the Contracts which accompanies
the Prospectus.
As of March 31, 1997, the PFL Endeavor Variable Annuity Account owned of
record the following approximate percentages of the outstanding shares of each
Portfolio: 75% of the TCW Money Market Portfolio; 95% of the TCW Managed Asset
Allocation Portfolio; 89% of the T. Rowe Price International Stock Portfolio;
85% of the Value Equity Portfolio; 88% of the Dreyfus Small Cap Value Portfolio;
83% of the Dreyfus U.S. Government Securities Portfolio; 83% of the T. Rowe
Price Equity Income Portfolio; 81% of the T. Rowe Price Growth Stock Portfolio;
and 77% of the Opportunity Value Portfolio. As of March 31, 1997, the PFL
Endeavor Platinum Variable Annuity Account owned of record the following
approximate percentages of the outstanding shares of each Portfolio: 23% of the
TCW Money Market Portfolio; 4% of the TCW Managed Asset Allocation Portfolio; 8%
of the T. Rowe Price International Stock Portfolio; 12% of the Value Equity
Portfolio; 9% of the Dreyfus Small Cap Value Portfolio; 14% of the Dreyfus U.S.
Government Securities Portfolio; 14% of the T. Rowe Price Equity Income
Portfolio; 10% of the T. Rowe Price Growth Stock Portfolio; and 14% of the
Opportunity Value Portfolio. As of March 31, 1997, the AUSA Endeavor Variable
Annuity Account owned of record the following approximate percentages of the
outstanding shares of each Portfolio: 2% of the TCW Money Market Portfolio; 1%
of the TCW Managed Asset Allocation Portfolio; 3% of the T. Rowe Price
International Stock Portfolio; 2% of the Value Equity Portfolio; 2% of the
Dreyfus Small Cap Value Portfolio; 3% of the Dreyfus U.S. Government Securities
Portfolio; 3% of the T. Rowe Price Equity Income Portfolio; 3% of the T. Rowe
Price Growth Stock Portfolio; and 9% of the Opportunity Value Portfolio.
Under Massachusetts law, shareholders could, under certain circumstances,
be held personally liable for the obligations of the Fund. However, the
Agreement and Declaration of Trust disclaims shareholder liability for acts and
obligations of the Fund and requires that notice of such disclaimer be given in
each agreement, obligation or instrument entered into or executed by the Fund or
the Trustees. The Agreement and Declaration of Trust provides for
indemnification out of Fund property for all loss and expense of any
shareholders held personally liable for obligations of the Fund. Thus, the risk
of a shareholder incurring financial loss on account of shareholder liability is
limited to circumstances in which the Fund would be unable to meet its
obligations. The likelihood of such circumstances is remote.
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<PAGE>
LEGAL MATTERS
Certain legal matters are passed on for the Fund by Sullivan & Worcester
LLP of Washington, D.C.
CUSTODIAN
Boston Safe Deposit and Trust Company, located at One Boston Place, Boston,
Massachusetts 02108, serves as the custodian of the Fund. Under the Custody
Agreement, Boston Safe holds the Portfolios' securities and keeps all necessary
records and documents.
FINANCIAL STATEMENTS
The financial statements of the TCW Money Market Portfolio, TCW Managed
Asset Allocation Portfolio, T. Rowe Price International Stock Portfolio, Value
Equity Portfolio, Dreyfus Small Cap Value Portfolio, Dreyfus U.S. Government
Securities Portfolio, T. Rowe Price Equity Income Portfolio, T. Rowe Price
Growth Stock Portfolio and Opportunity Value Portfolio for the fiscal year ended
December 31, 1996, including notes to the financial statements and supplementary
information and the Independent Auditors' Report are included in the Fund's
Annual Report to Shareholders. A copy of the Annual Report accompanies this
Statement of Additional Information. The financial statements (including the
Independent Auditors' Report) included in the Annual Report are incorporated
herein by reference. Interim financial statements (unaudited) for the
Opportunity Value Portfolio for the period January 1, 1997 through March 31,
1997 accompany this Statement of Additional Information.
-51-
<PAGE>
APPENDIX
SECURITIES RATINGS
Standard & Poor's Bond Ratings
A Standard & Poor's corporate debt rating is a current assessment of the
creditworthiness of an obligor with respect to a specific obligation. Debt rated
"AAA" has the highest rating assigned by Standard & Poor's. Capacity to pay
interest and repay principal is extremely strong. Debt rated "AA" has a very
strong capacity to pay interest and to repay principal and differs from the
highest rated issues only in small degree. Debt rated "A" has a strong capacity
to pay interest and repay principal although it is somewhat more susceptible to
the adverse effects of changes in circumstances and economic conditions than
debt of a higher rated category. Debt rated "BBB" is regarded as having an
adequate capacity to pay interest and repay principal. Whereas it normally
exhibits adequate protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay interest and
to repay principal for debt in this category than for higher rated categories.
Bonds rated "BB", "B", "CCC" and "CC" are regarded, on balance, as predominantly
speculative with respect to the issuer's capacity to pay interest and repay
principal in accordance with the terms of the obligation. "BB" indicates the
lowest degree of speculation and "CC" the highest degree of speculation. While
such bonds will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions. The ratings from "AA" to "B" may be modified by the addition of a
plus or minus sign to show relative standing within the major rating categories.
Moody's Bond Ratings
Bonds rated "Aaa" by Moody's are judged to be of the best quality and to
carry the smallest degree of investment risk. Bonds rated "Aa" are judged to be
of high quality by all standards. Bonds rated "A" possess many favorable
investment attributes and are to be considered as higher medium grade
obligations. Bonds rated "Baa" are considered as medium grade obligations, i.e.,
they are neither highly protected nor poorly secured and have speculative
characteristics as well. Bonds are rated "Ba", "B", "Caa", "Ca", "C" when
protection of interest and principal payments is questionable. A "Ba" rating
indicates some speculative elements while "Ca" represents a high degree of
speculation and "C" represents the lowest rated class of bonds. "Caa", "Ca" and
"C" bonds may be in default. Moody's applies numerical modifiers "1", "2" and
"3" in each generic rating classification from "Aa" to "B" in its corporate bond
rating system. The modifier "1" indicates that the security ranks in the higher
end of its generic rating category; the modifier "2" indicates a mid-range
ranking; and the modifier "3" indicates that the issue ranks at the lower end of
its generic rating category.
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<PAGE>
Standard & Poor's Commercial Paper Ratings
"A" is the highest commercial paper rating category utilized by Standard &
Poor's, which uses the numbers "1+", "1", "2" and "3" to denote relative
strength within its "A" classification. Commercial paper issuers rated "A" by
Standard & Poor's have the following characteristics. Liquidity ratios are
better than industry average. Long-term debt rating is "A" or better. The issuer
has access to at least two additional channels of borrowing. Basic earnings and
cash flow are in an upward trend. Typically, the issuer is a strong company in a
well-established industry and has superior management. Issues rated "B" are
regarded as having only an adequate capacity for timely payment. However, such
capacity may be damaged by changing conditions or short-term adversities. The
rating "C" is assigned to short-term debt obligations with a doubtful capacity
for repayment. An issue rated "D" is either in default or is expected to be in
default upon maturity.
Moody's Commercial Paper Ratings
"Prime-1" is the highest commercial paper rating assigned by Moody's, which
uses the numbers "1", "2" and "3" to denote relative strength within its highest
classification of Prime. Commercial paper issuers rated Prime by Moody's have
the following characteristics. Their short-term debt obligations carry the
smallest degree of investment risk. Margins of support for current indebtedness
are large or stable with cash flow and asset protection well assured. Current
liquidity provides ample coverage of near-term liabilities and unused
alternative financing arrangements are generally available. While protective
elements may change over the intermediate or longer terms, such changes are most
unlikely to impair the fundamentally strong position of short-term obligations.
IBCA Limited/IBCA Inc. Commercial Paper Ratings. Short-term obligations,
including commercial paper, rated A-1+ by IBCA Limited or its affiliate IBCA
Inc., are obligations supported by the highest capacity for timely repayment.
Obligations rated A-1 have a very strong capacity for timely repayment.
Obligations rated A-2 have a strong capacity for timely repayment, although such
capacity may be susceptible to adverse changes in business, economic or
financial conditions.
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<PAGE>
Fitch Investors Service LLP. Commercial Paper Ratings. Fitch Investors
Service LLP employs the rating F-1+ to indicate issues regarded as having the
strongest degree of assurance for timely payment. The rating F-1 reflects an
assurance of timely payment only slightly less in degree than issues rated F-1+,
while the rating F-2 indicates a satisfactory degree of assurance for timely
payment, although the margin of safety is not as great as indicated by the F-1+
and F-1 categories.
Duff & Phelps Inc. Commercial Paper Ratings. Duff & Phelps Inc. employs the
designation of Duff 1 with respect to top grade commercial paper and bank money
instruments. Duff 1+ indicates the highest certainty of timely payment: short-
term liquidity is clearly outstanding, and safety is just below risk-free U.S.
Treasury short-term obligations. Duff 1- indicates high certainty of timely
payment. Duff 2 indicates good certainty of timely payment: liquidity factors
and company fundamentals are sound.
Thomson BankWatch, Inc. ("BankWatch") Commercial Paper Ratings. BankWatch
will assign both short-term debt ratings and issuer ratings to the issuers it
rates. BankWatch will assign a short-term rating ("TBW-1", "TBW-2", "TBW-3", or
"TBW-4") to each class of debt (e.g., commercial paper or non-convertible debt),
having a maturity of one-year or less, issued by a holding company structure or
an entity within the holding company structure that is rated by BankWatch.
Additionally, BankWatch will assign an issuer rating ("A", "A/B", "B", "B/C",
"C", "C/D", "D", "D/E", and "E") to each issuer that it rates.
Various of the NRSROs utilize rankings within rating categories indicated
by a + or -. The Portfolios, in accordance with industry practice, recognize
such rankings within categories as graduations, viewing for example Standard &
Poor's rating of A-1+ and A-1 as being in Standard & Poor's highest rating
category.
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<PAGE>
Portfolio of Investments
Endeavor Series Trust
Opportunity Value Portfolio
March 31, 1997 (Unaudited)
<TABLE>
<CAPTION>
Value
Shares (Note 1)
------ --------
<S> <C>
COMMON STOCK - 58.5%
Banking - 10.1%
2,500 Bank of Boston Corporation.................... $167,500
1,700 Citicorp ..................................... 184,025
600 Wells Fargo & Company ........................ 170,475
--------
522,000
--------
Insurance - 4.9%
2,400 ACE, Ltd. .................................... 153,600
2,300 EXEL Ltd. Ord................................. 97,175
--------
250,775
--------
Restaurants - 4.6%
5,000 McDonald's Corporation ....................... 236,250
--------
Energy - 4.5%
4,000 Tenneco Inc .................................. 156,000
2,000 Triton Energy Corporation+.................... 77,500
--------
233,500
--------
Manufacturing and Engineering - 4.4%
2,800 Caterpillar, Inc ............................. 224,700
--------
Diversified Chemicals - 4.0%
1,600 duPont (E.I.) de Nemours & Company ........... 169,600
300 Hercules, Inc. ............................... 12,675
600 Monsanto Company ............................. 22,950
--------
205,225
--------
Financial Services - 3.5%
4,600 Federal Home Loan Mortgage Corporation ....... 125,350
1,600 Federal National Mortgage Association ........ 57,800
--------
183,150
--------
Paper and Paper Products - 3.5%
4,000 Champion International Corporation ........... 182,000
--------
Aerospace and Defense - 3.5%
1,400 Lockheed Martin Corporation................... 117,600
1,000 McDonnell Douglas Corporation ................ 61,000
--------
178,600
--------
</TABLE>
See Notes to Financial Statements.
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<PAGE>
Portfolio of Investments (Continued)
Endeavor Series Trust
Opportunity Value Portfolio
March 31, 1997 (Unaudited)
<TABLE>
<CAPTION>
Value
Shares (Note 1)
------ ---------
<S> <C>
COMMON STOCK - (Continued)
Electronics - 3.0%
2,800 National Semiconductor Corporation+.............. $77,000
1,500 Varian Associates, Inc........................... 80,250
---------
157,250
---------
Telecommunications - 3.0%
13,000 Tele-Communications, Inc., Class A+ ............. 156,000
---------
Waste Disposal - 2.9%
2,000 Browning-Ferris Industries, Inc.................... 57,750
3,000 WMX Technologies, Inc............................ 91,875
---------
149,625
---------
Toys, Games and Hobbies - 2.8%
6,000 Mattel, Inc ..................................... 144,000
---------
Food and Beverages - 2.3%
3,000 Heinz (H.J.) Company............................. 118,500
---------
Transportation - 0.8%
700 Union Pacific Corporation........................ 39,725
---------
Metals and Mining - 0.4%
700 Freeport McMoRan Copper & Gold, Inc., Class B ... 21,263
---------
Drugs and Medical Products - 0.3%
400 Becton, Dickinson & Company ..................... 18,000
---------
Total Common Stock
(Cost $3,149,798)............................. 3,020,563
---------
</TABLE>
See Notes to Financial Statements.
-56-
<PAGE>
Portfolio of Investments (Continued)
Endeavor Series Trust
Opportunity Value Portfolio
March 31, 1997 (Unaudited)
<TABLE>
<CAPTION>
Principal Value
Amount (Note 1)
--------- ---------
<S> <C>
AGENCY SECURITIES - 20.5%
Federal Farm Credit Bank (FFCB) - 12.9%
FFCB, Discount Notes:
$120,000 5.200%# due 04/07/1997..................... $119,896
550,000 5.340%# due 04/30/1997..................... 547,634
-----------
667,530
-----------
Federal Home Loan Bank (FHLB) - 7.6%
395,000 FHLB, Discount Note,
5.370%# due 04/17/1997..................... 394,057
----------
Total Agency Securities
(Cost $1,061,587).......................... 1,061,587
----------
COMMERCIAL PAPER - 24.2% (Cost $1,249,389)
1,255,000 Ford Motor Credit Corporation,
5.550%# due 04/30/1997.................... 1,249,389
----------
TOTAL INVESTMENTS (Cost $5,460,774*)........................... 103.2 % 5,331,539
OTHER ASSETS AND LIABILITIES (Net)............................. (3.2) (164,070)
--------- ----------
NET ASSETS..................................................... 100.0 % $5,167,469
========= ==========
</TABLE>
* Aggregate cost for federal tax purposes.
+ Non-income producing security.
# Rate represents annualized yield at date of purchase.
-57-
<PAGE>
Abbreviation:
Ord. - Ordinary
- --------------------------------------------------------------------------------
Statement of Assets and Liabilities
Endeavor Series Trust
Opportunity Value Portfolio
March 31, 1997 (Unaudited)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
<S> <C>
ASSETS:
Investments, at value (Cost $5,460,774) (Note 1)
See accompanying schedule................................................ $ 5,331,539
Cash........................................................................ 8,515
Receivable for Portfolio shares sold........................................ 173,798
Unamortized organization costs (Note 5)..................................... 24,073
Dividends receivable........................................................ 2,948
Receivable from investment manager (Note 2)................................. 2,802
--------------
Total Assets................................................................ 5,543,675
LIABILITIES:
Payable for investment securities purchased................................. $ 344,092
Organization costs payable (Note 5)......................................... 26,000
Investment management fee payable (Note 2).................................. 2,972
Custodian fees payable (Note 2)............................................. 1,205
Transfer agent fees payable ................................................ 167
Accrued Trustees' fees and expenses (Note 2)................................ 148
Accrued expenses and other payables......................................... 1,622
------------
Total Liabilities........................................................... 376,206
--------------
NET ASSETS.................................................................. $ 5,167,469
==============
NET ASSETS consist of:
Undistributed net investment income.......................................... $ 13,737
Accumulated net realized gain on investments sold............................ 1,956
Net unrealized depreciation of investments................................... (129,235)
Paid-in capital.............................................................. 5,281,011
--------------
Total Net Assets............................................................. $ 5,167,469
==============
NET ASSET VALUE,
offering price and redemption price per share:
($5,167,469 / 515,792 shares of beneficial interest outstanding).......... $ 10.02
==============
</TABLE>
See Notes to Financial Statements.
- --------------------------------------------------------------------------------
Statement of Assets and Liabilities
Endeavor Series Trust
Opportunity Value Portfolio
For the Three Months Ended March 31, 1997 (Unaudited)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
<S> <C> <C>
INVESTMENT INCOME:
Interest............................................................................. $ 15,822
Dividends............................................................................ 6,495
-------------
Total Investment Income.............................................................. 22,317
EXPENSES:
Investment management fee (Note 2)................................................... $ 5,354
Custodian fees (Note 2).............................................................. 1,721
Amortization of organization costs (Note 5).......................................... 1,300
Transfer agent fees.................................................................. 202
Trustees fees and expenses (Note 2).................................................. 50
Other................................................................................ 245
---------
Total expenses.................................................................... 8,872
-------------
NET INVESTMENT INCOME................................................................ 13,445
-------------
REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS
(Notes 1 and 3):
Net realized gain on investments during the period................................ 1,956
Net change in unrealized depreciation of investments during the period............ (129,395)
-------------
Net realized and unrealized loss on investments...................................... (127,439)
-------------
NET DECREASE IN NET ASSETS RESULTING FROM
OPERATIONS......................................................................... $ (113,994)
=============
</TABLE>
See Notes to Financial Statements.
-58-
<PAGE>
- --------------------------------------------------------------------------------
Statement of Changes in Net Assets
Endeavor Series Trust
Opportunity Value Portfolio
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Three months
Ended
03/31/97
(unaudited)
------------
<S> <C>
Net investment income............................................................... $ 13,445
Net realized gain on investments during the period.................................. 1,956
Net unrealized depreciation of investments during the period........................ (129,395)
------------
Net decrease in net assets resulting from operations................................ (113,994)
Net increase in net assets from Portfolio share transactions (Note 4)............... 4,580,338
------------
Net increase in net assets.......................................................... 4,466,344
NET ASSETS:
Beginning of period................................................................. 701,125
------------
End of period (including undistributed net investment income of $13,737)............ $ 5,167,469
============
</TABLE>
See Notes to Financial Statements.
Financial Highlights
Endeavor Series Trust
Opportunity Value Portfolio
For a Portfolio share outstanding throughout the period
<TABLE>
<CAPTION>
Three Months
Ended
03/31/97
(unaudited)+++
---------------
<S> <C>
Operating performance:
Net asset value, beginning of period................................................. $ 10.06
--------------
Net investment income................................................................ 0.05
Net realized and unrealized loss on investments...................................... (0.09)
--------------
Net decrease in net assets resulting from investment operations...................... (0.04)
--------------
Net asset value, end of period....................................................... $ 10.02
==============
Total return ++...................................................................... (0.04)%
==============
Ratios to average net assets/supplemental data:
Net assets, end of period (in 000's)................................................. $ 5,167
Ratio of net investment income to average net assets................................. 1.97%+
Ratio of operating expenses to average net assets.................................... 1.30%+
Portfolio turnover rate.............................................................. 4%
Average commission rate (per share of security)(a)................................... $ 0.0564
</TABLE>
- ---------------------------------------
+ Annualized.
++ Total return represents aggregate total return for the period indicated.
+++ Per share amounts have been calculated using the monthly average share
method which more appropriately presents the per share data for the period
since use of the undistributed method did not accord with results of
operations.
(a) Average commission rate paid per share of securities purchased and sold by
the Portfolio.
See Notes to Financial Statements
-59-
<PAGE>
ENDEAVOR SERIES TRUST
OPPORTUNITY VALUE PORTFOLIO
NOTES TO FINANCIAL STATEMENTS (Unaudited)
1. Significant Accounting Policies
Endeavor Series Trust (the "Fund") was organized as a Massachusetts business
trust on November 19, 1988 under the laws of the Commonwealth of Massachusetts.
The Fund is registered with the Securities and Exchange Commission under the
Investment Company Act of 1940, as amended, as a diversified, open-end
management investment company. As of the date of these financial statements,
the Fund offers nine managed investment portfolios. The information presented
in these financial statements pertains only to the Opportunity Value Portfolio
(the "Portfolio"). The following is a summary of significant accounting
policies consistently followed by the Portfolio in the preparation of its
financial statements. The preparation of financial statements in accordance
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts and disclosures in
the financial statements. Actual results could differ from those estimates.
Portfolio Valuation:
Generally, the Portfolio's investments are valued at market value or, in the
absence of market value with respect to any portfolio securities, at fair value
as determined by, or under the direction of, the Board of Trustees. Portfolio
securities for which the primary market is on a domestic or foreign exchange, or
which are traded over-the-counter and quoted on the NASDAQ System, are valued at
the last sale price on the day of valuation or, if there was no sale that day,
at the last reported bid price using prices as of the close of trading.
Portfolio securities not quoted on the NASDAQ System that are actively traded in
the over-the-counter market, including listed securities for which the primary
market is believed to be over-the-counter, are valued at the most recently
quoted bid price provided by the principal market makers. In the case of any
securities which are not actively traded, these investments are stated at fair
value as determined under the direction of the Board of Trustees. Short-term
investments that mature in 60 days or less are valued at amortized cost.
Foreign securities traded outside the United States are generally valued as
of the time their trading is complete, which is usually different from the close
of the New York Stock Exchange. Occasionally, events affecting the value of
such securities may occur between such times and the close of the New York Stock
Exchange that will not be reflected in the computation of the Portfolio's net
asset value. If events materially affecting the value of such securities occur
during such period, these securities will be valued at their fair value
according to procedures decided upon in good faith by the Fund's Board of
Trustees. All securities and other assets of the Portfolio initially expressed
in foreign currencies will be converted to U.S. dollar values at the mean of the
bid and offer prices of such currencies against U.S. dollars last quoted on a
valuation date by any recognized dealer.
-60-
<PAGE>
Securities Transactions and Investment Income:
Securities transactions are recorded as of the trade date. Realized gains
and losses from securities transactions are recorded on the identified cost
basis. Dividend income is recorded on the ex-dividend date. Interest income is
recorded on the accrual basis.
Securities purchased or sold on a when-issued or delayed-delivery basis may
be settled a month or more after the trade date. Interest income is not accrued
until settlement date.
ENDEAVOR SERIES TRUST
OPPORTUNITY VALUE PORTFOLIO
NOTES TO FINANCIAL STATEMENTS (Unaudited) (Continued)
Forward Foreign Currency Contracts:
The Opportunity Value Portfolio may engage in forward foreign currency
exchange contracts. The Portfolio engages in forward foreign currency exchange
transactions to protect against changes in future exchange rates. Forward
foreign currency exchange contracts are valued at the forward rate and are
marked-to-market daily. The change in market value is recorded by the Portfolio
as an unrealized gain or loss. When the contract is closed, the Portfolio
records a realized gain or loss equal to the difference between the value of the
contract at the time it was opened and the value at the time it was closed.
The use of forward foreign currency exchange contracts does not eliminate
fluctuations in the underlying prices of the Portfolio's securities, but it does
establish a rate of exchange that can be achieved in the future. Although
forward foreign currency contracts limit the risk of loss due to a decline in
the value of the hedged currency, they also limit any potential gain that might
result should the value of the currency increase. In addition, the Portfolio
could be exposed to risks if the counterparties to the contracts are unable to
meet the terms of their contracts.
Foreign Currency:
The books and records of the Portfolio are maintained in U.S. dollars.
Foreign currencies, investments and other assets and liabilities are translated
into U.S. dollars at the exchange rates prevailing at the end of the period.
Purchases and sales of investment securities, and items of income and expense
are translated on the respective dates of such transactions. Unrealized gains
and losses which result from changes in foreign currency exchange rates have
been included in the unrealized appreciation/ (depreciation) of investments and
net other assets. Net realized foreign currency gains and losses include the
effect of changes in exchange rates between trade date and settlement date on
investment security transactions, foreign currency transactions and interest and
dividends received. The portion of foreign currency gains and losses related to
fluctuation in exchange rates between the initial purchase trade date and
subsequent sale trade date is included in realized gains and losses on
investment securities sold.
Dividends and Distributions to Shareholders:
Dividends from net investment income of the Portfolio are declared and paid
at least annually. For the Portfolio, all net realized long-term or short-term
capital gains, if any, will be declared and distributed at least annually.
Income dividends and capital gain distributions are determined in accordance
with income tax regulations which may differ from generally accepted accounting
principles. These differences are primarily due to differing treatments of
income, gains and losses on various investment securities held by the Portfolio,
timing differences in the recognition of income, gains and losses and differing
characterizations of distributions made by the Fund.
-61-
<PAGE>
ENDEAVOR SERIES TRUST
OPPORTUNITY VALUE PORTFOLIO
NOTES TO FINANCIAL STATEMENTS (Unaudited) (Continued)
Federal Income Taxes:
The Fund intends that the Portfolio qualify annually as a regulated
investment company, if such qualification is in the best interest of its
shareholders, by complying with the requirements of the Internal Revenue Code of
1986, as amended, applicable to regulated investment companies and by
distributing substantially all of its taxable income to its shareholders.
Therefore, no federal income tax provision is required.
2. Investment Management Fee, Administrative Fee, Investment Advisory Fee and
Other Related Party Transactions
The Fund is managed by Endeavor Investment Advisers (the "Investment
Manager") pursuant to a management agreement. The Investment Manager is a
general partnership of which Endeavor Management Co. is the managing partner.
The Investment Manager is responsible for providing investment management and
administrative services to the Fund, including selecting the investment adviser
(the "Adviser") for the Fund's Portfolio. As compensation for these services,
the Portfolio pays the Investment Manager a monthly fee at the annual rate of
0.80% of the Portfolio's average daily net assets.
From the investment management fees, the Investment Manager pays the expenses
of providing investment advisory services to the Portfolio, including the fees
of the Adviser of the Portfolio. The Investment Manager also pays the fees and
expenses of First Data Investor Services Group, Inc. ("FDISG"), a wholly-owned
subsidiary of First Data Corporation. FDISG assists the Investment Manager in
the performance of its administrative responsibilities to the Portfolio. As
compensation for these services, the Investment Manager pays FDISG a fee
computed and payable monthly at an annual rate of .10% of the Fund's aggregate
daily net assets on the first $600 million, .06% on the next $400 million and
.01% on assets exceeding $1 billion, with a minimum annual fee for the Portfolio
of $40,000 until its assets reach $40 million.
OpCap Advisors ("OpCap"), a subsidiary of Oppenheimer Capital, serves as the
Adviser to the Portfolio pursuant to a separate investment advisory agreement
between the Investment Manager and OpCap. As compensation for its services as
investment adviser, the Investment Manager pays OpCap a monthly fee at the
annual rate of .40% of the average daily net assets of the Portfolio.
From time to time the Investment Manager may waive a portion or all of the
fees otherwise payable to it and/or reimburse expenses. The Investment Manager
has voluntarily undertaken to waive its fees and has agreed to bear certain
expenses so that total expenses of the Portfolio do not exceed 1.30% of the
Portfolio's average daily net assets. For the three month period ended March
31, 1997, the Investment Manager did not waive fees or reimburse expenses of the
Portfolio.
Boston Safe Deposit and Trust Company, an indirect wholly-owned subsidiary of
Mellon Bank Corporation, serves as the Fund's custodian. FDISG serves as the
Fund's transfer agent.
ENDEAVOR SERIES TRUST
OPPORTUNITY VALUE PORTFOLIO
NOTES TO FINANCIAL STATEMENTS (Unaudited) (Continued)
For the three month period ended March 31, 1997, the Portfolio incurred total
brokerage commissions of $2,900 of which $2,035 was paid to Oppenheimer &
Company, Inc., an affiliate broker-dealer of the Adviser.
No director, officer or employee of the Investment Manager, Endeavor
Management Co., the Adviser or FDISG received any compensation from the
Portfolio for serving as an officer or Trustee of the Fund. The Fund pays each
Trustee who is not a director, officer or employee of the Investment Manager,
Endeavor Management Co., the Adviser, FDISG or any of their affiliates $2,500
per annum plus $500 per regularly scheduled meeting attended and reimburses them
for travel and out-of-pocket expenses. Each series of the Fund, including the
Portfolio, bears its proportionate share of such fees and expenses.
-62-
<PAGE>
3. Purchases and Sales of Securities
Purchases of securities, excluding short-term investments, for the three
month period ended March 31, 1997 were $180,713. Purchases and proceeds from
sales of securities excluding U.S. government securities and short-term
investments, for the three month period ended March 31, 1997 were $2,789,128 and
$64,645, respectively.
At March 31, 1997, aggregate gross unrealized appreciation for all securities
in which there was an excess of value over tax cost and aggregate gross
unrealized depreciation for all securities in which there was an excess of tax
cost over value was $27,152 and $156,387, respectively.
4. Shares of Beneficial Interest
The Fund has authorized an unlimited number of shares of beneficial interest
without par value. Changes in shares of beneficial interest for the Portfolio
were as follows:
<TABLE>
<CAPTION>
Three Month
Period Ended
03/31/97
------------
Shares Amount
------- ----------
<S> <C> <C>
Sold.......... 458,614 $4,708,736
Redeemed...... (12,535) (128,398)
------- ----------
Net increase.. 446,079 $4,580,338
======= ==========
</TABLE>
ENDEAVOR SERIES TRUST
OPPORTUNITY VALUE PORTFOLIO
NOTES TO FINANCIAL STATEMENTS (Unaudited) (Continued)
5. Organization Costs
Organization costs are amortized on a straight-line basis over a period of
five years from the commencement of operations of the Portfolio. In the event
that any of the 10 initial shares of the Portfolio owned by a separate account
of PFL Life Insurance Company are redeemed during such amortization period, the
redemption proceeds will be reduced for any unamortized organization costs in
the same proportion as the number of shares redeemed bears to the number of
initial shares outstanding at the time of the redemption. The Fund bears the
expense of registering and qualifying the shares of the Portfolio for
distribution under Federal and state securities regulations.
ENDEAVOR SERIES TRUST
OPPORTUNITY VALUE PORTFOLIO
NOTES TO FINANCIAL STATEMENTS (Unaudited) (Continued)
- --------------------------------------------------------------------------------
The Financial Statements contained herein are submitted for the general
information of the policyholders of The Endeavor Variable Annuity. This
report is not authorized for distribution to prospective investors
unless preceded or accompanied by an effective prospectus.
- --------------------------------------------------------------------------------
-63-
<PAGE>
WRL SERIES FUND, INC.
GROWTH PORTFOLIO
STATEMENT OF ADDITIONAL INFORMATION
This Statement of Additional Information is not a prospectus but supplements
and should be read in conjunction with the Prospectus for the Growth Portfolio
of the WRL Series Fund, Inc. (the "Fund"). A copy of the Prospectus may be
obtained by writing PFL Life Insurance Company, Administrative and Service
Office, Financial Markets Division--Variable Annuity Dept., 4333 Edgewood
Road, N.E., Cedar Rapids, Iowa 52499 or by calling (800) 525-6205.
-------------------------------------------------
WRL INVESTMENT MANAGEMENT, INC.
Investment Adviser
JANUS CAPITAL CORPORATION
Sub-Adviser
-------------------------------------------------
The date of the Prospectus to which this Statement of Additional Information
relates and the date of this Statement of Additional Information is May 1,
1997.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE IN THIS STATEMENT OF CROSS-REFERENCE TO
ADDITIONAL INFORMATION PAGE IN PROSPECTUS
------------------------- ------------------
<S> <C> <C>
Investment Objective and
Policies........................ 3 5
Investment Restrictions........ 3 6
Repurchase and Reverse Repur-
chase Agreements.............. 5 10
Lending of Portfolio
Securities.................... 5 6
Foreign Securities............. 6 12
Non-Investment Grade Debt
Securities.................... 6 6
Investments in Futures, Options
and Other Derivative
Instruments................... 7 8
Management of the Fund........... 19 14
Directors and Officers......... 19 14
The Investment Adviser......... 22 14
Distribution and Service Plans. 24 16
The Sub-Adviser................ 25 17
Joint Trading Accounts......... 25 18
Portfolio Transactions and
Brokerage....................... 26 18
Portfolio Turnover............. 26 7
Placement of Portfolio
Brokerage..................... 26 18
Purchase and Redemption of
Shares.......................... 28 19
Offering of the Shares and
Determination of Offering
Price......................... 28 20
Portfolio Net Asset Valuation.. 28 19
Investment Experience
Information..................... 29 4
Calculation of Performance Re-
lated Information............... 29 4
Total Return................... 29 4
Taxes............................ 30 21
Capital Stock of the Fund........ 32 19
Registration Statement........... 32 N/A
Financial Statements............. 32 21
Other Information................ 32 21
Appendix A--Description of Port-
folio Securities................ A-1 8
Appendix B--Description of
Selected Corporate Bond and Com-
mercial Paper Ratings........... B-1 6
</TABLE>
- 2 -
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Growth Portfolio (the "Portfolio") of the
Fund is described in the Portfolio's Prospectus. Shares of the Portfolio are
sold only to the separate accounts of Western Reserve Life Assurance Co. of
Ohio ("WRL"), PFL Life Insurance Company, an affiliate of WRL, and to separate
accounts of certain of their affiliated life insurance companies
(collectively, the "Separate Accounts") to fund benefits under certain
variable life insurance policies (the "Policies") and variable annuity
contracts (the "Annuity Contracts", or "Contracts").
As indicated in the Prospectus, the Portfolio's investment objective and,
unless otherwise noted, its investment policies and techniques, may be changed
by the Board of Directors of the Fund without approval of shareholders or
owners of the Policies or the Annuity Contracts (collectively, "Contract
Owners"). A change in the investment objective or policies of the Portfolio
may result in the Portfolio's having an investment objective or policies
different from those which a Contract Owner deemed appropriate at the time of
investment.
INVESTMENT RESTRICTIONS
As indicated in the Prospectus, the Portfolio is subject to certain
fundamental policies and restrictions which may not be changed without the
approval of the holders of a majority of the outstanding voting shares of the
Portfolio. "Majority" for this purpose and under the Investment Company Act of
1940, as amended (the "1940 Act") means the lesser of (i) 67% of the shares
represented at a meeting at which more than 50% of the outstanding shares of
the Portfolio are represented or (ii) more than 50% of the outstanding shares
of the Portfolio. A complete statement of all such fundamental policies is set
forth below.
The Portfolio may not, as a matter of fundamental policy:
1. With respect to 75% of the Portfolio's total assets, purchase the
securities of any one issuer (other than cash items and "Government
securities" as defined in the 1940 Act) if immediately after and as a result
of such purchase (a) the value of the holdings of the Portfolio in the
securities of such issuer exceeds 5% of the value of the Portfolio's total
assets, or (b) the Portfolio owns more than 10% of the outstanding voting
securities of any one class of securities of such issuer;
2. Invest more than 25% of the value of the Portfolio's assets in any
particular industry (other than Government securities);
3. Purchase or sell physical commodities other than foreign currencies
unless acquired as a result of ownership of securities (but this restriction
shall not prevent the Portfolio from purchasing or selling options, futures
contracts, caps, floors and other derivative instruments, engaging in swap
transactions or investing in securities or other instruments backed by
physical commodities);
4. Invest directly in real estate or interests in real estate, including
limited partnership interests; however, the Portfolio may own debt or equity
securities issued by companies engaged in those businesses;
5. Act as underwriter of securities issued by others, except to the extent
that it may be deemed an underwriter in connection with the disposition of
portfolio securities of the Portfolio; and
6. Lend any security or make any other loan if, as a result, more than 25%
of its total assets would be lent to other parties (but this limitation does
not apply to purchases of commercial paper, debt securities or to repurchase
agreements).
- 3 -
<PAGE>
Furthermore, the Portfolio has adopted the following non-fundamental
investment restrictions which may be changed by the Board of Directors of the
Fund without shareholder or Contract Owner approval:
(A) The Portfolio may not, as a matter of non-fundamental policy: (i) enter
into any futures contracts or options on futures contracts for purposes other
than bona fide hedging transactions within the meaning of Commodity Futures
Trading Commission regulations if the aggregate initial margin deposits and
premiums required to establish positions in futures contracts and related
options that do not fall within the definition of bona fide hedging
transactions would exceed 5% of the fair market value of the Portfolio's net
assets, after taking into account unrealized profits and losses on such
contracts it has entered into and (ii) enter into any futures contracts or
options on futures contracts if the aggregate amount of the Portfolio's
commitments under outstanding futures contracts positions and options on
futures contracts would exceed the market value of its total assets;
(B) The Portfolio may not mortgage or pledge any securities owned or held by
the Portfolio in amounts that exceed, in the aggregate, 15% of the Portfolio's
net assets, provided that this limitation does not apply to reverse repurchase
agreements or in the case of assets deposited to provide margin or guarantee
positions in options, futures contracts, swaps, forward contracts or other
derivative instruments or segregation of assets in connection with such
transactions;
(C) The Portfolio may not sell securities short, unless it owns or has the
right to obtain securities equivalent in kind and amount to the securities
sold short, and provided that transactions in options, futures contracts,
swaps, forward contracts and other derivative instruments are not deemed to
constitute selling securities short;
(D) The Portfolio may not purchase securities on margin, except that the
Portfolio may obtain such short-term credits as are necessary for the
clearance of transactions, and provided that margin payments and other
deposits made in connection with transactions in options, futures contracts,
swaps, forward contracts, and other derivative instruments shall not be deemed
to constitute purchasing securities on margin;
(E) The Portfolio may borrow money only for temporary or emergency purposes
(not for leveraging or investment) in an amount not exceeding 25% of the value
of the Portfolio's total assets (including the amount borrowed) less
liabilities (other than borrowings). Any borrowings that exceed 25% of the
value of the Portfolio's total assets by reason of a decline in net assets
will be reduced within three business days to the extent necessary to comply
with the 25% limitation. This policy shall not prohibit reverse repurchase
agreements or deposits of assets to provide margin or guarantee positions in
connection with transactions in options, futures contracts, swaps, forward
contracts, or other derivative instruments or the segregation of assets in
connection with such transactions;
(F) The Portfolio may not invest more than 15% of its net assets in illiquid
securities. This does not include securities eligible for resale pursuant to
Rule 144A under the Securities Act of 1933 or any securities for which the
Board of Directors or the Sub-Adviser, as appropriate, has made a
determination of liquidity, as permitted under the 1940 Act;
(G) The Portfolio may not (i) purchase securities of other investment
companies, except in the open market where no commission except the ordinary
broker's commission is paid, or (ii) purchase or retain securities issued by
other open-end investment companies. Restrictions (i) and (ii) do not apply to
money market funds or to securities received as dividends, through offers to
exchange, or as a result of reorganization, consolidation, or merger. If the
Portfolio
- 4 -
<PAGE>
invests in a money market fund, the Investment Adviser will reduce its
advisory fee by the amount of any investment advisory or administrative
service fees paid to the investment manager of the money market fund;
(H) The Portfolio may not invest directly in oil, gas or other mineral
development or exploration programs or leases; however, the Portfolio may own
debt or equity securities of companies engaged in those businesses;
(I) The Portfolio may not invest more than 25% of its net assets at the time
of purchase in the securities of foreign issuers and obligors;
(J) The Portfolio may not invest in companies for the purpose of exercising
control or management; and
(K) The Portfolio may not issue senior securities, except as permitted by
the 1940 Act.
Except with respect to borrowing money, if a percentage limitation set forth
above is complied with at the time of the investment, a subsequent change in
the percentage resulting from any change in value or of the Portfolio's net
assets will not result in a violation of such restriction. State laws and
regulations may impose additional limitations on borrowing, lending and use of
options, futures, and other derivative instruments. In addition, such laws and
regulations may require the Portfolio's investments in foreign securities to
meet additional diversification and other requirements.
REPURCHASE AND REVERSE REPURCHASE AGREEMENTS
In a repurchase agreement, the Portfolio purchases a security and
simultaneously commits to resell that security to the seller at an agreed upon
price on an agreed upon date within a number of days (usually not more than
seven) from the date of purchase. The resale price reflects the purchase price
plus an agreed upon incremental amount that is unrelated to the coupon rate or
maturity of the purchased security. A repurchase agreement involves the
obligation of the seller to pay the agreed upon price, which obligation is in
effect secured by the value (at least equal to the amount of the agreed upon
resale price and marked-to-market daily) of the underlying security. The
Portfolio may engage in a repurchase agreement with respect to any security in
which it is authorized to invest. While it does not presently appear possible
to eliminate all risks from these transactions (particularly the possibility
of a decline in the market value of the underlying securities, as well as
delays and costs to the Portfolio in connection with bankruptcy proceedings),
it is the policy of the Portfolio to limit repurchase agreements to those
parties whose creditworthiness has been reviewed and found satisfactory by the
Sub-Adviser.
In a reverse repurchase agreement, the Portfolio sells a portfolio security
to another party, such as a bank or broker-dealer, in return for cash and
agrees to repurchase the instrument at a particular price and time. While a
reverse repurchase agreement is outstanding, the Portfolio will maintain cash
and appropriate liquid assets in a segregated custodial account to cover its
obligation under the agreement. The Portfolio will enter into reverse
repurchase agreements only with parties that the Sub-Adviser deems
creditworthy.
LENDING OF PORTFOLIO SECURITIES
The Portfolio may lend its portfolio securities subject to the restrictions
stated in this Statement of Additional Information. Under applicable
regulatory requirements (which are subject to change), the following
conditions apply to securities loans: (a) the loan must be continuously
secured by liquid assets maintained on a current basis in an amount at least
equal
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to the market value of the securities loaned; (b) the Portfolio must receive
any dividends or interest paid by the issuer on such securities; (c) the
Portfolio must have the right to call the loan and obtain the securities
loaned at any time upon notice of not more than five business days, including
the right to call the loan to permit voting of the securities; and (d) the
Portfolio must receive either interest from the investment of collateral or a
fixed fee from the borrower. Securities loaned by the Portfolio remain subject
to fluctuations in market value. The Portfolio may pay reasonable finders,
custodian and administrative fees in connection with a loan. Securities
lending, as with other extensions of credit, involves the risk that the
borrower may default. Although securities loans will be fully collateralized
at all times, the Portfolio may experience delays in, or be prevented from,
recovering the collateral. During the period that the Portfolio seeks to
enforce its rights against the borrower, the collateral and the securities
loaned remain subject to fluctuations in market value. The Portfolio does not
have the right to vote securities on loan, but would terminate the loan and
regain the right to vote if it were considered important with respect to the
investment. The Portfolio may also incur expenses in enforcing its rights. If
the Portfolio has sold a loaned security, it may not be able to settle the
sale of the security and may incur potential liability to the buyer of the
security on loan for its costs to cover the purchase.
FOREIGN SECURITIES
Subject to the limitations set forth above, the Portfolio may purchase
certain foreign securities. Investments in foreign securities, particularly
those of non-governmental issuers, involve considerations which are not
ordinarily associated with investing in domestic issuers. These considerations
include changes in currency rates, currency exchange control regulations, the
possibility of expropriation, the unavailability of financial information or
the difficulty of interpreting financial information prepared under foreign
accounting standards, less liquidity and more volatility in foreign securities
markets, the impact of political, social or diplomatic developments, and the
difficulty of assessing economic trends in foreign countries. It is possible
that market quotations for foreign securities will not be readily available.
In such event, these securities shall be valued at fair market value as
determined in good faith by the Sub-Adviser under the supervision of the Board
of Directors. If it should become necessary, the Portfolio could encounter
greater difficulties in invoking legal processes abroad than would be the case
in the United States. Transaction costs with respect to foreign securities may
be higher. The Investment Adviser and the Sub-Adviser will consider these and
other factors before investing in foreign securities. The Portfolio will not
concentrate its investments in any particular foreign country.
To the extent the Portfolio invests directly in foreign securities, the
Portfolio will engage in foreign exchange transactions. The foreign currency
exchange market is subject to little government regulation, and such
transactions generally occur directly between parties rather than on an
exchange or in an organized market. This means that the Portfolio is subject
to the full risk of default by a counterparty in such a transaction. Because
such transactions often take place between different time zones, the Portfolio
may be required to complete a currency exchange transaction at a time outside
of normal business hours in the counterparty's location, making prompt
settlement of such transaction impossible. This exposes the Portfolio to an
increased risk that the counterparty will be unable to settle the transaction.
Although the counterparty in such transactions is often a bank or other
financial institution, currency transactions are generally not covered by
insurance otherwise applicable to such institutions. For a more detailed
explanation regarding the special risks of investing in foreign securities,
see "Foreign Investments and Special Risks" in the Prospectus.
NON-INVESTMENT GRADE DEBT SECURITIES
The Portfolio may, but does not currently invest, or intend to invest, in
debt securities below the four highest grades ("lower grade debt securities")
as determined by Moody's Investors
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Service, Inc. ("Moody's") (Baa) or Standard & Poor's (BBB). The Portfolio does
not currently intend to invest more than 5% of its assets in non-investment
grade securities. Before investing in any lower-grade debt securities, the
Sub-Adviser will determine that such investments meet the Portfolio's
investment objectives and that the lower-grade debt securities' ratings are
supported by an internal credit review, which the Sub-Adviser will conduct in
each such instance. Lower-grade debt securities usually have moderate to poor
protection of principal and interest payments, have certain speculative
characteristics (see Appendix B for a description of the ratings), and involve
greater risk of default or price declines due to changes in the issuer's
creditworthiness than investment-grade debt securities. Because the market for
lower-grade debt securities may be thinner and less active than for investment
grade debt securities, there may be market price volatility for these
securities and limited liquidity in the resale market. Market prices for
lower-grade debt securities may decline significantly in periods of general
economic difficulty or rising interest rates. Through portfolio
diversification and credit analysis, investment risk can be reduced, although
there can be no assurance that losses will not occur.
The quality limitation set forth in the Portfolio's investment policies is
determined immediately after the Portfolio's acquisition of a given security.
Accordingly, any later change in ratings will not be considered when
determining whether an investment complies with the Portfolio's investment
policies.
INVESTMENTS IN FUTURES, OPTIONS AND OTHER DERIVATIVE INSTRUMENTS
Futures Contracts. The Portfolio may enter into contracts for the purchase
or sale for future delivery of fixed-income securities, foreign currencies or
contracts based on financial indices including interest rates or indices of
U.S. Government or foreign government securities or equity or fixed-income
securities ("futures contracts"). U.S. futures contracts are traded on
exchanges that have been designated "contract markets" by the Commodity
Futures Trading Commission ("CFTC") and must be executed through a futures
commission merchant ("FCM"), or brokerage firm, which is a member of the
relevant contract market. Through their clearing corporations, the exchanges
guarantee performance of the contracts as between the clearing members of the
exchange. Since all transactions in the futures market are made through a
member of, and are offset or fulfilled through a clearinghouse associated
with, the exchange on which the contracts are traded, the Portfolio will incur
brokerage fees when it buys or sells futures contracts.
When the Portfolio buys or sells a futures contract, it incurs a contractual
obligation to receive or deliver the underlying instrument (or a cash payment
based on the difference between the underlying instrument's closing price and
the price at which the contract was entered into) at a specified price on a
specified date. Transactions in futures contracts will not be made for
speculation and will not be made other than to seek to hedge against potential
changes in interest or currency exchange rates or the price of a security or a
securities index which might correlate with or otherwise adversely affect
either the value of the Portfolio's securities or the prices of securities
which the Portfolio is considering buying at a later date.
The buyer or seller of a futures contract is not required to deliver or pay
for the underlying instrument unless the contract is held until the delivery
date. However, both the buyer and seller are required to deposit "initial
margin" for the benefit of an FCM when the contract is entered into. Initial
margin deposits are equal to a percentage of the contract's value, as set by
the exchange on which the contract is traded, and may be maintained in cash or
certain high-grade liquid assets. If the value of either party's position
declines, that party will be required to make additional "variation margin"
payments with an FCM to settle the change in value on a daily basis. The party
that has a gain may be entitled to receive all or a portion of this amount.
Initial and variation margin payments are similar to good faith deposits or
performance bonds, unlike margin extended by a securities broker, and initial
and variation margin payments do not
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constitute purchasing securities on margin for purposes of the Portfolio's
investment limitations. In the event of the bankruptcy of an FCM that holds
margin on behalf of the Portfolio, the Portfolio may be entitled to return of
margin owed to the Portfolio only in proportion to the amount received by the
FCM's other customers. The Sub-Adviser will attempt to minimize the risk by
careful monitoring of the creditworthiness of the FCM's with which the
Portfolio does business and by depositing margin payments in a segregated
account with the custodian when practical or otherwise required by law.
Although the Portfolio would hold cash and liquid assets in a segregated
account with a value sufficient to cover the Portfolio's open futures
obligations, the segregated assets would be available to the Portfolio
immediately upon closing out the futures position, while settlement of
securities transactions could take several days. However, because the
Portfolio's cash that may otherwise be invested would be held uninvested or
invested in high-grade liquid assets so long as the futures position remains
open, the Portfolio's return could be diminished due to the opportunity cost
of foregoing other potential investments.
The acquisition or sale of a futures contract may occur, for example, when
the Portfolio holds or is considering purchasing equity securities and seeks
to protect itself from fluctuations in prices without buying or selling those
securities. For example, if prices were expected to decrease, the Portfolio
might sell equity index futures contracts, thereby hoping to offset a
potential decline in the value of equity securities in the Portfolio by a
corresponding increase in the value of the futures contract position held by
the Portfolio and thereby preventing the Portfolio's net asset value from
declining as much as it otherwise would have. The Portfolio also could seek to
protect against potential price declines by selling portfolio securities and
investing in money market instruments. However, since the futures market is
more liquid than the cash market, the use of futures contracts as an
investment technique allows the Portfolio to maintain a defensive position
without having to sell portfolio securities.
Similarly, when prices of equity securities are expected to increase,
futures contracts may be bought to attempt to hedge against the possibility of
having to buy equity securities at higher prices. This technique is sometimes
known as an anticipatory hedge. Since the fluctuations in the value of futures
contracts should be similar to those of equity securities, the Portfolio could
take advantage of the potential rise in the value of equity securities without
buying them until the market has stabilized. At that time, the futures
contracts could be liquidated and the Portfolio could buy equity securities on
the cash market. To the extent the Portfolio enters into futures contracts for
this purpose, the assets in the segregated asset account maintained to cover
the Portfolio's obligations with respect to futures contracts will consist of
high-grade liquid assets from its portfolio in an amount equal to the
difference between the contract price and the aggregate value of the initial
and variation margin payments made by the Portfolio with respect to the
futures contracts.
The ordinary spreads between prices in the cash and futures markets, due to
differences in the nature of those markets, are subject to distortions. First,
all participants in the futures market are subject to initial margin and
variation margin requirements. Rather than meeting additional variation margin
requirements, investors may close out futures contracts through offsetting
transactions which could distort the normal price relationship between the
cash and futures markets. Second, the liquidity of the futures market depends
on participants entering into offsetting transactions rather than making or
taking delivery. To the extent participants decide to make or take delivery,
liquidity in the futures market could be reduced and prices in the futures
market distorted. Third, from the point of view of speculators, the margin
deposit requirements in the futures market are less onerous than margin
requirements in the securities market. Therefore, increased participation by
speculators in the futures market may cause temporary price distortions. Due
to the possibility of the foregoing distortions, a correct forecast of general
price trends by the Sub-Adviser still may not result in a successful use of
futures contracts.
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<PAGE>
Futures contracts entail risks. Although the Sub-Adviser believes that use
of such contracts can benefit the Portfolio, if the Sub-Adviser's investment
judgment is incorrect, the Portfolio's overall performance could be worse than
if the Portfolio had not entered into futures contracts. For example, if the
Portfolio has attempted to hedge against the effects of a possible decrease in
prices of securities held by the Portfolio and prices increase instead, the
Portfolio may lose part or all of the benefit of the increased value of these
securities because of offsetting losses in the Portfolio's futures positions.
In addition, if the Portfolio has insufficient cash, it may have to sell
securities from its portfolio to meet daily variation margin requirements.
Those sales may, but will not necessarily, be at increased prices which
reflect the rising market and may occur at a time when the sales are
disadvantageous to the Portfolio.
The prices of futures contracts depend primarily on the value of their
underlying instruments. Because there are a limited number of types of futures
contracts, it is possible that the standardized futures contracts available to
the Portfolio will not match exactly the Portfolio's current or potential
investments. The Portfolio may buy and sell futures contracts based on
underlying instruments with different characteristics from the securities in
which it typically invests--for example, by hedging investments in portfolio
securities with a futures contract based on a broad index of securities--which
involves a risk that the futures position will not correlate precisely with
the performance of the Portfolio's investments.
Futures prices can also diverge from the prices of their underlying
instruments, even if the underlying instruments correlate with the Portfolio's
investments. Futures prices are affected by such factors as current and
anticipated short-term interest rates, changes in volatility of the underlying
instruments, and the time remaining until expiration of the contract. Those
factors may affect securities prices differently from futures prices.
Imperfect correlations between the Portfolio's investments and its futures
positions may also result from differing levels of demand in the futures
markets and the securities markets, from structural differences in how futures
and securities are traded, and from imposition of daily price fluctuation
limits for futures contracts. The Portfolio may buy or sell futures contracts
with a greater or lesser value than the securities it wishes to hedge or is
considering purchasing in order to attempt to compensate for differences in
historical volatility between the futures contract and the securities,
although this may not be successful in all cases. If price changes in the
Portfolio's futures positions are poorly correlated with its other
investments, its futures positions may fail to produce desired gains or result
in losses that are not offset by the gains in the Portfolio's other
investments.
Because futures contracts are generally settled within a day from the date
they are closed out, compared with a settlement period of seven days for some
types of securities, the futures markets can provide superior liquidity to the
securities markets. Nevertheless, there is no assurance a liquid secondary
market will exist for any particular futures contract at any particular time.
In addition, futures exchanges may establish daily price fluctuation limits
for futures contracts and may halt trading if a contract's price moves upward
or downward more than the limit in a given day. On volatile trading days when
the price fluctuation limit is reached, it may be impossible for the Portfolio
to enter into new positions or close out existing positions. If the secondary
market for a futures contract is not liquid because of price fluctuation
limits or otherwise, the Portfolio may not be able to promptly liquidate
unfavorable positions and potentially be required to continue to hold a
futures position until the delivery date, regardless of changes in its value.
As a result, the Portfolio's access to other assets held to cover its futures
positions also could be impaired.
Although futures contracts by their terms call for the delivery or
acquisition of the underlying commodities or a cash payment based on the value
of the underlying commodities, in most cases the contractual obligation is
offset before the delivery date of the contract by buying, in the case of a
contractual obligation to sell, or selling, in the case of a contractual
obligation to buy, an identical futures contract on a commodities exchange.
Such a transaction cancels the obligation to make or take delivery of the
commodities.
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The Portfolio intends to comply with guidelines of eligibility for exclusion
from the definition of the term "commodity pool operator" with the CFTC and
the National Futures Association, which regulate trading in the futures
markets. Such guidelines presently require that to the extent that the
Portfolio enters into futures contracts or options on a futures position that
are not for bona fide hedging purposes (as defined by the CFTC), the aggregate
initial margin and premiums on these positions (excluding the amount by which
options are "in-the-money") may not exceed 5% of the Portfolio's net assets.
Options on Futures Contracts. The Portfolio may buy and write options on
futures contracts for only hedging purposes. An option on a futures contract
gives the Portfolio the right (but not the obligation) to buy or sell a
futures contract at a specified price on or before a specified date. The
purchase and writing of options on futures contracts is similar in some
respects to the purchase and writing of options on individual securities. See
"Options on Securities" on page 14. Transactions in options on futures
contracts will not be made for speculation and will not be made other than to
attempt to hedge against potential changes in interest rates or currency
exchange rates or the price of a security or a securities index which might
correlate with or otherwise adversely affect either the value of the
Portfolio's securities or the prices of securities which the Portfolio is
considering buying at a later date.
The purchase of a call option on a futures contract may or may not be less
risky than ownership of the futures contract or the underlying instrument,
depending on the pricing of the option compared to either the price of the
futures contract upon which it is based or the price of the underlying
instrument. As with the purchase of futures contracts, when the Portfolio is
not fully invested it may buy a call option on a futures contract to attempt
to hedge against a market advance.
The writing of a call option on a futures contract may constitute a partial
hedge against declining prices of the security or foreign currency which is
deliverable under, or of the index comprising, the futures contract. If the
futures price at the expiration of the option is below the exercise price, the
Portfolio will retain the full amount of the option premium which provides a
partial hedge against any decline that may have occurred in the Portfolio's
holdings. The writing of a put option on a futures contract may constitute a
partial hedge against increasing prices of the security or foreign currency
which is deliverable under, or of the index comprising, the futures contract.
If the futures price at expiration of the option is higher than the exercise
price, the Portfolio will retain the full amount of the option premium which
provides a partial hedge against any increase in the price of securities which
the Portfolio is considering buying. If a call or put option the Portfolio has
written is exercised, the Portfolio will incur loss which will be reduced by
the amount of the premium it received. Depending on the degree of correlation
between change in the value of its portfolio securities and changes in the
value of the futures positions, the Portfolio's losses from existing options
on futures may to some extent be reduced or increased by changes in the value
of portfolio securities.
The purchase of a put option on a futures contract is similar in some
respect to the purchase of protective put options on portfolio securities. For
example, the Portfolio may buy a put option on a futures contract to attempt
to hedge the Portfolio's securities against the risk of falling prices.
The amount of risk the Portfolio assumes when it buys an option on a futures
contract is the premium paid for the option plus related transaction costs. In
addition to the correlation risks discussed above, the purchase of an option
also entails the risk that changes in the value of the underlying futures
contract will not be fully reflected in the value of the options bought.
Forward Contracts. The Portfolio may enter into forward foreign currency
exchange contracts ("forward currency contracts") to attempt to minimize the
risk to the Portfolio from adverse changes in the relationship between the
U.S. dollar and other currencies. A forward
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currency contract is an obligation to buy or sell an amount of a specified
currency for an agreed price (which may be in U.S. dollars or a foreign
currency) at a future date which is individually negotiated between currency
traders and their customers. The Portfolio may invest in forward currency
contracts with stated contract values of up to the value of the Portfolio's
assets.
The Portfolio may exchange foreign currencies for U.S. dollars and for other
foreign currencies in the normal course of business and may buy and sell
currencies through forward currency contracts in order to fix a price for
securities it has agreed to buy or sell. The Portfolio may enter into a
forward currency contract, for example, when it enters into a contract to buy
or sell a security denominated in a foreign currency in order to "lock in" the
U.S. dollar price of the security ("transaction hedge").
Additionally, when the Sub-Adviser believes that a foreign currency in which
portfolio securities are denominated may suffer a substantial decline against
the U.S. dollar, the Portfolio may enter into a forward currency contract to
sell an amount of that foreign currency (or a proxy currency whose performance
is expected to replicate the performance of that currency) for U.S. dollars
approximating the value of some or all of the portfolio securities denominated
in that currency (not exceeding the value of the Portfolio's assets
denominated in that currency) or by participating in options or futures
contracts with respect to the currency, or, when the Sub-Adviser believes that
the U.S. dollar may suffer a substantial decline against a foreign currency,
the Portfolio may enter into a forward currency contract to buy that foreign
currency for a fixed U.S. dollar amount ("position hedge"). This type of hedge
seeks to minimize the effect of currency appreciation as well as depreciation,
but does not protect against a decline in the security's value relative to
other securities denominated in the foreign currency.
The Portfolio also may enter into a forward currency contract with respect
to a currency where the Portfolio is considering the purchase of investments
denominated in that currency but has not yet done so ("anticipatory hedge").
In any of the above circumstances the Portfolio may, alternatively, enter
into a forward currency contract with respect to a different foreign currency
when the Sub-Adviser believes that the U.S. dollar value of that currency will
correlate with the U.S. dollar value of the currency in which portfolio
securities of, or being considered for purchase by, the Portfolio are
denominated ("cross-hedge"). For example, if the Sub-Adviser believes that a
particular foreign currency may decline relative to the U.S. dollar, the
Portfolio could enter into a contract to sell that currency or a proxy
currency (up to the value of the Portfolio's assets denominated in that
currency) in exchange for another currency that the Sub-Adviser expects to
remain stable or to appreciate relative to the U.S. dollar. Shifting the
Portfolio's currency exposure from one foreign currency to another removes the
Portfolio's opportunity to profit from increases in the value of the original
currency and involves a risk of increased losses to the Portfolio if the Sub-
Adviser's projection of future exchange rates is inaccurate.
The Portfolio also may enter into forward contracts to buy or sell at a
later date instruments in which the Portfolio may invest directly or on
financial indices based on those instruments. The market for those types of
forward contracts is developing and it is not currently possible to identify
instruments on which forward contracts might be created in the future.
Forward contracts are currently considered illiquid. Accordingly, the Fund's
custodian will place cash or high-grade liquid assets in a segregated account
of the Portfolio having a value equal to the aggregate amount of the
Portfolio's commitments under forward contracts entered into with respect to
position hedges and cross-hedges. If the value of the securities placed in the
segregated account declines, additional cash or high-grade liquid assets will
be placed in the account on a daily basis so that the value of the account
will be equal to the amount of the Portfolio's
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commitments with respect to such contracts. As an alternative to maintaining
all or part of the segregated account, the Portfolio may buy call options
permitting the Portfolio to buy the amount of foreign currency subject to the
hedging transaction by a forward sale contract or the Portfolio may buy put
options permitting the Portfolio to sell the amount of foreign currency
subject to a forward buy contract.
While forward contracts are not currently regulated by the CFTC, the CFTC
may in the future assert authority to regulate forward contracts. In such
event the Portfolio's ability to utilize forward contracts in the manner set
forth in the Prospectus may be restricted. Forward contracts will reduce the
potential gain from a positive change in the relationship between the U.S.
dollar and foreign currencies. Unforeseen changes in currency prices may
result in poorer overall performance for the Portfolio than if it had not
entered into such contracts. The use of foreign currency forward contracts
will not eliminate fluctuations in the underlying U.S. dollar equivalent value
of the proceeds of or rates of return on the Portfolio's foreign currency
denominated portfolio securities.
The matching of the increase in value of a forward contract and the decline
in the U.S. dollar equivalent value of the foreign currency denominated asset
that is the subject of the hedging transaction generally will not be precise.
In addition, the Portfolio may not always be able to enter into forward
contracts at attractive prices and accordingly may be limited in its ability
to use these contracts in seeking to hedge the Portfolio's assets.
Also, with regard to the Portfolio's use of cross-hedging transactions,
there can be no assurance that historical correlations between the movement of
certain foreign currencies relative to the U.S. dollar will continue. Thus, at
any time poor correlation may exist between movements in the exchange rates of
the foreign currencies underlying the Portfolio's cross-hedges and the
movements in the exchange rates of the foreign currencies in which the
Portfolio's assets that are subject of the cross-hedging transaction are
denominated.
Options on Foreign Currencies. The Portfolio may buy put and call options
and may write covered put and call options on foreign currencies for hedging
purposes in a manner similar to that in which futures contracts or forward
contracts on foreign currencies may be utilized. For example, a decline in the
U.S. dollar value of a foreign currency in which portfolio securities are
denominated will reduce the U.S. dollar value of such securities, even if
their value in the foreign currency remains constant. In order to protect
against such diminutions in the value of portfolio securities, the Portfolio
may buy put options on the foreign currency. If the value of the currency
declines, the Portfolio will have the right to sell such currency for a fixed
amount in U.S. dollars and will thereby offset, in whole or in part, the
adverse effect on its portfolio which otherwise would have resulted.
Conversely, when a rise in the U.S. dollar value of a currency in which
securities to be acquired are denominated is projected, thereby increasing the
cost of such securities, the Portfolio may buy call options thereon. The
purchase of such options could offset, at least partially, the effects of the
adverse movements in exchange rates. The purchase of an option on a foreign
currency may constitute an effective hedge against fluctuations in exchange
rates, although, in the event of exchange rate movements adverse to the
Portfolio's option position, the Portfolio could sustain losses on
transactions in foreign currency options which would require that the
Portfolio lose a portion or all of the benefits of advantageous changes in
those rates. In addition, in the case of other types of options, the benefit
to the Portfolio from purchases of foreign currency options will be reduced by
the amount of the premium and related transaction costs.
The Portfolio may write options on foreign currencies for the same types of
hedging purposes. For example, in attempting to hedge against a potential
decline in the U.S. dollar value of foreign currency denominated securities
due to adverse fluctuations in exchange rates, the Portfolio could,
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instead of purchasing a put option, write a call option on the relevant
currency. If the expected decline occurs, the option will most likely not be
exercised and the diminution in value of portfolio securities will be offset
by the amount of the premium received.
Similarly, instead of purchasing a call option to attempt to hedge against a
potential increase in the U.S. dollar cost of securities to be acquired, the
Portfolio could write a put option on the relevant currency which, if rates
move in the manner projected, will expire unexercised and allow the Portfolio
to hedge the increased cost up to the amount of the premium. As in the case of
other types of options, however, the writing of a foreign currency option will
constitute only a partial hedge up to the amount of the premium received, and
only if exchange rates move in the expected direction. If that does not occur,
the option may be exercised and the Portfolio would be required to buy or sell
the underlying currency at a loss which may not be offset by the amount of the
premium. Through the writing of options on foreign currencies, the Portfolio
also may lose all or a portion of the benefits which might otherwise have been
obtained from favorable movements in exchange rates.
The Portfolio may write covered call options on foreign currencies. A call
option written on a foreign currency by the Portfolio is "covered" if the
Portfolio owns the underlying foreign currency covered by the call or has an
absolute and immediate right to acquire that foreign currency without
additional cash consideration (or for additional cash consideration held in a
segregated account by its custodian) upon conversion or exchange of other
foreign currency held in its portfolio. A call option is also covered if the
Portfolio has a call on the same foreign currency and in the same principal
amount as the call written if the exercise price of the call held (i) is equal
to or less than the exercise price of the call written or (ii) is greater than
the exercise price of the call written, and if the difference is maintained by
the Portfolio in cash or high-grade liquid assets in a segregated account with
the Fund's custodian.
The Portfolio may also write call options on foreign currencies for cross-
hedging purposes that may not be deemed to be covered. A call option on a
foreign currency is for cross-hedging purposes if it is not covered but is
designed to provide a hedge against a decline due to an adverse change in the
exchange rate in the U.S. dollar value of a security which the Portfolio owns
or has the right to acquire and which is denominated in the currency
underlying the option. In such circumstances, the Portfolio collateralizes the
option by maintaining, in a segregated account with the Fund's custodian, cash
or high-grade liquid assets in an amount not less than the value of the
underlying foreign currency in U.S. dollars marked-to-market daily.
The Portfolio may buy or write options in privately negotiated transactions
on the types of securities and indices based on the types of securities in
which the Portfolio is permitted to invest directly. The Portfolio will effect
such transactions only with investment dealers and other financial
institutions (such as commercial banks or savings and loan institutions)
deemed creditworthy, and only pursuant to procedures adopted by the Sub-
Adviser for monitoring the creditworthiness of those entities. To the extent
that an option bought or written by the Portfolio in a negotiated transaction
is illiquid, the value of an option bought or the amount of the Portfolio's
obligations under an option written by the Portfolio, as the case may be, will
be subject to the Portfolio's limitation on illiquid investments. In the case
of illiquid options, it may not be possible for the Portfolio to effect an
offsetting transaction at the time when the Sub-Adviser believes it would be
advantageous for the Portfolio to do so.
Options on Securities. In an effort to reduce fluctuations in net asset
value, the Portfolio may write covered put and call options and may buy put
and call options and warrants on securities that are traded on United States
and foreign securities exchanges and over-the-counter. The Portfolio also may
write call options that are not covered for cross-hedging purposes. The
Portfolio may write and buy options on the same types of securities that the
Portfolio could buy directly
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and may buy options on financial indices as described above with respect to
futures contracts. There are no specific limitations on the Portfolio's
writing and buying options on securities.
A put option gives the holder the right, upon payment of a premium, to
deliver a specified amount of a security to the writer of the option on or
before a fixed date at a predetermined price. A call option gives the holder
the right, upon payment of a premium, to call upon the writer to deliver a
specified amount of a security on or before a fixed date at a predetermined
price.
A put option written by the Portfolio is "covered" if the Portfolio (i)
maintains cash not available for investment or high-grade liquid assets with a
value equal to the exercise price in a segregated account with its custodian
or (ii) holds a put on the same security and in the same principal amount as
the put written and the exercise price of the put held is equal to or greater
than the exercise price of the put written. The premium paid by the buyer of
an option will reflect, among other things, the relationship of the exercise
price to the market price and the volatility of the underlying security, the
remaining term of the option, supply and demand and interest rates.
A call option written by the Portfolio is "covered" if the Portfolio owns
the underlying security covered by the call or has an absolute and immediate
right to acquire that security without additional cash consideration (or has
segregated additional cash consideration with its custodian) upon conversion
or exchange of other securities held in its portfolio. A call option is also
deemed to be covered if the Portfolio holds a call on the same security and in
the same principal amount as the call written and the exercise price of the
call held (i) is equal to or less than the exercise price of the call written
or (ii) is greater than the exercise price of the call written if the
difference is maintained by the Portfolio in cash and high-grade liquid assets
in a segregated account with its custodian.
The Portfolio collateralizes its obligation under a written call option for
cross-hedging purposes by maintaining in a segregated account with its
custodian cash or high-grade liquid assets in an amount not less than the
market value of the underlying security, marked-to-market daily. The Portfolio
would write a call option for cross-hedging purposes, instead of writing a
covered call option, when the premium to be received from the cross-hedge
transaction would exceed that which would be received from writing a covered
call option and the Sub-Adviser believes that writing the option would achieve
the desired hedge.
If a put or call option written by the Portfolio was exercised, the
Portfolio would be obligated to buy or sell the underlying security at the
exercise price. Writing a put option involves the risk of a decrease in the
market value of the underlying security, in which case the option could be
exercised and the underlying security would then be sold by the option holder
to the Portfolio at a higher price than its current market value. Writing a
call option involves the risk of an increase in the market value of the
underlying security, in which case the option could be exercised and the
underlying security would then be sold by the Portfolio to the option holder
at a lower price than its current market value. Those risks could be reduced
by entering into an offsetting transaction. The Portfolio retains the premium
received from writing a put or call option whether or not the option is
exercised.
The writer of an option may have no control when the underlying security
must be sold, in the case of a call option, or bought, in the case of a put
option, since with regard to certain options, the writer may be assigned an
exercise notice at any time prior to the termination of the obligation.
Whether or not an option expires unexercised, the writer retains the amount of
the premium. This amount, of course, may, in the case of a covered call
option, be offset by a decline in the market value of the underlying security
during the option period. If a call option is exercised, the writer
experiences a profit or loss from the sale of the underlying security. If a
put option is exercised, the writer must fulfill the obligation to buy the
underlying security.
- 14 -
<PAGE>
The writer of an option that wishes to terminate its obligation may effect a
"closing purchase transaction". This is accomplished by buying an option of
the same series as the option previously written. The effect of the purchase
is that the writer's position will be canceled by the clearing corporation.
However, a writer may not effect a closing purchase transaction after being
notified of the exercise of an option. Likewise, an investor who is the holder
of an option may liquidate its position by effecting a "closing sale
transaction". This is accomplished by selling an option of the same series as
the option previously bought. There is no guarantee that either a closing
purchase or a closing sale transaction can be effected.
Effecting a closing transaction in the case of a written call option will
permit the Portfolio to write another call option on the underlying security
with either a different exercise price or expiration date or both or, in the
case of a written put option, will permit the Portfolio to write another put
option to the extent that the exercise price thereof is secured by deposited
high-grade liquid assets. Also, effecting a closing transaction will permit
the cash or proceeds from the concurrent sale of any securities subject to the
option to be used for other portfolio investments. If the Portfolio desires to
sell a particular security on which the Portfolio has written a call option,
the Portfolio will effect a closing transaction prior to or concurrent with
the sale of the security.
The Portfolio may realize a profit from a closing transaction if the price
of the purchase transaction is less than the premium received from writing the
option or the price received from a sale transaction is more than the premium
paid to buy the option; the Portfolio may realize a loss from a closing
transaction if the price of the purchase transaction is more than the premium
received from writing the option or the price received from a sale transaction
is less than the premium paid to buy the option. Because increases in the
market price of a call option will generally reflect increases in the market
price of the underlying security, any loss resulting from the repurchase of a
call option is likely to be offset in whole or in part by appreciation of the
underlying security owned by the Portfolio.
An option position may be closed out only where there exists a secondary
market for an option of the same series. If a secondary market does not exist,
it might not be possible to effect closing transactions in particular options
with the result that the Portfolio would have to exercise the options in order
to realize any profit. If the Portfolio is unable to effect a closing purchase
transaction in a secondary market, it will not be able to sell the underlying
security until the option expires or the Portfolio delivers the underlying
security upon exercise. Reasons for the absence of a liquid secondary market
may include the following: (i) there may be insufficient trading interest in
certain options, (ii) restrictions may be imposed by a national securities
exchange on which the option is traded ("Exchange") on opening or closing
transactions or both, (iii) trading halts, suspensions or other restrictions
may be imposed with respect to particular classes or series of options or
underlying securities, (iv) unusual or unforeseen circumstances may interrupt
normal operations on an Exchange, (v) the facilities of an Exchange or the
Options Clearing Corporation ("OCC") may not at all times be adequate to
handle current trading volume, or (vi) one or more Exchanges could, for
economic or other reasons, decide or be compelled at some future date to
discontinue the trading of options (or a particular class or series of
options), in which event the secondary market on that Exchange (or in that
class or series of options) would cease to exist, although outstanding options
on that Exchange that had been issued by the OCC as a result of trades on that
Exchange would continue to be exercisable in accordance with their terms.
The Portfolio may write options in connection with buy-and-write
transactions; that is, the Portfolio may buy a security and then write a call
option against that security. The exercise price of the call the Portfolio
determines to write will depend upon the expected price movement of the
underlying security. The exercise price of a call option may be below ("in-
the-money"), equal to
- 15 -
<PAGE>
("at-the-money") or above ("out-of-the-money") the current value of the
underlying security at the time the option is written. Buy-and-write
transactions using in-the-money call options may be used when it is expected
that the price of the underlying security will remain flat or decline
moderately during the option period. Buy-and-write transactions using at-the-
money call options may be used when it is expected that the price of the
underlying security will remain fixed or advance moderately during the option
period. Buy-and-write transactions using out-of-the-money call options may be
used when it is expected that the premiums received from writing the call
option plus the appreciation in the market price of the underlying security up
to the exercise price will be greater than the appreciation in the price of
the underlying security alone. If the call options are exercised in such
transactions, the Portfolio's maximum gain will be the premium received by it
for writing the option, adjusted upwards or downwards by the difference
between the Portfolio's purchase price of the security and the exercise price.
If the options are not exercised and the price of the underlying security
declines, the amount of such decline will be offset by the amount of premium
received.
The writing of covered put options is similar in terms of risk and return
characteristics to buy-and-write transactions. If the market price of the
underlying security rises or otherwise is above the exercise price, the put
option will expire worthless and the Portfolio's gain will be limited to the
premium received. If the market price of the underlying security declines or
otherwise is below the exercise price, the Portfolio may elect to close the
position or take delivery of the security at the exercise price and the
Portfolio's return will be the premium received from the put option minus the
amount by which the market price of the security is below the exercise price.
The Portfolio may buy put options to attempt to hedge against a decline in
the value of its securities. By using put options in this way, the Portfolio
will reduce any profit it might otherwise have realized in the underlying
security by the amount of the premium paid for the put option and by
transaction costs.
The Portfolio may buy call options to attempt to hedge against an increase
in the price of securities that the Portfolio may buy in the future. The
premium paid for the call option plus any transaction costs will reduce the
benefit, if any, realized by the Portfolio upon exercise of the option, and,
unless the price of the underlying security rises sufficiently, the option may
expire worthless to the Portfolio.
In purchasing an option, the Portfolio would be in a position to realize a
gain if, during the option period, the price of the underlying security
increased (in the case of a call) or decreased (in the case of a put) by an
amount in excess of the premium paid and would realize a loss if the price of
the underlying security did not increase (in the case of a call) or decrease
(in the case of a put) during the period by more than the amount of the
premium. If a put or call option bought by the Portfolio were permitted to
expire without being sold or exercised, the Portfolio would lose the amount of
the premium.
Although they entitle the holder to buy equity securities, warrants on and
options to purchase equity securities do not entitle the holder to dividends
or voting rights with respect to the underlying securities, nor do they
represent any rights in the assets of the issuer of those securities.
Interest Rate Swaps and Swap-Related Products. In order to attempt to
protect the value of the Portfolio's investments from interest rate or
currency exchange rate fluctuations, the Portfolio may enter into interest
rate swaps, and may buy or sell interest rate caps and floors. The Portfolio
expects to enter into these transactions primarily to attempt to preserve a
return or spread on a particular investment or portion of its portfolio. The
Portfolio also may enter into these
- 16 -
<PAGE>
transactions to attempt to protect against any increase in the price of
securities the Portfolio may consider buying at a later date. The Portfolio
does not intend to use these transactions as a speculative investment.
Interest rate swaps involve the exchange by the Portfolio with another party
of their respective commitments to pay or receive interest, e.g., an exchange
of floating rate payments for fixed rate payments. The exchange commitments
can involve payments to be made in the same currency or in different
currencies. The purchase of an interest rate cap entitles the purchaser, to
the extent that a specified index exceeds a predetermined interest rate, to
receive payments of interest on a contractually based principal amount from
the party selling the interest rate cap. The purchase of an interest rate
floor entitles the purchaser, to the extent that a specified index falls below
a predetermined interest rate, to receive payments of interest on a
contractually based principal amount from the party selling the interest rate
floor.
Swap and swap-related products are specialized over-the-counter instruments
and their use involves risks specific to the markets in which they are entered
into. The Portfolio will usually enter into interest rate swaps on a net
basis, i.e., the two payment streams are netted out, with the Portfolio
receiving or paying, as the case may be, only the net amount of the two
payments. The net amount of the excess, if any, of the Portfolio's obligations
over its entitlements with respect to each interest rate swap will be
calculated on a daily basis and an amount of cash or high-grade liquid assets
having an aggregate net asset value at least equal to the accrued excess will
be maintained in a segregated account by the Fund's custodian. If the
Portfolio enters into an interest rate swap on other than a net basis, the
Portfolio would maintain a segregated account in the full amount accrued on a
daily basis of the Portfolio's obligations with respect to the swap. The
Portfolio will not enter into any interest rate swap, cap or floor transaction
unless the unsecured senior debt or the claims-paying ability of the other
party thereto is rated in one of the three highest rating categories of at
least one nationally recognized statistical rating organization at the time of
entering into such transaction. The Sub-Adviser will monitor the
creditworthiness of all counterparties on an ongoing basis. If there is a
default by the other party to such a transaction, the Portfolio will have
contractual remedies pursuant to the agreements related to the transaction.
The swap market has grown substantially in recent years with a large number
of banks and investment banking firms acting both as principals and as agents
utilizing standardized swap documentation. The Sub-Adviser has determined
that, as a result, the swap market has become relatively liquid. Caps and
floors are more recent innovations for which standardized documentation has
not yet been developed and, accordingly, they are less liquid than swaps. To
the extent the Portfolio sells (i.e., writes) caps and floors, it will
maintain in a segregated account cash or high-grade liquid assets having an
aggregate net asset value at least equal to the full amount, accrued on a
daily basis, of the Portfolio's obligations with respect to any caps or
floors.
There is no limit on the amount of interest rate swap transactions that may
be entered into by the Portfolio; although the Portfolio does not presently
intend to engage in such transactions in excess of 5% of its total assets.
These transactions may in some instances involve the delivery of securities or
other underlying assets by the Portfolio or its counterparty to collateralize
obligations under the swap. Under the documentation currently used in those
markets, the risk of loss with respect to interest rate swaps is limited to
the net amount of the interest payments that the Portfolio is contractually
obligated to make. If the other party to an interest rate swap that is not
collateralized defaults, the Portfolio would risk the loss of the net amount
of the payments that the Portfolio contractually is entitled to receive. The
Portfolio may buy and sell (i.e., write) caps and floors without limitation,
subject to the segregated account requirement described above.
In addition to the instruments, strategies and risks described in this
Statement of Additional Information and in the Prospectus, there may be
additional opportunities in connection with
- 17 -
<PAGE>
options, futures contracts, forward currency contracts and other hedging
techniques, that become available as the Sub-Adviser develops new techniques,
as regulatory authorities broaden the range of permitted transactions and as
new instruments and techniques are developed. The Sub-Adviser may use these
opportunities to the extent they are consistent with the Portfolio's
respective investment objectives and are permitted by the Portfolio's
respective investment limitations and applicable regulatory requirements.
Special Investment Considerations and Risks. The successful use of the
investment practices described above with respect to futures contracts,
options on futures contracts, forward contracts, options on securities and on
foreign currencies, and swaps and swap-related products draws upon skills and
experience which are different from those needed to select the other
instruments in which the Portfolio invests. Should interest or exchange rates
or the prices of securities or financial indices move in an unexpected manner,
the Portfolio may not achieve the desired benefits of futures, options, swaps
and forwards or may realize losses and thus be in a worse position than if
such strategies had not been used. Unlike many exchange-traded futures
contracts and options on futures contracts, there are no daily price
fluctuation limits with respect to options on currencies, forward contracts
and other negotiated or over-the-counter instruments, and adverse market
movements could therefore continue to an unlimited extent over a period of
time. In addition, the correlation between movements in the price of the
securities and currencies hedged or used for cover will not be perfect and
could produce unanticipated losses.
The Portfolio's ability to dispose of its positions in the foregoing
instruments will depend on the availability of liquid markets in the
instruments. Markets in a number of the instruments are relatively new and
still developing, and it is impossible to predict the amount of trading
interest that may exist in those instruments in the future. Particular risks
exist with respect to the use of each of the foregoing instruments and could
result in such adverse consequences to the Portfolio as the possible loss of
the entire premium paid for an option bought by the Portfolio, the inability
of the Portfolio, as the writer of a covered call option, to benefit from the
appreciation of the underlying securities above the exercise price of the
option and the possible need to defer closing out positions in certain
instruments to avoid adverse tax consequences. As a result, no assurance can
be given that the Portfolio will be able to use those instruments effectively
for the purposes set forth above.
In connection with certain of its hedging transactions, the Portfolio must
place assets in a segregated account with the Fund's Custodian bank to ensure
that the Portfolio will be able to meet its obligations under these
instruments. Assets held in a segregated account generally may not be disposed
of during the period the Portfolio maintains the positions giving rise to the
segregation requirement. Segregation of a large percentage of the Portfolio's
assets could impede implementation of the Portfolio's investment policies or
the Portfolio's ability to meet redemption requests or other current
obligations.
Additional Risks of Options on Foreign Currencies, Forward Contracts and
Foreign Instruments. Unlike transactions entered into by the Portfolio in
futures contracts, options on foreign currencies and forward contracts are not
traded on contract markets regulated by the CFTC or (with the exception of
certain foreign currency options) by the SEC. To the contrary, such
instruments are traded through financial institutions acting as market-makers,
although foreign currency options are also traded on certain national
securities exchanges, such as the Philadelphia Stock Exchange and the Chicago
Board Options Exchange, subject to SEC regulation. Similarly, options on
currencies may be traded over-the-counter. In an over-the-counter trading
environment, many of the protections afforded to exchange participants will
not be available. For example, there are no daily price fluctuation limits,
and adverse market movements could therefore continue to an unlimited extent
over a period of time. Although the
- 18 -
<PAGE>
buyer of an option cannot lose more than the amount of the premium plus
related transaction costs, this entire amount could be lost. Moreover, an
option writer and a buyer or seller of futures or forward contracts could lose
amounts substantially in excess of any premium received or initial margin or
collateral posted due to the potential additional margin and collateral
requirements associated with such positions.
Options on foreign currencies traded on national securities exchanges are
within the jurisdiction of the SEC, as are other securities traded on such
exchanges. As a result, many of the protections provided to traders on
organized exchanges are available with respect to such transactions. In
particular, all foreign currency option positions entered into on a national
securities exchange are cleared and guaranteed by the OCC, thereby reducing
the risk of counterparty default. Further, a liquid secondary market in
options traded on a national securities exchange may be more readily available
than in the over-the-counter market, potentially permitting the Portfolio to
liquidate open positions at a profit prior to exercise or expiration, or to
limit losses in the event of adverse market movements.
The purchase and sale of exchange-traded foreign currency options, however,
is subject to the risks of the availability of a liquid secondary market
described above, as well as the risks regarding adverse market movements,
margining of options written, the nature of the foreign currency market,
possible intervention by governmental authorities and the effects of other
political and economic events. In addition, exchange-traded options on foreign
currencies involve certain risks not presented by the over-the-counter market.
For example, exercise and settlement of such options must be made exclusively
through the OCC, which has established banking relationships in applicable
foreign countries for this purpose. As a result, the OCC may, if it determines
that foreign government restrictions or taxes would prevent the orderly
settlement of foreign currency option exercises, or would result in undue
burdens on the OCC or its clearing member, impose special procedures on
exercise and settlement.
In addition, options on U.S. Government securities, futures contracts,
options on futures contracts, forward contracts and options on foreign
currencies may be traded on foreign exchanges and over-the-counter in foreign
countries. Such transactions are subject to the risk of governmental actions
affecting trading in or the prices of foreign currencies or securities. The
value of such positions also could be adversely affected by (i) other complex
foreign political and economic factors, (ii) lesser availability than in the
United States of data on which to make trading decisions, (iii) delays in the
Portfolio's ability to act upon economic events occurring in foreign markets
during nonbusiness hours in the United States, (iv) the imposition of
different exercise and settlement terms and procedures and margin requirements
than in the United States, and (v) low trading volume.
MANAGEMENT OF THE FUND
DIRECTORS AND OFFICERS
The directors and executive officers of the Fund and their principal
occupations for at least the last five years are set forth below:
<TABLE>
<CAPTION>
NAME, RELATIONSHIP WITH PRINCIPAL OCCUPATION
THE FUND, AND ADDRESS (1) PAST FIVE YEARS
- ------------------------- --------------------
<S> <C>
PETER R. BROWN (68) Chairman of the Board, Peter Brown Construction Company
Director (construction contractors and engineers), Largo,
1475 South Belcher Road Florida (1963 - present); Trustee of IDEX Series Fund;
Largo, Florida 33771 former Trustee of IDEX Fund, IDEX II Series Fund and
IDEX Fund 3; Rear Admiral (Ret.) U.S. Navy Reserve,
Civil Engineer Corps.
</TABLE>
- 19 -
<PAGE>
<TABLE>
<CAPTION>
NAME, RELATIONSHIP WITH PRINCIPAL OCCUPATION
THE FUND, AND ADDRESS (1) PAST FIVE YEARS
- ------------------------- --------------------
<S> <C>
CHARLES C. HARRIS (66) Retired (1988 - present); Senior Vice President,
Director Treasurer (1966 - 1988), Western Reserve Life Assurance
35 Winston Drive Co. of Ohio; Trustee of IDEX Series Fund; former
Clearwater, Florida Trustee of IDEX Fund; IDEX II Series Fund and IDEX Fund
34616 3; Vice President, Treasurer (1968 - 1988), Director
(1968 - 1987), Pioneer Western Corporation; Vice
President of the Fund (1986 to December, 1990).
RUSSELL A. KIMBALL, Jr. General Manager, Sheraton Sand Key Resort (resort
(52) hotel), Clearwater, Florida (1975 - present).
Director
1160 Gulf Boulevard
Clearwater Beach,
Florida 34630
JOHN R. KENNEY (59) Chairman of the Board of Directors (1987 - present),
Chairman of the Board of Chief Executive Officer (1982 - present), President
Directors and President (1978 - 1987 and December, 1992 - present), Director
(2) (1978 - present), Western Reserve Life Assurance Co. of
Ohio; Chairman of the Board of Directors (September
1996 - present), WRL Investment Management, Inc.
(investment adviser), Largo, Florida; Chairman of the
Board of Directors (September, 1996 - present), WRL
Investment Services, Inc., Largo, Florida; Director,
AEGON Asset Management Services, Inc. (February, 1997 -
present) Largo, Florida; Chairman of the Board of
Directors and Chief Executive Officer (1988 to
February, 1991), President (1988 - 1989), Director
(1976 to February, 1991), Executive Vice President
(1972 - 1988), Pioneer Western Corporation (financial
services), Largo, Florida; President and Director
(1985 - September, 1990) and Director (December, 1990
to present), Idex Management, Inc. (investment
adviser), Largo, Florida; Trustee (1987 - September,
1996), Chairman (December, 1989 to September, 1990 and
November, 1990 to September, 1996) and President and
Chief Executive Officer (November, 1986 to September,
1990), IDEX Fund, IDEX II Series Fund and IDEX Fund 3;
Trustee and Chairman (September, 1996 - present) of
IDEX Series Fund, (investment companies), all of Largo,
Florida.
G. JOHN HURLEY (48) Executive Vice President (June 1993 - present), Chief
Director and Executive Operating Officer (March, 1994 - January, 1997) Western
Vice President (2) Reserve Life Assurance Co. of Ohio; Director
(September, 1996 - present), WRL Investment Management,
Inc. (investment adviser), Largo, Florida; Director
(September, 1996 - present), WRL Investment Services,
Inc., Largo, Florida; Director, President and Chief
Executive Officer, AEGON Asset Management Services,
Inc. (February, 1997 - present), Largo, Florida;
President and Chief Executive Officer (September,
1990 - September, 1996), Trustee (June, 1990 -
September, 1996) and Executive Vice President (June,
1988 -September, 1990) of IDEX Fund, IDEX II Series
Fund and IDEX Fund 3 (investment companies); Trustee,
President and Chief Financial Officer (September,
1996 - present) of IDEX Series Fund; President, Chief
Executive Officer and Director of InterSecurities, Inc.
(May, 1988 - present); Assistant Vice
</TABLE>
- 20 -
<PAGE>
<TABLE>
<CAPTION>
NAME, RELATIONSHIP WITH PRINCIPAL OCCUPATION
THE FUND, AND ADDRESS (1) PAST FIVE YEARS
- ------------------------- --------------------
<S> <C>
President of AEGON USA Managed Portfolios, Inc.
(September, 1991 - August, 1992); Vice President of
Pioneer Western Corporation (May, 1988 -February, 1991)
(financial services), all of Largo, Florida.
ALLAN J. HAMILTON (40) Vice President and Controller (1987 - present),
Treasurer, Principal Fi- Treasurer (February, 1997 - present), Assistant Vice
nancial Officer (2) President and Assistant Controller (1983 - 1987),
Western Reserve Life Assurance Co. of Ohio; Vice
President and Controller (1988 - February, 1991),
Pioneer Western Corporation (financial services), all
of Largo, Florida.
ALAN M. YAEGER (50) Executive Vice President (June, 1993 - present), Chief
Executive Vice President Financial Officer (December, 1995 - present), Senior
(2) Vice President (1981-June, 1993) and Actuary (1972-
present), Western Reserve Life Assurance Co. of Ohio;
Director (September, 1996 - present), WRL Investment
Management, Inc., (investment adviser) Largo, Florida;
Director (September, 1996 - present) WRL Investment
Services, Inc., Largo, Florida.
REBECCA A. FERRELL (36) Vice President and Associate General Counsel (March,
Secretary, Vice Presi- 1997 - present) Assistant Vice President and Counsel
dent, and Counsel (2) (June, 1995 - March, 1997), Attorney (August, 1993 -
June, 1995), Western Reserve Life Assurance Co. of
Ohio; Secretary, Vice President and Counsel of IDEX
Series Fund (September, 1996 - present), Vice President
and Associate General Counsel (February, 1997 -
present) AEGON Asset Management Services, Inc., Largo,
Florida; Secretary and Assistant Vice President (March,
1994 - September, 1995), Vice President and Counsel
(September, 1995 - September, 1996) of IDEX Fund, IDEX
II Series Fund and IDEX Fund 3; Attorney (September,
1992 - August, 1993), Hearne, Graziano, Nader & Buhr,
P.A.; Legal Writing Instructor (August, 1991 - June,
1992), Florida State University College of Law.
</TABLE>
- --------
(1) The principal business address of each person listed, unless otherwise
indicated, is Western Reserve Life Assurance Co. of Ohio, P.O. Box 5068,
Clearwater, Florida 34618.
(2) Interested person as defined in the 1940 Act and affiliated person of
Investment Adviser.
The Fund pays no salaries or compensation to any of its officers, all of
whom are employees of WRL. The Fund pays an annual fee of $6,000 to each
Director who is not affiliated with the Investment Adviser or the Sub-Adviser.
Each Director also receives $500, plus expenses, per each regular and special
Board meeting attended. For the year ended December 31, 1996, the Portfolio
paid Directors' fees and expenses of $8,449. The following table provides
compensation amounts paid to disinterested Directors of the Fund for the
fiscal year ended December 31, 1996.
COMPENSATION TABLE
<TABLE>
<CAPTION>
PENSION OR
RETIREMENT
AGGREGATE BENEFITS
COMPENSATION FROM ACCRUED AS TOTAL COMPENSATION PAID TO
WRL PART OF DIRECTORS FROM WRL SERIES
NAME OF PERSON, POSITION SERIES FUND, INC. FUND EXPENSES* FUND, INC., IDEX SERIES FUND
- ------------------------ ----------------- -------------- ----------------------------
<S> <C> <C> <C>
Peter R. Brown, Director $9,500 $0 $34,000
Charles C. Harris, Di-
rector $9,500 0 $34,000
Russell A. Kimball, Jr.,
Director $9,000 0 $ 9,000
</TABLE>
- --------
* The Plan became effective January 1, 1996.
- 21 -
<PAGE>
Commencing on January 1, 1996, a non-qualified deferred compensation plan
(the "Plan") became available to directors who are not interested persons of
the Fund. Under the Plan, compensation may be deferred that would otherwise be
payable by the Fund or IDEX Series Fund, to a disinterested Director or
Trustee on a current basis for services rendered as director. (IDEX Fund and
IDEX Fund 3 were merged with and into the Growth Portfolio of IDEX II Series
Fund on September 20, 1996, at which time IDEX II Series Fund was renamed IDEX
Series Fund.) Deferred compensation amounts will accumulate based on the value
of Class A shares of a portfolio of IDEX II Series Fund (without imposition of
sales charges), as elected by the directors. It is not anticipated that the
Plan will have any impact on the Fund.
As of March 1, 1997, the Directors and officers of the Fund beneficially
owned in the aggregate less than 1% of the Fund's shares through ownership of
the Contract indirectly invested in the Fund. The Board of Directors has
established an Audit Committee consisting of Messrs. Brown, Harris and
Kimball.
THE INVESTMENT ADVISER
The information that follows supplements the information provided about the
Investment Adviser under the caption "Management of the Fund--The Investment
Adviser" in the Prospectus.
WRL Investment Management, Inc. ("WRL Management" or the "Investment
Adviser") serves as the investment adviser to the Portfolio pursuant to an
Investment Advisory Agreement dated January 1, 1997 with the Fund. The
Investment Adviser is a direct, wholly-owned subsidiary of WRL, which is a
wholly-owned subsidiary of First AUSA Life Insurance Company ("First AUSA"), a
stock life insurance company which is wholly-owned by AEGON USA, Inc.
("AEGON"). AEGON is a financial services holding company whose primary
emphasis is on life and health insurance and annuity and investment products.
AEGON is a wholly-owned indirect subsidiary of AEGON nv, a Netherlands
corporation, which is a publicly traded international insurance group. Prior
to January 1, 1997, WRL served as investment adviser to the Fund.
The Investment Advisory Agreement was approved by the Fund's Board of
Directors, including a majority of the Directors who are not "interested
persons" of the Fund (as defined in the 1940 Act), on October 3, 1996 and by
the shareholders of the Portfolio on December 16, 1996. The Investment
Advisory Agreement provides that it will continue in effect for an initial
term ending January 1, 1999, and from year to year thereafter, if approved
annually (a) by the Board of Directors of the Fund or by a majority of the
outstanding shares of the Portfolio, and (b) by a majority of the Directors
who are not parties to such contract or "interested persons" of any such
party. The Investment Advisory Agreement may be terminated without penalty on
60 days' written notice at the option of either party or by the vote of the
shareholders of the Portfolio and terminates automatically in the event of its
assignment (within the meaning of the 1940 Act).
While the Investment Adviser is at all times subject to the direction of the
Board of Directors of the Fund, the Investment Advisory Agreement provides
that the Investment Adviser, subject to review by the Board of Directors, is
responsible for the actual management of the Portfolio and has responsibility
for making decisions to buy, sell or hold any particular security. The
Investment Adviser also is obligated to provide all the office space,
facilities, equipment and personnel necessary to perform its duties under the
Agreement. For further information about the management of the Portfolio, see
"The Sub-Adviser", below.
- 22 -
<PAGE>
Advisory Fee. The method of computing the investment advisory fee is fully
described in the Prospectus. For the years ended December 31, 1996, 1995 and
1994, the Investment Adviser was paid fees for its services to the Portfolio
in the following amounts:
<TABLE>
<CAPTION>
ADVISORY FEES
YEAR ENDED
----------------------------------------------------------------------------------------
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1996 1995 1994
------------ ------------ ------------
<S> <C> <C>
$11,137,321 $7,847,750 $6,850,340
</TABLE>
Payment of Expenses. Under the terms of the Investment Advisory Agreement,
the Investment Adviser is responsible for providing investment advisory
services and furnishing office space for officers and employees of the
Investment Adviser connected with investment management of the Portfolio. The
Portfolio pays: all expenses incurred in connection with the formation and
organization of the Portfolio, including the preparation (and filing, when
necessary) of the Portfolio's contracts, plans, and documents, conducting
meetings of organizers, directors and shareholders; preparing and filing the
post-effective amendment to the Fund's registration statement effecting
registration of the Portfolio and its shares under the 1940 Act and the
Securities Act of 1933 Act and all other matters relating to the information
and organization of the Portfolio and the preparation for offering its shares;
expenses in connection with ongoing registration or qualification requirements
under Federal and state securities laws; investment advisory fees; pricing
costs (including the daily calculations of net asset value); brokerage
commissions and all other expenses in connection with execution of portfolio
transactions, including interest; all federal, state and local taxes
(including stamp, excise, income and franchise taxes) and the preparation and
filing of all returns and reports in connection therewith; any compensation,
fees, or reimbursements which the Fund pays to its Directors who are not
"interested persons," as that phrase is defined in the 1940 Act, of the Fund
or WRL Management; compensation of the Fund's custodian, administrative and
transfer agent; registrar and dividend disbursing agent; legal, accounting and
printing expenses; other administrative, clerical, recordkeeping and
bookkeeping expenses; auditing fees; certain insurance premiums; services for
shareholders (including allocable telephone and personnel expenses); costs of
certificates and the expenses of delivering such certificates to the purchaser
of shares relating thereto; expenses of local representation in Maryland; fees
and/or expenses payable pursuant to any plan of distribution adopted with
respect to the Fund in accordance with Rule 12b-1 under the 1940 Act; expenses
of shareholders' meetings and of preparing, printing, and distributing
notices, proxy statements and reports to shareholders and Contract Owners;
expenses of preparing and filing reports with Federal and state regulatory
authorities; all costs and expenses, including fees and disbursements, of
counsel and auditors, filing and renewal fees and printing costs in connection
with the filing of any required amendments, supplements or renewals of
registration statement, qualifications or prospectuses under the Securities
Act of 1933 and the securities laws of any states or territories, subsequent
to the effectiveness of the initial registration statement under the
Securities Act of 1933; all costs involved in preparing and printing
prospectuses of the Fund; extraordinary expenses; and all other expenses
properly payable by the Fund or the Portfolio.
The Investment Adviser has voluntarily undertaken, until at least April 30,
1998, to pay expenses on behalf of the Portfolio to the extent normal
operating expenses (including investment advisory fees but excluding interest,
taxes, brokerage fees, commissions and extraordinary charges) exceed, as a
percentage of the Portfolio's average daily net assets, 1.00%. There were no
expenses paid by the Investment Adviser on behalf of the Portfolio for the
fiscal years ended December 31, 1996, 1995 and 1994, inasmuch as the normal
operating expenses of the Portfolio did not exceed the limitations described
above.
- 23 -
<PAGE>
Service Agreement. Effective January 1, 1997, the Fund entered into an
------------------
Administrative Services and Transfer Agency Agreement ("Services Agreement")
with WRL Investment Services, Inc. ("WRL Services"), an affiliate of WRL
Management and WRL, to furnish the Fund with administrative services to assist
the Fund in carrying out certain of its functions and operations. The Service
Agreement was approved by the Fund's Board of Directors, including a majority
of Directors who are not "interested persons" of the Fund (as defined in the
1940 Act) on October 3, 1996. Under this Agreement, WRL Services shall furnish
to each Portfolio, subject to the overall supervision of the Fund's Board,
supervisory, administrative, and transfer agency services, including
recordkeeping and reporting. WRL Services is reimbursed by the Fund monthly on
a cost incurred basis.
Distribution Agreement. Effective January 1, 1997, the Fund adopted a
-----------------------
distribution plan ("Distribution Plan") pursuant to Rule 12b-1 under the 1940
Act, as amended. Pursuant to the Distribution Plan, the Fund entered into a
Distribution Agreement with InterSecurities, Inc. ("ISI"), whose principal
office is located at 201 Highland Avenue, Largo, Florida 33770. The
Distribution Plan and related Agreement were approved by the Fund's Board of
Directors, including a majority of Directors who are not "interested persons"
of the Fund (as defined in the 1940 Act) on October 3, 1996, and the
Distribution Plan was approved by the shareholders and Contract Owners of each
Portfolio of the Fund on December 16, 1996. ISI is an affiliate of the
Investment Adviser.
Under the Distribution Plan and Distribution Agreement, the Fund, on behalf
of the Portfolios, will reimburse ISI after each calendar month for certain
Fund distribution expenses incurred or paid by ISI, provided that these
expenses in the aggregate do not exceed 0.15%, on an annual basis, of the
average daily net asset value of shares of each Portfolio.
Distribution expenses for which ISI may be reimbursed under the Distribution
Plan and Distribution Agreement include, but are not limited to, expenses of
printing and distributing the Fund's prospectus and statement of additional
information to potential Contract Owners; developing and preparing Fund
advertisements; sales literature and other promotional materials; holding
seminars and sales meetings designed to promote distribution of Fund shares;
the development of consumer-oriented sales materials describing and/or
relating to the Fund; and expenses attributable to "distribution-related
services" provided to the Fund, which include such things as salaries and
benefits, office expenses, equipment expenses, training costs, travel costs,
printing costs, supply expenses, computer programming time, and data center
expenses, each as they relate to the promotion of the sale of Fund shares.
ISI submits to the Directors of the Fund for approval annual distribution
budgets and quarterly reports of distribution expenses with respect to each
Portfolio. ISI allocates to each Portfolio distribution expenses specifically
attributable to the distribution of shares of such Portfolio. Distribution
expenses not specifically attributable to the distribution of shares of a
particular Portfolio are allocated among the Portfolios, based upon the ratio
of net asset value of each Portfolio to the net asset value of all Portfolios,
or such other factors as ISI deems fair and are approved by the Fund's Board
of Directors. ISI has determined that will not seek payment by the Fund of
distribution expenses with respect to any Portfolio during the fiscal year
ending December 31, 1997. Prior to ISI seeking reimbursement, Policyowners
will be notified in advance.
It is anticipated that benefits provided by the Distribution Plan may
include lower fixed costs as a percentage of assets as Fund assets increase
through the growth of the Fund due to enhanced marketing efforts.
- 24 -
<PAGE>
THE SUB-ADVISER
This discussion supplements the information provided about the Sub-Adviser
under the caption "Management of the Fund--The Sub-Adviser" in the Prospectus.
Janus Capital Corporation (the "Sub-Adviser") serves as the Sub-Adviser for
the Portfolio pursuant to a Sub-Advisory Agreement dated January 1, 1997
between WRL Management and the Sub-Adviser on behalf of the Portfolio. The
Sub-Advisory Agreement was approved by the Board of Directors of the Fund,
including a majority of the Directors who were not "interested persons" of the
Fund (as defined in the 1940 Act), on October 3, 1996 and by the shareholders
and Contract Owners of the Portfolio on December 16, 1996. The Sub-Advisory
Agreement provides that it will continue in effect for an initial term ending
January 1, 1999, and from year to year thereafter, if approved annually (a) by
the Board of Directors of the Fund or by a majority of the outstanding shares
of the Portfolio, and (b) by a majority of the Directors who are not parties
to such Agreement or "interested persons" (as defined in the 1940 Act) of any
such party. The Sub-Advisory Agreement may be terminated without penalty on 60
days' written notice at the option of either party or by the vote of the
shareholders of the Portfolio and terminates automatically in the event of
assignment (within the meaning of the 1940 Act) or termination of the
Investment Advisory Agreement.
Pursuant to the Sub-Advisory Agreement, the Sub-Adviser provides investment
advisory assistance and portfolio management advice to the Investment Adviser
with respect to the Portfolio. Subject to review by the Investment Adviser and
the Board of Directors of the Fund, the Sub-Adviser is responsible for the
actual management of the Portfolio and for making decisions to buy, sell or
hold any particular security. The Sub-Adviser provides the portfolio managers
for the Portfolio. Such managers consider analyses from various sources, make
the necessary decisions and effect transactions accordingly. The Sub-Adviser
bears all of its expenses in connection with the performance of its services
under the Sub-Advisory Agreement, such as compensating and furnishing office
space for its officers and employees connected with investment and economic
research, trading and investment management of the Portfolio. The method of
computing the Sub-Adviser's fee is set forth in the Prospectus. For the years
ended December 31, 1996, 1995 and 1994, the Sub-Adviser was paid fees in the
amount of $5,568,661, $3,923,875 and $3,425,888, respectively.
The Sub-Adviser, located at 100 Fillmore Street, Denver, Colorado 80206, has
been engaged in the management of Janus funds since 1969. Janus Capital
Corporation also serves as investment adviser or sub-adviser to other mutual
funds, and for individual, corporate, charitable and retirement accounts. The
aggregate market value of the assets managed by the Sub-Adviser was over $50
billion as of January 31, 1997. Kansas City Southern Industries, Inc. ("KCSI")
owns 83% of the Sub-Adviser. KCSI, whose address is 114 West 11th Street,
Kansas City, Missouri 64105-1804, is a publicly-traded holding company whose
largest subsidiary, the Kansas City Southern Railway Company, is primarily
engaged in the transportation industry. Other KCSI subsidiaries are engaged in
financial services and real estate.
JOINT TRADING ACCOUNTS
As described in the Prospectus, the Portfolio and other clients of the Sub-
Adviser and its affiliates may place assets in joint trading accounts for the
purpose of making short-term investments in money market instruments. The
Board of Directors of the Fund must approve the participation of each
Portfolio in these joint trading accounts, and procedures pursuant to which
the joint accounts will operate. The joint trading accounts are to be operated
pursuant to an exemptive order issued to the Sub-Adviser and certain of its
affiliates by the SEC. All joint account participants including the Portfolio,
will bear the expenses of the joint trading accounts in proportion to their
investments. Financial difficulties of other participants in the joint
accounts could cause delays or other difficulties for the Portfolio in
withdrawing their assets from joint trading accounts.
- 25 -
<PAGE>
PORTFOLIO TRANSACTIONS AND BROKERAGE
PORTFOLIO TURNOVER
The information that follows supplements the information provided about
portfolio turnover under the caption "The Growth Portfolio and the Fund--
Portfolio Turnover" in the Prospectus. In computing the portfolio turnover
rate for the Portfolio, securities whose maturities or expiration dates at the
time of acquisition are one year or less are excluded. Subject to this
exclusion, the turnover rate for the Portfolio is calculated by dividing (a)
the lesser of purchases or sales of portfolio securities for the fiscal year
by (b) the monthly average of portfolio securities owned by the Portfolio
during the fiscal year. The portfolio turnover rates for the years 1996, 1995
and 1994 were 45.21%, 130.48%, and 107.33%, respectively. The Fund's
management is unable to predict precisely the Portfolio's future annual
turnover rate, although an annual turnover rate in excess of 150% is not
presently anticipated. Higher turnover rates tend to result in higher
brokerage fees.
There are no fixed limitations regarding the portfolio turnover of the
Portfolio. Portfolio turnover rates are expected to fluctuate under constantly
changing economic conditions and market circumstances. Securities initially
satisfying the basic policies and objectives of the Portfolio may be disposed
of when they are no longer deemed suitable.
PLACEMENT OF PORTFOLIO BROKERAGE
Subject to policies established by the Board of Directors, the Sub-Adviser
is primarily responsible for placement of the Portfolio's securities
transactions. In placing orders, it is the policy of the Portfolio to obtain
the most favorable net results, taking into account various factors, including
price, dealer spread or commissions, if any, size of the transaction and
difficulty of execution. While the Sub-Adviser generally will seek reasonably
competitive spreads or commissions, the Portfolio will not necessarily be
paying the lowest spread or commission available. The Portfolio does not have
any obligation to deal with any broker, dealer or group of brokers or dealers
in the execution of transactions in portfolio securities.
Decisions as to the assignment of portfolio brokerage business for the
Portfolio and negotiation of its commission rates are made by the Sub-Adviser,
whose policy is to obtain "best execution" (prompt and reliable execution at
the most favorable security price) of all portfolio transactions. In placing
portfolio transactions, the Sub-Adviser may give consideration to brokers who
provide supplemental investment research, in addition to such research
obtained for a flat fee, to the Sub-Adviser, and pay spreads or commissions to
such brokers or dealers furnishing such services which are in excess of
spreads or commissions which another broker or dealer may charge for the same
transaction.
In selecting brokers and in negotiating commissions, the Sub-Adviser
considers such factors as: the Sub-Adviser's knowledge of currently available
negotiated commission rates or prices of securities currently available and
other current transaction costs; the nature of the security being traded; the
size and type of the transaction; the nature and character of the markets for
the security to be purchased or sold; the desired timing of the trade; the
activity existing and expected in the market for the particular security;
confidentiality; the quality of execution, clearance, and settlement services;
financial stability; the existence of actual or apparent operational problems
of any broker or dealer; and research products or services to be provided.
These products and services may include furnishing advice, either directly
or through publications or writings, as to the value of securities, the
advisability of purchasing or selling specific securities and the availability
of securities or purchasers or sellers of securities; furnishing seminars,
information, analyses and reports concerning issuers, industries, securities,
trading markets and methods, legislative developments, changes in accounting
practices, economic factors
- 26 -
<PAGE>
and trends and portfolio strategy; access to research analysts, corporate
management personnel, industry experts, economists and government officials;
comparative performance evaluation and technical measurement services and
quotation services, and products and other services (such as third party
publications, reports and analyses, and computer and electronic access,
equipment, software, information and accessories that deliver, process or
otherwise utilize information), including the research described above.
Supplemental research obtained through brokers or dealers will be in
addition to and not in lieu of the services required to be performed by the
Sub-Adviser. The expenses of the Sub-Adviser will not necessarily be reduced
as a result of the receipt of such supplemental information. The Sub-Adviser
may use such research products and services in servicing other accounts in
addition to the Portfolio. If the Sub-Adviser determines that any research
product or service has a mixed use, such that it also serves functions that do
not assist in the investment decision-making process, the Sub-Adviser will
allocate the costs of such service or product accordingly. The portion of the
product or service that a Sub-Adviser determines will assist it in the
investment decision-making process may be paid for in brokerage commission
dollars. Such allocation may create a conflict of interest for the Sub-
Adviser. Conversely, such supplemental information obtained by the placement
of business for the Sub-Adviser will be considered by and may be useful to the
Sub-Adviser in carrying out its obligations to the Portfolio.
When the Portfolio purchases or sells a security in the over-the-counter
market, the transaction takes place directly with a principal market-maker,
without the use of a broker, except in those circumstances where, in the
opinion of the Sub-Adviser, better prices and executions are likely to be
achieved through the use of a broker. The Portfolio does not have any
obligation to deal with any broker, dealer or group of brokers or dealers in
the execution of transactions in portfolio securities.
Normally, the Portfolio will deal directly with the underwriters or dealers
who make a market in the securities involved unless better prices and
execution are available elsewhere. Such dealers usually act as principals for
their own account. On occasion, securities may be purchased directly from the
issuer. Bonds and money market securities are generally traded on a net basis
and do not normally involve either brokerage commissions or transfer taxes.
The cost of portfolio securities transactions of the Portfolio that are
transactions with principals will consist primarily of brokerage commissions
or dealer or underwriter spreads between the bid and asked price, although
purchases from underwriters of portfolio securities include a commission or
concession paid by the issuer. No stated commission is generally applicable to
securities traded in the U.S. over-the-counter markets, but the prices of
those securities include undisclosed commissions or mark-ups.
Securities held by the Portfolio may also be held by other separate
accounts, mutual funds or other accounts for which the Investment Adviser or
Sub-Adviser serves as an adviser, or held by the Investment Adviser or Sub-
Adviser for their own accounts. Because of different investment objectives or
other factors, a particular security may be bought by the Investment Adviser
or Sub-Adviser for one or more clients when one or more clients are selling
the same security. If purchases or sales of securities for the Portfolio or
other entities for which they act as investment adviser or for their advisory
clients arise for consideration at or about the same time, transactions in
such securities will be made, insofar as feasible, for the respective entities
and clients in a manner deemed equitable to all. To the extent that
transactions on behalf of more than one client of the Investment Adviser or
Sub-Adviser during the same period may increase the demand for securities
being purchased or the supply of securities being sold, there may be an
adverse effect on price.
On occasions when the Investment Adviser or the Sub-Adviser deems the
purchase or sale of a security to be in the best interests of the Portfolio as
well as other accounts or companies, it may
- 27 -
<PAGE>
to the extent permitted by applicable laws and regulations, but will not be
obligated to, aggregate the securities to be sold or purchased for the
Portfolio with those to be sold or purchased for such other accounts or
companies in order to obtain favorable execution and lower brokerage
commissions. In that event, allocation of the securities purchased or sold, as
well as the expenses incurred in the transaction, will be made by the Sub-
Adviser in the manner it considers to be most equitable and consistent with
its fiduciary obligations to the Portfolio and to such other accounts or
companies. In some cases this procedure may adversely affect the size of the
position obtainable for the Portfolio.
The Board of Directors of the Fund periodically reviews the brokerage
placement practices of the Sub-Adviser on behalf of the Portfolio, and reviews
the prices and commissions, if any, paid by the Portfolio to determine if they
were reasonable.
The Board of Directors of the Fund has authorized the Sub-Adviser to
consider sales of the Policies and Annuity Contracts issued by a broker-dealer
as a factor in the selection of broker-dealers to execute Portfolio
transactions. In addition, the Sub-Adviser may occasionally place portfolio
business with affiliated brokers of the Investment Adviser or the Sub-Adviser,
including: DST Securities, Inc., 301 West 11th Street, Kansas City, Missouri
64105; and InterSecurities, Inc., P.O. Box 5068, Clearwater, Florida 33518. As
stated above, any such placement of portfolio business will be subject to the
ability of the broker-dealer to provide best execution and to the Conduct
Rules of the National Association of Securities Dealers, Inc.
The Portfolio paid aggregate commissions for the years ended December 31,
1996, 1995 and 1994 in the amount of $720,978, $1,577,115, and $1,466,443,
respectively. For the years ended December 31, 1996 and 1995, the Portfolio
did not pay any brokerage commissions to DST Securities, Inc. For the year
ended December 31, 1994, the Portfolio paid commissions to DST Securities,
Inc. in the amount of $2,796. The percentage of the Portfolio's aggregate
brokerage commissions and aggregate dollar amount of transactions paid to DST
Securities, Inc. during the Portfolio's most recent fiscal year did not exceed
one percent.
PURCHASE AND REDEMPTION OF SHARES
OFFERING OF THE SHARES AND DETERMINATION OF OFFERING PRICE
Shares of the Portfolio are currently sold only to the Separate Accounts.
The Separate Account invests in shares of the Portfolio in accordance with the
allocation instructions received from owners of the Contract ("Owners"). Such
allocation rights are further described in the prospectus and disclosure
documents for the Contract. Shares of the Portfolio are sold and redeemed at
their net asset value as described in the Prospectus. Net asset value of the
Portfolio's shares is determined, once daily, as of the close of the regular
session of business on the New York Stock Exchange ("Exchange") (usually 4:00
p.m., Eastern time), on each day the Exchange is open. (Currently the Exchange
is closed on New Year's Day, Presidents' Day, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving Day and Christmas Day.)
Net asset value of a Portfolio share is computed by dividing the value of
the net assets of the Portfolio by the total number of shares of the Portfolio
outstanding.
PORTFOLIO NET ASSET VALUATION
As stated in the Prospectus and above, the net asset value of a Portfolio
share is determined, once daily, as of the close of the regular session of
business on the Exchange (usually 4:00 p.m., Eastern time), on each day the
Exchange is open. The per share net asset value of the Portfolio is
- 28 -
<PAGE>
determined by dividing the total value of the securities and other assets,
less liabilities, by the total number of shares outstanding. In determining
asset value, securities listed on the national securities exchanges and the
NASDAQ National Market are valued at the closing prices on such markets, or if
such a price is lacking for the trading period immediately preceding the time
of determination, such securities are valued at their current bid price. Other
securities which are traded on the over-the-counter market are valued at bid
price. Foreign securities and currencies are converted to U.S. dollars using
the exchange rate in effect at the close of the Exchange. Other securities for
which quotations are not readily available, and other assets, are valued at
fair values as determined in good faith by the Sub-Adviser under the
supervision of the Fund's Board of Directors. Money market instruments
maturing in 60 days or less are valued on the amortized cost basis discussed
above.
INVESTMENT EXPERIENCE INFORMATION
The information provided in this section shows the historical investment
experience of the Portfolio. It does not represent or project future
investment performance.
The Portfolio commenced operations on October 2, 1986. The rates of return
shown below depict the actual investment experience of the Portfolio for the
periods shown.
CALCULATION OF PERFORMANCE RELATED INFORMATION
TOTAL RETURN
The rates of return shown below are based on the actual investment
performance, after the deduction of investment advisory fees and direct
Portfolio expenses. The rates are average annual compounded rates of return
for the periods ended on December 31, 1996.
The rates of return do not reflect charges or deductions against the
Separate Accounts, or charges and deductions against the Policies or
Contracts. Accordingly, these rates of return do not illustrate how actual
investment performance will affect benefits under the Contract. The
prospectuses for the Contracts contains relevant performance information.
Moreover, these rates of return are not an estimate, projection or guarantee
of future performance.
Also shown are comparable figures for the unmanaged Standard & Poor's Index
of 500 Common Stocks, a widely used measure of stock market performance.
AVERAGE ANNUAL COMPOUNDED RATES OF RETURN
FOR THE PERIODS ENDED ON DECEMBER 31, 1996
<TABLE>
<CAPTION>
INCEPTION* 10 YEARS 5 YEARS 1 YEAR
---------- -------- ------- ------
<S> <C> <C> <C> <C>
Growth Portfolio 17.66% 17.98% 11.11% 17.96%
Standard & Poor's Index
of 500 Common Stocks 15.46% 15.28% 15.22% 22.96%
</TABLE>
- --------
* The Portfolio commenced operations on October 2, 1986.
Additional information regarding the investment performance of the Portfolio
appears in the Prospectus.
- 29 -
<PAGE>
Total Return for the Portfolio
Total return quotations for the Portfolio are computed by finding the
average annual compounded rates of return over the relevant periods that
would equate the initial amount invested to the ending redeemable value,
according to the following equation:
P(1+T)n = ERV
Where: P = a hypothetical initial payment of $1,000
T = average annual total return
N = number of years
ERV = ending redeemable value (at the end of the applicable period of
a hypothetical $1,000 payment made at the beginning of the applicable
period).
The total return quotation calculations for the Portfolio reflect the
deduction of a proportionate share of the Portfolio's investment advisory fee
and Portfolio expenses and assume that all dividends and capital gains during
the period are reinvested in the Portfolio when made. The calculations also
assume a complete redemption as of the end of the particular period.
TAXES
Shares of the Portfolio are offered to the Separate Account of PFL that
funds the Contracts. See the prospectus for the Contract for a discussion of
the special taxation of insurance companies with respect to the Separate
Account and the Contract, and the owners thereof.
The Portfolio has qualified and expects to continue to qualify as a
regulated investment company ("RIC") under the Internal Revenue Code of 1986,
as amended (the "Code"). In order to qualify for that treatment, the Portfolio
must distribute to its Contract Owners for each taxable year at least 90% of
its investment company taxable income (consisting generally of net investment
income, net short-term capital gain, and net gains from certain foreign
currency transactions) ("Distribution Requirement") and must meet several
additional requirements. These requirements include the following: (1) the
Portfolio must derive at least 90% of its gross income each taxable year from
dividends, interest, payments with respect to securities loans, and gains from
the sale or other disposition of securities or foreign currencies, or other
income (including gains from options, futures or forward contracts) derived
with respect to its business of investing in securities or those currencies
("Income Requirement"); (2) the Portfolio must derive less than 30% of its
gross income each taxable year from the sale or other disposition of
securities, or any of the following, that were held for less than three
months--options, futures or forward contracts (other than those on foreign
currencies), or foreign currencies (or options, futures or forward contracts
thereon) that are not directly related to the Portfolio's principal business
of investing in securities (or options and futures with respect thereto)
("Short-Short Limitation"); (3) at the close of each quarter of the
Portfolio's taxable year, at least 50% of the value of its total assets must
be represented by cash and cash items, U.S. Government securities, securities
of other RICs, and other securities that, with respect to any one issuer, do
not exceed 5% of the value of the Portfolio's total assets and that do not
represent more than 10% of the outstanding voting securities of the issuer;
and (4) at the close of each quarter of the Portfolio's taxable year, not more
than 25% of the value of its total assets may be invested in securities (other
than U.S. Government securities or the securities of other RICs) of any one
issuer.
As noted in the Prospectus, the Portfolio must, and intends to, comply with
the diversification requirements imposed by section 817(h) of the Code and the
regulations thereunder. These
- 30 -
<PAGE>
requirements, which are in addition to the diversification requirements
mentioned above, place certain limitations on the proportion of the
Portfolio's assets that may be represented by any single investment (which
includes all securities of the same issuer). For purposes of section 817(h),
all securities of the same issuer, all interests in the same real property
project, and all interests in the same commodity are treated as a single
investment. In addition, each U.S. Government agency or instrumentality is
treated as a separate issuer, while a particular foreign government and its
agencies, instrumentalities and political subdivisions all are considered the
same issuer. For information concerning the consequences of failure to meet
the requirements of section 817(h), see the respective prospectus for the
Contract.
The Portfolio will not be subject to the 4% Federal excise tax imposed on
RICs that do not distribute substantially all their income and gains each
calendar year because that tax does not apply to a RIC whose only shareholders
are segregated asset accounts of life insurance companies held in connection
with variable annuity contracts and/or variable life insurance policies.
Dividends and interest received by the Portfolio may be subject to income,
withholding or other taxes imposed by foreign countries and U.S. possessions
that would reduce the yield on its securities. Tax conventions between certain
countries and the United States may reduce or eliminate these foreign taxes,
however, and foreign countries generally do not impose taxes on capital gains
in respect of investments by foreign investors.
The Portfolio may invest in the stock of "passive foreign investment
companies" ("PFICs"). A PFIC is a foreign corporation that, in general, meets
either of the following tests: (1) at least 75% of its gross income is passive
or (2) an average of at least 50% of its assets produce, or are held for the
production of, passive income. Under certain circumstances, the Portfolio will
be subject to Federal income tax on a portion of any "excess distribution"
received on the stock of a PFIC or of any gain on disposition of that stock
(collectively "PFIC income"), plus interest thereon, even if the Portfolio
distributes the PFIC income as a taxable dividend to its shareholders. The
balance of the PFIC income will be included in the Portfolio's investment
company taxable income and, accordingly, will not be taxable to it to the
extent that income is distributed to its shareholders. If the Portfolio
invests in a PFIC and elects to treat the PFIC as a "qualified electing fund,"
then in lieu of the foregoing tax and interest obligation, the Portfolio will
be required to include in income each year its pro rata share of the qualified
electing fund's annual ordinary earnings and net capital gain (the excess of
net long-term capital gain over net short-term capital loss), even if they are
not distributed to the Portfolio; those amounts would be subject to the
Distribution Requirement. In most instances it will be very difficult, if not
impossible, to make this election because of certain requirements thereof.
The use of hedging strategies, such as writing (selling) and purchasing
options and futures contracts and entering into forward contracts, involves
complex rules that will determine for income tax purposes the character and
timing of recognition of the income received in connection therewith by the
Portfolio. Income from the disposition of foreign currencies (except certain
gains therefrom that may be excluded by future regulations), and income from
transactions in options, futures and forward contracts derived by the
Portfolio with respect to its business of investing in securities or foreign
currencies, will qualify as permissible income under the Income Requirement.
However, income from the disposition of options and futures contracts (other
than those on foreign currencies) will be subject to the Short-Short
Limitation if they are held for less than three months. Income from the
disposition of foreign currencies, and options, futures, and forward contracts
on foreign currencies, that are not directly related to the Portfolio's
principal business of investing in securities (or options and futures with
respect thereto) also will be subject to the Short-Short Limitation if they
are held for less than three months.
If the Portfolio satisfies certain requirements, any increase in value on a
position that is part of a "designated hedge" will be offset by any decrease
in value (whether realized or not) of the
- 31 -
<PAGE>
offsetting hedging position during the period of the hedge for purposes of
determining whether the Portfolio satisfies the Short-Short Limitation. Thus,
only the net gain (if any) from the designated hedge will be included in gross
income for purposes of that limitation. The Portfolio intends that, when it
engages in hedging transactions, they will qualify for this treatment, but at
the present time it is not clear whether this treatment will be available for
all of the Portfolio's hedging transactions. To the extent this treatment is
not available, the Portfolio may be forced to defer the closing out of certain
options and futures contracts beyond the time when it otherwise would be
advantageous to do so, in order for the Portfolio to qualify as a RIC.
The foregoing is only a general summary of some of the important Federal
income tax considerations generally affecting the Portfolio and its Owners. No
attempt is made to present a complete explanation of the Federal tax treatment
of the Portfolio's activities, and this discussion and the discussion in the
prospectus or statement of additional information for the Contract are not
intended as a substitute for careful tax planning. Accordingly, potential
investors are urged to consult their own tax advisors for more detailed
information and for information regarding any state, local, or foreign taxes
applicable to the Contract and the holders thereof.
CAPITAL STOCK OF THE FUND
As described in the Prospectus, the Fund offers a separate class of common
stock for each portfolio of the Fund.
REGISTRATION STATEMENT
The Fund has filed with the Securities and Exchange Commission, Washington,
D.C., a Registration Statement under the Securities Act of 1933, as amended,
with respect to the securities to which this Statement of Additional
Information relates. If further information is desired with respect to the
Portfolio or such securities, reference is made to the Registration Statement
and the exhibits filed as part thereof.
FINANCIAL STATEMENTS
The audited financial statements for the Portfolio described in this
Statement of Additional Information for the year ended December 31, 1996 and
the report of the Fund's independent accountants are included in the Fund's
1996 Annual Report and are incorporated herein by reference to such Report. A
copy of the Annual Report may be obtained without charge upon request.
OTHER INFORMATION
INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP, located at 1055 Broadway, 10th Floor, Kansas City,
Missouri 64105, serves as the Fund's independent accountants. The Fund has
engaged Price Waterhouse LLP to examine, in accordance with generally accepted
auditing standards, its annual report. In addition, Price Waterhouse LLP signs
the tax returns for the Portfolio of the Fund.
CUSTODIAN
Investors Bank & Trust Company ("IBT"), located at 89 South Street, Boston,
Massachusetts 02111, serves as the Fund's Custodian and Dividend Disbursing
Agent. IBT provides comprehensive asset administrative services to the Fund
and other members of the financial industry which include: multi-currency
accounting; institutional transfer agency services; domestic and global
custody; performance measures; foreign exchange; and securities lending and
mutual fund administrative services.
- 32 -
<PAGE>
APPENDIX A
DESCRIPTION OF PORTFOLIO SECURITIES
The following is intended only as a supplement to the information contained
in the Prospectus and should be read only in conjunction with the Prospectus.
Terms defined in the Prospectus and not defined herein have the same meanings
as those in the Prospectus.
1. Certificate of Deposit.* A certificate of deposit generally is a short-
term, interest bearing negotiable certificate issued by a commercial bank or
savings and loan association against funds deposited in the issuing
institution.
2. Eurodollar Certificate of Deposit.* A Eurodollar certificate of deposit is
a short-term obligation of a foreign subsidiary of a U.S. bank payable in U.S.
dollars.
3. Floating Rate Note.* A floating rate note is debt issued by a corporation
or commercial bank that is typically several years in term but whose interest
rate is reset every one to six months.
4. Time Deposit.* A time deposit is a deposit in a commercial bank for a
specified period of time at a fixed interest rate for which a negotiable
certificate is not received.
5. Bankers' Acceptance.* A bankers' acceptance is a time draft drawn on a
commercial bank by a borrower, usually in connection with international
commercial transactions (to finance the import, export, transfer or storage of
goods). The borrower is liable for payment as well as the bank, which
unconditionally guarantees to pay the draft at its face amount on the maturity
date. Most acceptances have maturities of six months or less and are traded in
secondary markets prior to maturity.
6. Variable Amount Master Demand Note.* A variable amount master demand note
is a note which fixes a minimum and maximum amount of credit and provides for
lending and repayment within those limits at the discretion of the lender.
Before investing in any variable amount master demand notes, the Portfolio
will consider the liquidity of the issuer through periodic credit analysis
based upon publicly available information.
7. Commercial Paper.* Commercial paper is a short-term promissory note issued
by a corporation primarily to finance short-term credit needs.
8. Repurchase Agreement.* A repurchase agreement is an instrument under which
the Portfolio acquires ownership of a debt security and the seller agrees to
repurchase the obligation at a mutually agreed upon time and price. The total
amount received on repurchase is calculated to exceed the price paid by the
Portfolio, reflecting an agreed upon market rate of interest for the period
from the time of the Portfolio's purchase of the security to the settlement
date (i.e., the time of repurchase), and would not necessarily relate to the
interest rate on the underlying securities. The Portfolio will only enter into
repurchase agreements with respect to underlying securities consisting of U.S.
Government or government agency securities, certificates of deposit,
commercial paper or bankers' acceptances, and will be entered only with
primary dealers. While the Portfolio may invest in repurchase agreements for
periods up to 30 days, it is expected that typically such periods will be for
a week or less. The staff of the Securities and Exchange Commission has taken
the position that repurchase agreements of greater than seven days together
with other illiquid investments should be limited to an amount not in excess
of 15% of the Portfolio's net assets.
Although repurchase transactions usually do not impose market risks on the
purchaser, the Portfolio would be subject to the risk of loss if the seller
fails to repurchase the securities for any
- --------
* Short-term Securities.
A-1
<PAGE>
reason and the value of the securities is less than the agreed upon repurchase
price. In addition, if the seller defaults, the Portfolio may incur
disposition costs in connection with liquidating the securities. Moreover, if
the seller is insolvent and bankruptcy proceedings are commenced, under
current law, the Portfolio could be ordered by a court not to liquidate the
securities for an indeterminate period of time and the amount realized by the
Portfolio upon liquidation of the securities may be limited.
9. Reverse Repurchase Agreement. A reverse repurchase agreement involves the
sale of securities held by the Portfolio, with an agreement to repurchase the
securities at an agreed upon price, date and interest payment. The Portfolio
will use the proceeds of the reverse repurchase agreements to purchase other
money market securities maturing, or under an agreement to resell, at a date
simultaneous with or prior to the expiration of the reverse repurchase
agreement. The Portfolio will utilize reverse repurchase agreements when the
interest income to be earned from the investment of the proceeds from the
transaction is greater than the interest expense of the reverse repurchase
transaction.
10. Asset-Backed Securities. The Portfolio may invest in securities backed by
automobile receivables and credit-card receivables and other securities backed
by other types of receivables or other assets. Credit support for asset-backed
securities may be based on the underlying assets and/or provided through
credit enhancements by a third party. Credit enhancement techniques include
letters of credit, insurance bonds, limited guarantees (which are generally
provided by the issuer), senior-subordinated structures and over-
collateralization. The Portfolio will only purchase an asset-backed security
if it is rated at least "A" by S&P or Moody's.
11. Mortgage-Backed Securities. The Portfolio may purchase mortgage-backed
securities issued by government and non-government entities such as banks,
mortgage lenders, or other financial institutions. Mortgage-backed securities
include mortgage pass-through securities, mortgage-backed bonds, and mortgage
pay-through securities. A mortgage pass-through security is a pro-rata
interest in a pool of mortgages where the cash flow generated from the
mortgage collateral is passed through to the security holder. Mortgage-backed
bonds are general obligations of their issuers, payable out of the issuers'
general funds and additionally secured by a first lien on a pool of mortgages.
Mortgage pay-through securities exhibit characteristics of both pass-through
and mortgage-backed bonds. Mortgage-backed securities also include other debt
obligations secured by mortgages on commercial real estate or residential
properties. Other types of mortgage-backed securities will likely be developed
in the future, and the Portfolio may invest in them if it is determined they
are consistent with the Portfolio's investment objective and policies.
12. Collateralized Mortgage Obligations. (CMOs) are pay-through securities
collateralized by mortgages or mortgage-backed securities. CMOs are issued in
classes and series that have different maturities and often are retired in
sequence.
13. Stripped Mortgage-Backed Securities. Stripped mortgage-backed securities
are created when the principal and interest payments of a mortgage-backed
security are separated by a U.S. Government agency or a financial institution.
The holder of the "principal-only" security receives the principal payments
made by the underlying mortgage-backed security, while the holder of the
"interest-only" security receives interest payments from the same underlying
security.
The value of mortgage-backed securities may change due to changes in the
market's perception of issuers. In addition, the mortgage securities market in
general may be adversely affected by regulatory or tax changes. Non-
governmental mortgage-backed securities may offer a higher yield than those
issued by government entities but also may be subject to greater price change
then government securities.
A-2
<PAGE>
Like most mortgage securities, mortgage-backed securities are subject to
prepayment risk. When prepayment occurs, unscheduled or early payments are
made on the underlying mortgages, which may shorten the effective maturities
of those securities and may lower their total returns. Furthermore, the prices
of stripped mortgage-backed securities can be significantly affected by
changes in interest rates as well. As interest rates fall, prepayment rates
tend to increase, which in turn tends to reduce prices of "interest-only"
securities and increase prices of "principal-only" securities. Rising interest
rates can have the opposite effect.
14. Zero Coupon Bonds. Zero coupon bonds are created three ways:
1) U.S. TREASURY STRIPS (Separate Trading of Registered Interest and
Principal of Securities) are created when the coupon payments and the
principal payment are stripped from an outstanding Treasury bond by the
Federal Reserve Bank. Bonds issued by the Resolution Funding Corporation
(REFCORP) and the Financial Corporation (FICO) also can be stripped in
this fashion.
2) STRIPS are created when a dealer deposits a Treasury Security or a
Federal agency security with a custodian for safe keeping and then sells
the coupon payments and principal payments that will be generated by
this security separately. Proprietary receipts, such as Certificates of
Accrual on Treasury Securities (CATS), Treasury Investment Growth
Receipts (TIGRS), and generic Treasury Receipts (TRs), are stripped U.S.
Treasury securities separated into their component parts through
custodial arrangements established by their broker sponsors. FICO bonds
have been stripped in this fashion. The Portfolio has been advised that
the staff of the Division of Investment Management of the Securities and
Exchange Commission does not consider such privately stripped
obligations to be U.S. Government securities, as defined by the 1940
Act. Therefore, the Portfolio will not treat such obligations as U.S.
Government securities for purposes of the 65% portfolio composition
ratio.
3) ZERO COUPON BONDS can be issued directly by Federal agencies and
instrumentalities, or by corporations. Such issues of zero coupon bonds
are originated in the form of a zero coupon bond and are not created by
stripping an outstanding bond.
Zero coupon bonds do not make regular interest payments. Instead they are
sold at a deep discount from their face value. Because a zero coupon bond does
not pay current income, its price can be very volatile when interest rates
change. In calculating its dividends, the fund takes into account as income a
portion of the difference between a zero coupon bond's purchase price and its
face value.
A-3
<PAGE>
APPENDIX B
DESCRIPTION OF SELECTED CORPORATE BOND AND
COMMERCIAL PAPER RATINGS
CORPORATE BONDS--MOODY'S INVESTORS SERVICE, INC.
Aaa--Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt edge." Interest payments are protected by a large, or by an
exceptionally stable, margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized
are most unlikely to impair the fundamentally strong position on such issues.
Aa--Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known
as high grade bonds. They are rated lower than the best bonds because margins
of protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risks appear somewhat larger than in Aaa
securities.
A--Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper-medium-grade obligations. Factors giving
security to principal and interest are considered adequate but elements may be
present which suggest a susceptibility to impairment sometime in the future.
Baa--Bonds which are rated Baa are considered as medium-grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba--Bonds which are rated Ba are judged to have speculative elements and
their future cannot be considered as well assured. Often the protection of
interest and principal payments may be very moderate and thereby not well
safe-guarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B--Bonds which are rated B generally lack characteristics of a desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Unrated--Where no rating has been assigned or where a rating has been
suspended or withdrawn, it may be for reasons unrelated to the quality of the
issue.
Should no rating be assigned, the reason may be one of the following:
1. An application for rating was not received or accepted.
2. The issue or issuer belongs to a group of securities or companies
that are not rated as a matter of policy.
3. There is a lack of essential data pertaining to the issue or issuer.
4. The issue was privately placed, in which case the rating is not
published in Moody's publications.
Suspension or withdrawal may occur if new and material circumstances arise,
the effects of which preclude satisfactory analysis; if there is no longer
available reasonable up-to-date data to permit a judgment to be formed; if a
bond is called for redemption; or for other reasons.
B-1
<PAGE>
CORPORATE BONDS--STANDARD & POOR'S CORPORATION
AAA--This is the highest rating assigned by Standard & Poor's to a debt
obligation and indicates an extremely strong capacity to pay principal and
interest.
AA--Bonds rated AA also qualify as high-quality debt obligations. Capacity
to pay principal and interest is very strong, and in the majority of instances
they differ from AAA issues only in small degree.
A--Bonds rated A have a strong capacity to pay principal and interest,
although they are somewhat more susceptible to the adverse effects of changes
in circumstances and economic conditions.
BBB--Bonds rated BBB are regarded as having an adequate capacity to pay
principal and interest. Whereas they exhibit an adequate degree of protection,
adverse economic conditions or changing circumstances are more likely to lead
to a weakened capacity to pay principal and interest for bonds in this
category than for bonds in the A category.
BB, B, CCC and CC--Bonds rated BB, B, CCC and CC are regarded, on balance,
as predominantly speculative with respect to the issuer's capacity to pay
interest and repay principal in accordance with the terms of the obligation.
BB indicates the lowest degree of speculation. While such bonds will likely
have some quality and protective characteristics, these are outweighed by
large uncertainties or major risk exposures to adverse conditions.
Plus (+) or Minus (-)--The ratings from "AA" to "BBB" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
Unrated--Indicates that no public rating has been requested, that there is
insufficient information on which to base a rating, or that S&P does not rate
a particular type of obligation as a matter of policy.
COMMERCIAL PAPER--MOODY'S INVESTORS SERVICE, INC.
"Prime-1"--Commercial paper issuers rated Prime-1 are judged to be of the
best quality. Their short-term debt obligations carry the smallest degree of
investment risk. Margins of support for current indebtedness are large or
stable with cash flow and asset protection well assured. Current liquidity
provides ample coverage of near-term liabilities and unused alternative
financing arrangements are generally available. While protective elements may
change over the intermediate or longer term, such changes are most unlikely to
impair the fundamentally strong position of short-term obligations.
"Prime-2"--Issuers in the Commercial Paper market rated Prime-2 are high
quality. Protection for short-term holders is assured with liquidity and value
of current assets as well as cash generation in sound relationship to current
indebtedness. They are rated lower than the best commercial paper issuers
because margins of protection may not be as large or because fluctuations of
protective elements over the near or immediate term may be of greater
amplitude. Temporary increases in relative short and overall debt load may
occur. Alternative means of financing remain assured.
COMMERCIAL PAPER--STANDARD & POOR'S CORPORATION
"A"--Issues assigned this highest rate are regarded as having the greatest
capacity for timely payment. Issues in this category are further refined with
the designation 1, 2 and 3 to indicate the relative degree of safety.
"A-1"--This designation indicates that the degree of safety regarding timely
payment is very strong.
"A-2"--Capacity for timely payment on issues with this designation is
strong. However, the relative degree of safety is not overwhelming as for
issues designated "A-1".
"A-3"--Issues carrying this designation have a satisfactory capacity for
timely payment. They are, however, somewhat vulnerable to the adverse effects
of changes in circumstances than obligations carrying the higher designation.
B-2
<PAGE>
APRIL 25, 1997
STATEMENT OF ADDITIONAL INFORMATION
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.
P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011 . PHONE NO. (609) 282-2800
----------------
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company which has a wide range of investment objectives
among its sixteen separate funds (hereinafter referred to as the "Funds" or
individually as a "Fund"): Merrill Lynch Domestic Money Market Fund, Merrill
Lynch Reserve Assets Fund, Merrill Lynch Prime Bond Fund, Merrill Lynch High
Current Income Fund, Merrill Lynch Quality Equity Fund, Merrill Lynch Equity
Growth Fund, Merrill Lynch Natural Resources Focus Fund, Merrill Lynch
American Balanced Fund, Merrill Lynch Global Strategy Focus Fund, Merrill
Lynch Basic Value Focus Fund, Merrill Lynch Global Bond Focus Fund, Merrill
Lynch Global Utility Focus Fund, Merrill Lynch International Equity Focus
Fund, Merrill Lynch Developing Capital Markets Focus Fund, Merrill Lynch
Government Bond Fund and Merrill Lynch Index 500 Fund. A separate class of
Class A Common Stock is issued for each Fund. The Company may issue Class B
Common Stock for one or more Funds in 1997.
The shares of the Funds are sold to separate accounts ("Separate Accounts")
of certain insurance companies (the "Insurance Companies") including Merrill
Lynch Life Insurance Company ("MLLIC") and ML Life Insurance Company of New
York ("ML of New York") to fund benefits under variable annuity contracts (the
"Variable Annuity Contracts") and/or variable life insurance contracts
(together with the Variable Annuity Contracts, the "Contracts") issued by such
companies. The Insurance Companies will redeem shares to the extent necessary
to provide benefits under the respective Contracts or for such other purposes
as may be consistent with the respective Contracts. MLLIC and ML of New York
are wholly owned subsidiaries of Merrill Lynch & Co., Inc., as is the
Company's investment adviser, Merrill Lynch Asset Management, L.P. (the
"Investment Adviser").
----------------
THIS STATEMENT OF ADDITIONAL INFORMATION OF THE COMPANY IS NOT A PROSPECTUS
AND SHOULD BE READ IN CONJUNCTION WITH THE PROSPECTUS OF THE COMPANY (THE
"PROSPECTUS") DATED APRIL 25, 1997 WHICH HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION AND WHICH IS AVAILABLE UPON
REQUEST AND WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT
THE ADDRESS AND TELEPHONE NUMBER SET FORTH ABOVE.
----------------
MERRILL LYNCH ASSET MANAGEMENT--INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC.--DISTRIBUTOR
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C>
Investment Objectives and Policies......................................... 3
Investment Restrictions.................................................... 3
Management of the Company.................................................. 11
Investment Advisory Arrangements........................................... 15
Determination of Net Asset Value........................................... 17
Portfolio Transactions and Brokerage....................................... 18
Redemption of Shares....................................................... 20
Dividends, Distributions and Taxes......................................... 20
Distribution Arrangements.................................................. 21
Performance Data........................................................... 21
Additional Information..................................................... 24
Independent Auditors' Report............................................... 25
Audited Financial Statements............................................... 26
Unaudited Financial Statements for the Index 500 Fund...................... 142
</TABLE>
2
<PAGE>
INVESTMENT OBJECTIVES AND POLICIES
The investment objectives and certain investment policies of the Funds are
as follows: The Domestic Money Market Fund seeks preservation of capital,
liquidity and the highest possible current income consistent with the
foregoing objectives by investing in short-term domestic money market
securities. The Reserve Assets Fund seeks the preservation of capital,
liquidity and the highest possible current income consistent with the
foregoing objectives by investing in short-term money market securities. The
Prime Bond Fund seeks to attain as high a level of current income as is
consistent with prudent investment management, and as a secondary objective,
capital appreciation when consistent with the foregoing objective, by
investing primarily in long-term corporate bonds rated A or better by either
Moody's Investors Service, Inc. ("Moody's") or Standard & Poor's Rating Group
("Standard & Poor's"). The High Current Income Fund seeks to attain as high a
level of current income as is consistent with its investment policies and
prudent investment management, and as a secondary objective, capital
appreciation when consistent with the foregoing objective; the Fund invests
principally in fixed-income securities which are rated in the lower rating
categories of the established rating services or in unrated securities of
comparable quality. The Quality Equity Fund seeks to attain the highest total
investment return consistent with prudent risk; the Fund uses a fully managed
investment policy utilizing equity securities, primarily common stocks of
large-capitalization companies, as well as investment grade debt and
convertible securities. The Equity Growth Fund seeks to attain long-term
capital growth by investing primarily in common shares, of small companies and
of emerging growth companies regardless of size. The Natural Resources Focus
Fund seeks to attain long-term growth of capital and the protection of the
purchasing power of shareholders' capital by investing primarily in equity
securities of domestic and foreign companies with substantial natural resource
assets. The American Balanced Fund seeks a level of current income and a
degree of stability of principal not normally available from an investment
solely in equity securities and the opportunity for capital appreciation
greater than normally available from an investment solely in debt securities
by investing in a balanced portfolio of fixed income and equity securities.
The Global Strategy Focus Fund seeks high total investment return by investing
primarily in a portfolio of equity and fixed income securities of U.S. and
foreign issuers. The Basic Value Focus Fund seeks to attain capital
appreciation and, secondarily, income by investing in securities, primarily
equities, that management of the Fund believes are undervalued and therefore
represent basic investment value. The Global Bond Focus Fund seeks to attain
high total investment return by investing in a global portfolio of fixed
income securities denominated in various currencies, including multinational
currency units. The Global Utility Focus Fund seeks to attain capital
appreciation and current income through investment of at least 65% of its
total assets in equity and debt securities issued by domestic and foreign
companies which are, in the opinion of the Investment Adviser, primarily
engaged in the ownership or operation of facilities used to generate, transmit
or distribute electricity, telecommunications, gas or water. The International
Equity Focus Fund seeks to attain capital appreciation and, secondarily,
income, through investment in securities, principally equities, of issuers in
countries other than the United States. The Developing Capital Markets Focus
Fund seeks long-term capital appreciation through investment in securities,
principally equities, of issuers in countries having smaller capital markets.
The Government Bond Fund seeks the highest possible current income consistent
with the protection of capital afforded by investing in debt securities issued
or guaranteed by the United States Government, its agencies or
instrumentalities. The Index 500 Fund seeks to provide investment results
that, before expenses, correspond to the aggregate price and yield performance
of Standard & Poor's 500 Composite Stock Price Index (the "S&P 500 Index").
Investors are referred to "Investment Objectives and Policies of the Funds"
in the Prospectus for a more complete discussion of the investment objectives
and policies of the Company.
INVESTMENT RESTRICTIONS
The Company has adopted the following fundamental and non-fundamental
restrictions and policies relating to the investment of the assets of the
Funds and their activities. The fundamental policies set forth below may not
be changed without the approval of the holders of a majority of the
outstanding voting shares of each Fund affected (which for this purpose and
under the Investment Company Act of 1940 means the lesser of (i) 67% of the
shares represented at a meeting at which more than 50% of the outstanding
shares of the affected Fund are represented or (ii) more than 50% of the
outstanding shares of the affected Fund).
3
<PAGE>
RESTRICTIONS APPLICABLE TO THE DOMESTIC MONEY MARKET FUND
The Domestic Money Market Fund may not purchase any security other than
money market and other securities described under "Investment Objectives and
Policies of the Funds--Domestic Money Market Fund" in the Prospectus. In
addition, the Domestic Money Market Fund may not purchase securities of
foreign issuers (including Eurodollar and Yankeedollar obligations). In
addition, the Domestic Money Market Fund may not:
(1) invest more than 10% of its total assets (taken at market value at
the time of each investment) in the securities (other than U.S. Government
or government agency securities) of any one issuer (including repurchase
agreements with any one bank) except that up to 25% of the value of the
Fund's total assets may be invested without regard to such 10% limitation.
(2) alone, or together with any other Fund or Funds, make investments for
the purpose of exercising control or management.
(3) purchase securities of other investment companies, except in
connection with a merger, consolidation, acquisition or reorganization.
(4) purchase or sell interests in oil, gas or other mineral exploration
or development programs, commodities, commodity contracts or real estate,
except that the Fund may invest in securities secured by real estate or
interests therein or securities issued by companies which invest in real
estate or interest therein.
(5) purchase any securities on margin except that the Company may obtain
such short-term credit as may be necessary for the clearance of purchases
and sales of portfolio securities.
(6) make short sales of securities or maintain a short position or write,
purchase or sell puts, calls, straddles, spreads or combination thereof.
(7) make loans to other persons; provided that the Fund may purchase
money market securities or enter into repurchase agreements; lend
securities owned or held by it pursuant to (8) below; and provided further
that for purposes of this restriction the acquisition of a portion of an
issue of publicly distributed bonds, debentures or other corporate debt
securities or of government obligations, short-term commercial paper,
certificates of deposit and bankers' acceptances shall not be deemed the
making of a loan.
(8) lend its portfolio securities in excess of 20% of its total assets,
taken at market value at the time of the loan, provided that such loans are
made according to the guidelines set forth below and the guidelines of the
Securities and Exchange Commission and the Company's Board of Directors,
including maintaining collateral from the borrower equal at all times to
the current market value of the securities loaned.
(9) borrow amounts in excess of 20% of its total assets, taken at market
value, and then only from banks as a temporary measure for extraordinary or
emergency purposes. The borrowing provisions shall not apply to reverse
repurchase agreements. Usually only "leveraged" investment companies may
borrow in excess of 5% of their assets; however, the Fund will not borrow
to increase income but only to meet redemption requests which might
otherwise require untimely dispositions of portfolio securities. The Fund
will not purchase securities while borrowings are outstanding.
(10) mortgage, pledge, hypothecate or in any manner transfer (except as
provided in (8) above), as security for indebtedness, any securities owned
or held by the Fund except as may be necessary in connection with
borrowings mentioned in (9) above, and then such mortgaging, pledging or
hypothecating may not exceed 25% of the Fund's total assets, taken at
market value at the time thereof. Although the Fund has the authority to
mortgage, pledge or hypothecate more than 10% of its total assets under
this investment restriction (10), as a matter of operating policy, the Fund
will not mortgage, pledge or hypothecate in excess of 10% of total net
assets.
(11) act as an underwriter of securities, except insofar as the Fund may
be deemed an underwriter under the Securities Act of 1933 in selling
portfolio securities.
(12) purchase, either alone or together with any other Fund or Funds,
more than 10% of the outstanding securities of an issuer except that such
restriction does not apply to U.S. Government or government agency
securities, bank money instruments or repurchase agreements.
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<PAGE>
(13) invest in securities (except for repurchase agreements or variable
amount master notes) with legal or contractual restrictions on resale or
for which no readily available market exists or in securities of issuers
(other than issuers of government agency securities) having a record,
together with predecessors, of less than three years of continuous
operation if, regarding all such securities, more than 10% of its total
assets (taken at market value) would be invested in such securities.
(14) enter into repurchase agreements if, as a result thereof, more than
10% of the Fund's total assets (taken at market value at the time of each
investment) would be subject to repurchase agreements maturing in more than
seven days.
(15) enter into reverse repurchase agreements if, as a result thereof,
the Fund's obligations with respect to reverse repurchase agreements would
exceed one-third of the Fund's net assets (defined to be total assets,
taken at market value, less liabilities other than reverse repurchase
agreements).
(16) invest more than 25% of its total assets (taken at market value at
the time of each investment) in the securities of issuers in any particular
industry (other than U.S. Government securities, government agency
securities or bank money instruments).
RESTRICTIONS APPLICABLE TO THE RESERVE ASSETS FUND
The Reserve Assets Fund may not purchase any security other than money
market and other securities described under "Investment Objectives and
Policies of the Funds--Reserve Assets Fund" in the Prospectus. In addition,
the Reserve Assets Fund may not:
(1) invest more than 10% of its total assets (taken at market value at
the time of each investment) in the securities (other than U.S. Government
or government agency securities) of any one issuer (including repurchase
agreements with any one bank) except that up to 25% of the value of the
Fund's total assets may be invested without regard to such 10% limitation.
(2) alone, or together with any other Fund or Funds, make investments for
the purpose of exercising control or management.
(3) purchase securities of other investment companies, except in
connection with a merger, consolidation, acquisition or reorganization.
(4) purchase or sell interests in oil, gas or other mineral exploration
or development programs, commodities, commodity contracts or real estate,
except that the Fund may invest in securities secured by real estate or
interests therein or securities issued by companies which invest in real
estate or interest therein.
(5) purchase any securities on margin except that the Company may obtain
such short-term credit as may be necessary for the clearance of purchases
and sales of portfolio securities.
(6) make short sales of securities or maintain a short position or write,
purchase or sell puts, calls, straddles, spreads or combinations thereof.
(7) make loans to other persons; provided that the Fund may purchase
money market securities or enter into repurchase agreements; lend
securities owned or held by it pursuant to (8) below; and provided further
that for purposes of this restriction the acquisition of a portion of an
issue of publicly-distributed bonds, debentures or other corporate debt
securities or of government obligations, short-term commercial paper,
certificates of deposit and bankers' acceptances shall not be deemed the
making of a loan.
(8) lend its portfolio securities in excess of 20% of its total assets,
taken at market value at the time of the loan, provided that such loans are
made according to the guidelines set forth below and the guidelines of the
Securities and Exchange Commission and the Company's Board of Directors,
including maintaining collateral from the borrower equal at all times to
the current market value of the securities loaned.
(9) borrow amounts in excess of 20% of its total assets, taken at market
value and then only from banks as a temporary measure for extraordinary or
emergency purposes. The borrowing provisions shall not apply to reverse
repurchase agreements. Usually only "leveraged" investment companies may
borrow in excess of 5% of their assets; however, the Fund will not borrow
to increase income but only to meet redemption requests which might
otherwise require untimely dispositions of portfolio securities. The Fund
will not purchase securities while borrowings are outstanding.
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<PAGE>
(10) mortgage, pledge, hypothecate or in any manner transfer (except as
provided in (8) above), as security for indebtedness, any securities owned
or held by the Fund except as may be necessary in connection with
borrowings mentioned in (9) above, and then such mortgaging, pledging or
hypothecating may not exceed 25% of the Fund's total assets, taken at
market value at the time thereof. As a matter of operating policy, the Fund
will not mortgage, pledge or hypothecate in excess of 10% of total net
assets.
(11) act as an underwriter of securities, except insofar as the Fund may
be deemed an underwriter under the Securities Act of 1933 in selling
portfolio securities.
(12) purchase, either alone or together with any other Fund or Funds,
more than 10% of the outstanding securities of an issuer except that such
restriction does not apply to U.S. Government or government agency
securities, bank money instruments or repurchase agreements.
(13) invest in securities (except for repurchase agreements or variable
amount master notes) with legal or contractual restrictions on resale or
for which no readily available market exists or in securities of issuers
(other than issuers of government agency securities) having a record,
together with predecessors, of less than three years of continuous
operation if, regarding all such securities, more than 5% of its total
assets (taken at market value) would be invested in such securities.
(14) enter into repurchase agreements if, as a result thereof, more than
10% of the Fund's total assets (taken at market value at the time of each
investment) would be subject to repurchase agreements maturing in more than
seven days.
(15) enter into reverse repurchase agreements if, as a result thereof,
the Fund's obligations with respect to reverse repurchase agreements would
exceed one-third of the Fund's net assets (defined to be total assets,
taken at market value, less liabilities other than reverse repurchase
agreements).
(16) invest more than 25% of its total assets (taken at market value at
the time of each investment) in the securities of issuers in any particular
industry (other than U.S. Government securities, government agency
securities or bank money instruments).
RESTRICTIONS APPLICABLE TO EACH OF THE FUNDS (EXCEPT THE DOMESTIC MONEY MARKET
FUND AND THE RESERVE ASSETS FUND)
Under the fundamental investment restrictions, each of the Funds (unless
noted otherwise below) may not:
1. Make any investment inconsistent with the Fund's classification as a
diversified company under the Investment Company Act.(1)
2. Invest more than 25% of its assets, taken at market value, in the
securities of issuers in any particular industry (excluding the U.S.
Government and its agencies and instrumentalities).(2)
3. Make investments for the purpose of exercising control or management.
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(1) The Developing Capital Markets Focus, Global Bond Focus, Global Strategy
Focus, Index 500 and Natural Resource Focus Funds are classified as non-
diversified investment companies under the Investment Company Act, and
therefore this restriction is not applicable to those Funds.
(2) For purposes of this restriction, states, municipalities and their
political subdivisions are not considered to be part of any industry, and
utilities will be divided according to their services; for example, gas,
gas transmission, electricity, telecommunications and water each will be
considered a separate industry for purposes of this restriction. In
addition, this restriction will not restrict (i) the Global Utility Focus
Fund, under normal circumstances, from investing 65% or more of its total
assets in equity and debt securities issued by domestic and foreign
companies in the utilities industries (i.e., electricity,
telecommunications, gas or water), and (ii) the Natural Resources Focus
Fund from investing greater than 25% of its assets in gold-related
companies.
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<PAGE>
4. Purchase or sell real estate, except that the Fund may invest in
securities directly or indirectly secured by real estate or interests
therein or issued by companies which invest in real estate or interests
therein.
5. Make loans to other persons, except that the acquisition of bonds,
debentures or other corporate debt securities and investment in government
obligations, commercial paper, pass-through instruments, certificates of
deposit, bankers acceptances, repurchase agreements or any similar
instruments shall not be deemed to be the making of a loan, and except
further that the Fund may lend its portfolio securities, provided that the
lending of portfolio securities may be made only in accordance with
applicable law and the guidelines set forth in the Prospectus and Statement
of Additional Information, as they may be amended from time to time.
6. Issue senior securities to the extent such issuance would violate
applicable law.
7. Borrow money, except that (i) the Fund may borrow from banks (as
defined in the Investment Company Act) in amounts up to 33 1/3% of its
total assets (including the amount borrowed), (ii) the Fund may borrow up
to an additional 5% of its total assets for temporary purposes, (iii) the
Fund may obtain such short-term credit as may be necessary for the
clearance of purchases and sales of portfolio securities and (iv) the Fund
may purchase securities on margin to the extent permitted by applicable
law. The Fund may not pledge its assets other than to secure such
borrowings or, to the extent permitted by the Fund's investment policies as
set forth in the Prospectus and Statement of Additional Information, as
they may be amended from time to time, in connection with hedging
transactions, short sales, when-issued and forward commitment transactions
and similar investment strategies.
8. Underwrite securities of other issuers except insofar as the Fund
technically may be deemed an underwriter under the Securities Act of 1933
in selling portfolio securities.
9. Purchase or sell commodities or contracts on commodities, except to
the extent the Fund may do so in accordance with applicable law and the
Prospectus and Statement of Additional Information, as they may be amended
from time to time, and without registering as a commodity pool operator
under the Commodity Exchange Act.
Under the non-fundamental investment restrictions, each of the Funds
(unless noted otherwise below) may not:
a. Purchase securities of other investment companies, except to the
extent such purchases are permitted by applicable law.
b. Engage in short sales of securities or maintain a short position
except to the extent permitted by applicable law. The Fund does not
currently intend to engage in short sales or maintain a short position,
except for short sales "against the box."(3)
c. Invest in securities which cannot be readily resold because of legal
or contractual restrictions or which cannot otherwise be marketed, redeemed
or put to the issuer or a third party, if at the time of acquisition more
than 15% of its total assets would be invested in such securities. This
restriction shall not apply to securities which mature within seven days or
securities which the Board of Directors has otherwise determined to be
liquid pursuant to applicable law. Securities purchased in accordance with
Rule 144A under the Securities Act and determined to be liquid by the Board
of Directors of the Company are not subject to the limitations set forth in
this investment restriction.
d. Invest in warrants if, at the time of acquisition, its investments in
warrants, valued at the lower of cost or market value, would exceed 5% of
the Fund's total assets; included within such limitation, but not to exceed
2% of the Fund's total assets, are warrants which are not listed on the New
York Stock Exchange or American Stock Exchange or a major foreign exchange.
For purposes of this restriction, warrants acquired by the Fund in units or
attached to securities may be deemed to be without value.
- -------------------------
(3) The Global Bond Focus, Global Strategy Focus, International Equity Focus
and Natural Resources Focus Funds may maintain short positions in forward
currency contracts, options, futures contracts and options on futures
contracts.
7
<PAGE>
e. Invest in securities of companies having a record, together with
predecessors, of less than three years of continuous operation, except to
the extent permitted under applicable law. This restriction shall not apply
to mortgage-backed securities, asset-backed securities or obligations
issued or guaranteed by the U.S. Government, its agencies or
instrumentalities.
f. Purchase or retain the securities of any issuer, if those individual
officers and directors of the Company, the officers and general partner of
the Investment Adviser, the directors of such general partner or the
officers and directors of any subsidiary thereof each owning beneficially
more than one-half of one percent of the securities of such issuer own in
the aggregate more than 5% of the securities of such issuer.
g. Invest in real estate limited partnership interests or interests in
oil, gas or other mineral leases, or exploration or development programs,
except that the Fund may invest in securities issued by companies that
engage in oil, gas or other mineral exploration or development activities.
h. Write, purchase or sell puts, calls, straddles, spreads or
combinations thereof, except to the extent permitted in the Prospectus and
Statement of Additional Information, as they may be amended from time to
time.
i. Notwithstanding fundamental investment restriction number 7 above,
borrow amounts in excess of 5% (20% in the case of the Developing Capital
Markets Focus and Global Bond Focus Funds and 10% in the case of the Global
Strategy Focus, Government Bond, International Equity Focus and Natural
Resources Focus Funds) of the total assets of the Fund, taken at market
value, and then only from banks as a temporary measure for extraordinary or
emergency purposes such as the redemption of Fund shares.(4)
j. Pledge greater than 10% (20% in the case of the Developing Capital
Markets Focus Fund) of its total assets, taken at market value at the time
of the pledge. For the purpose of this restriction, collateral arrangements
with respect to (i) transactions in options, foreign currency contracts,
futures contracts and options on futures contracts and (ii) initial and
variation margin are not deemed to be a pledge of assets.
k. Lend its portfolio securities in excess of 20% of its total assets,
taken at market value at the time of the loan, provided however that the
Quality Equity Fund may only make loans to New York Stock Exchange Member
firms, other brokerage firms having net capital of at least $10 million and
financial institutions, such as registered investment companies, banks and
insurance companies, having at least $10 million in capital and surplus.
l. In the case of the Global Utility Focus Fund only, invest less than
65% of its total assets in equity and debt securities issued by domestic
and foreign companies in the utilities industries, except during temporary
defensive periods.
m. In the case of each of the American Balanced Fund, the Basic Value
Focus Fund, the Equity Growth Fund, the High Current Income Fund, the Prime
Bond Fund and the Quality Equity Fund, invest in the securities of foreign
issuers except that each such Fund (except the American Balanced Fund) may
invest in securities of foreign issuers if at the time of acquisition no
more than 10% (25% in the case of the Quality Equity Fund) of its total
assets, taken at market value at the time of the investment, would be
invested in such securities. Consistent with the general policy of the
Securities and Exchange Commission, the nationality or domicile of an
issuer for determination of foreign issuer status may be (i) the country
under whose laws the issuer is organized, (ii) the country in which the
issuer's securities are principally traded, or (iii) a country in which the
issuer derives a significant proportion (at least 50%) of its revenues or
profits from goods produced or sold, investments made, or services
performed in the country, or in which at
- -------------------------
(4) In addition, the American Balanced, Basic Value Focus, Developing Capital
Markets Focus, Equity Growth, Global Strategy Focus, High Current Income,
Natural Resources Focus, Prime Bond and Quality Equity Funds will not
purchase securities while borrowings are outstanding, except, in the case
of the Developing Capital Markets Focus Fund, (a) to honor prior
commitments or (b) to exercise subscription rights where outstanding
borrowings have been obtained exclusively for settlements of other
securities transactions. The Global Bond Focus, Global Utility Focus and
International Equity Focus Funds will not purchase securities while
borrowings in excess of 5% of its total assets are outstanding.
8
<PAGE>
least 50% of the assets of the issuer are situated. See "Other Portfolio
Strategies--Foreign Securities" in the Prospectus.(5)
OVER-THE-COUNTER OPTIONS
The staff of the Commission has taken the position that purchased OTC
options and the assets used as cover for written OTC options are illiquid
securities. Therefore, the Company has adopted an investment policy pursuant
to which it will not purchase or sell OTC options if, as a result of such
transactions, the sum of the market value of OTC options currently outstanding
which are held by a Fund, the market value of the underlying securities
covered by OTC call options currently outstanding which were sold by the Fund
and margin deposits on the Fund's existing OTC options on futures contracts
exceeds 15% of the total assets of the Fund, taken at market value, together
with all other assets of the Fund which are illiquid or are otherwise not
readily marketable. However, if an OTC option is sold by a Fund to a primary
U.S. Government securities dealer recognized by the Federal Reserve Bank of
New York and if the Fund has the unconditional contractual right to repurchase
such OTC option from the dealer at a predetermined price, then the Fund will
treat as illiquid such amount of the underlying securities equal to the
repurchase price less the amount by which the option is "in-the-money" (i.e.,
current market value of the underlying securities minus the option's strike
price). The repurchase price with the primary dealers is typically a formula
price which is generally based on a multiple of the premium received for the
option, plus the amount by which the option is "in-the-money." This policy as
to OTC options is not a fundamental policy of any Fund and may be amended by
the Directors of the Company without the approval of the Company's
shareholders. However, the Company will not change or modify this policy prior
to the change or modification by the Commission staff of its position.
RESTRICTED SECURITIES
From time to time a Fund may invest in securities the disposition of which
is subject to legal restrictions, such as restrictions imposed by the
Securities Act of 1933 (the "Securities Act") on the resale of securities
acquired in private placements. If registration of such securities under the
Securities Act is required, such registration may not be readily accomplished
and if such securities may be sold without registration, such resale may be
permissible only in limited quantities. In either event, a Fund may not be
able to sell its restricted securities at a time which, in the judgement of
the Investment Adviser, would be most opportune.
Each of the Funds is subject to limitations on the amount of securities
which are illiquid, because of restrictions under the Securities Act or
otherwise, they may purchase. Each Fund may, however, purchase without regard
to that limitation securities that are not registered under the Securities
Act, but that can be offered and sold to "qualified institutional buyers"
under Rule 144A under the Securities Act, provided that the Company's Board of
Directors continuously determines, based on the trading markets for the
specific Rule 144A security, that it is liquid. The Board of Directors may
adopt guidelines and delegate to the Investment Adviser the daily function of
determining and monitoring liquidity of restricted securities. The Board has
determined that securities which are freely tradeable in their primary market
offshore should be deemed liquid. The Board, however, will retain sufficient
oversight and be ultimately responsible for the determinations.
Since it is not possible to predict with assurance exactly how the market
for restricted securities sold and offered under Rule 144A will develop, the
Board of Directors will carefully monitor the Fund's investments in these
securities, focusing on such factors, among others, as valuation, liquidity
and availability of information. This investment practice could have the
effect of increasing the level of illiquidity in a Fund to the extent that
qualified institutional buyers become for a time uninterested in purchasing
these restricted securities.
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(5) Notwithstanding this restriction, each of the Prime Bond Fund and the High
Current Income Fund may invest up to 25% of its total assets in securities
(i) issued, assumed or guaranteed by foreign governments, or political
subdivisions or instrumentalities thereof, (ii) assumed or guaranteed by
domestic issuers, including Eurodollar securities or (iii) issued, assumed
or guaranteed by foreign issuers having a class of securities listed for
trading on the New York Stock Exchange.
9
<PAGE>
PORTFOLIO STRATEGIES
Liquidity. In order to assure that each Fund has sufficient liquidity, as a
matter of operating policy no Fund may invest more than 10% of its net assets,
except that the Developing Capital Markets Focus Fund may not invest more than
15% of its net assets in securities for which market disposition is not
readily available. Market disposition may not be readily available for
repurchase agreements maturing in more than seven days and for securities
having restrictions on resale.
Lending of Portfolio Securities. Subject to any applicable investment
restriction above, each Fund may from time to time loan securities from its
portfolio to brokers, dealers and financial institutions and receive
collateral in cash, securities issued or guaranteed by the U.S. Government or,
in the case of the Domestic Money Market and Reserve Assets Fund, cash
equivalents which while the loan is outstanding will be maintained at all
times in an amount equal to at least 100% of the current market value of the
loaned securities. Such cash collateral will be invested in short-term
securities, the income from which will increase the return to the Fund. The
Fund will retain all rights of beneficial ownership as to the loaned portfolio
securities, including voting rights and rights to interest or other
distributions, and will have the right to regain record ownership of loaned
securities to exercise such beneficial rights. Such loans will be terminable
at any time. The Fund may pay reasonable finders', administrative and
custodial fees to persons unaffiliated with the Fund in connection with the
arranging of such loans. The dividends, interest and other distributions
received by the Company on loaned securities may, for tax purposes, be treated
as income other than qualified income for the 90% test discussed under
"Dividends, Distributions and Taxes--Federal Income Taxes." The Company
intends to lend portfolio securities only to the extent that such activity
does not jeopardize the Company's qualification as a regulated investment
company under Subchapter M of the Internal Revenue Code of 1986, as amended.
Forward Commitments. Securities may be purchased or sold on a delayed
delivery basis or may be purchased on a forward commitment basis by each of
the Company's Funds at fixed purchase terms with periods of up to 180 days
between the commitment and settlement dates. The purchase will be recorded on
the date the purchasing Fund enters into the commitment and the value of
security will thereafter be reflected in the calculation of the Fund's net
asset value. The value of the security on the delivery date may be more or
less than its purchase price. A separate account of the Fund will be
established with The Bank of New York or Brown Brothers Harriman & Co. (for
Developing Capital Markets Focus Fund) (the "Custodian") consisting of cash or
liquid securities having a market value at all times until the delivery date
at least equal to the amount of its commitments in connection with such
delayed delivery and purchase transactions. Although a Fund will generally
enter into forward commitments with the intention of acquiring securities for
its portfolio, it may dispose of a commitment prior to settlement if the
Investment Adviser deems it appropriate to do so. There can, of course, be no
assurance that the judgement upon which these techniques are based will be
accurate or that such techniques when applied will be effective. The Funds
will enter into forward commitment arrangements only with respect to
securities in which they may otherwise invest as described under "Investment
Objectives and Policies of the Funds" in the Prospectus.
Eurodollar and Yankeedollar Obligations. The Reserve Assets Fund (and, for
temporary or defensive purposes, the Natural Resources Focus, Global Strategy
Focus, Global Bond Focus, Global Utility Focus, International Equity Focus and
Developing Capital Markets Focus Funds) may invest in obligations issued by
foreign branches or subsidiaries of U.S. banks ("Eurodollar" obligations), by
U.S. branches or subsidiaries of foreign banks ("Yankeedollar" obligations),
or by foreign depository institutions and their foreign branches and
subsidiaries ("foreign bank obligations"). Investment in such obligations may
involve different risks from the risks of investing in obligations of U.S.
banks. Such risks include adverse political and economic developments, the
possible imposition of withholding taxes on interest income payable on such
obligations, the possible seizure or nationalization of foreign deposits and
the possible establishment of exchange controls or other foreign governmental
laws or restrictions which might adversely affect the payment of principal and
interest. Generally the issuers of such obligations are subject to fewer U.S.
regulatory requirements than are applicable to U.S. banks. Foreign depository
institutions and their foreign branches and subsidiaries, and foreign branches
or subsidiaries of U.S. banks, may be subject to less stringent reserve
requirements than U.S. banks. U.S. branches or subsidiaries of foreign banks
are subject to the reserve requirements of the state in which they are
located.
10
<PAGE>
There may be less publicly available information about a foreign depository
institution, branch or subsidiary, or a U.S. branch or subsidiary of a foreign
bank, than about a U.S. bank, and such institutions may not be subject to the
same accounting, auditing and financial record keeping standards and
requirements as U.S. banks. Evidence of ownership of Eurodollar and foreign
bank obligations may be held outside of the United States, and a Fund may be
subject to the risks associated with the holding of such property overseas.
Eurodollar and foreign bank obligations of the Fund held overseas will be held
by foreign branches of the Custodian for the Fund or by other U.S. or foreign
banks under subcustodian arrangements complying with the requirements of the
Investment Company Act of 1940.
The Investment Adviser will consider the above factors in making investments
in Eurodollar, Yankeedollar and foreign bank obligations and will not
knowingly purchase obligations which, at the time of purchase, are subject to
exchange controls or withholding taxes. Generally, the Reserve Assets Fund
will limit its Yankeedollar investments to obligations of banks organized in
Canada, France, Germany, Japan, the Netherlands, Switzerland, the United
Kingdom and other western industrialized nations.
Standby Commitment Agreements. The High Current Income Fund, Global Utility
Focus Fund, International Equity Focus Fund and Developing Capital Markets
Focus Fund may from time to time enter into standby commitment agreements.
Such agreements commit a Fund, for a stated period of time, to purchase a
stated amount of a fixed income security which may be issued and sold to the
Fund at the option of the issuer. The price and coupon of the security is
fixed at the time of the commitment. At the time of entering into the
agreement the Fund is paid a commitment fee, regardless of whether or not the
security is ultimately issued, which is typically approximately 0.5% of the
aggregate purchase price of the security which the Fund has committed to
purchase. A Fund will enter into such agreements only for the purpose of
investing in the security underlying the commitment at a yield and price which
is considered advantageous to the Fund. A Fund will not enter into a standby
commitment with a remaining term in excess of 45 days and will limit its
investment in such commitments so that the aggregate purchase price of the
securities subject to such commitments, together with the value of portfolio
securities subject to legal restrictions on resale, will not exceed 10% of its
assets taken at the time of acquisition of such commitment or security. A Fund
will at all times maintain a segregated account with its custodian of cash or
liquid securities in an amount equal to the purchase price of the securities
underlying the commitment.
There can be no assurance that the securities subject to a standby
commitment will be issued and the value of the security, if issued, on the
delivery date may be more or less than its purchase price. Since the issuance
of the security underlying the commitment is at the option of the issuer, a
Fund may bear the risk of a decline in the value of such security and may not
benefit from an appreciation in the value of the security during the
commitment period.
The purchase of a security subject to a standby commitment agreement and the
related commitment fee will be recorded on the date on which the security can
reasonably be expected to be issued and the value of the security will
thereafter be reflected in the calculation of a Fund's net asset value. If the
security is issued, the cost basis of the security will be adjusted by the
amount of the commitment fee. In the event the security is not issued, the
commitment fee will be recorded as income on the expiration date of the
standby commitment.
MANAGEMENT OF THE COMPANY
The Directors and executive officers of the Company and their ages and
principal occupations for at least the last five years are set forth below.
Unless otherwise noted, the address of each executive officer and director is
P.O. Box 9011, Princeton, New Jersey 08543-9011.
Arthur Zeikel (64)--President and Director(1)(2)--President of the
Investment Adviser (which term as used herein includes its corporate
predecessors) since 1977; President of Fund Asset Management, L.P. ("FAM")
(which term as used herein includes its corporate predecessors) since 1977;
President and Director of Princeton Services, Inc. ("Princeton Services")
since 1993; Executive Vice President of Merrill Lynch & Co., Inc. ("ML&Co.")
since 1990; Director of the Merrill Lynch Funds Distributor, Inc. (the
"Distributor").
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Walter Mintz (68)--Director--1114 Avenue of the Americas, New York, New York
10036. Special Limited Partner of Cumberland Partners (investment partnership)
since 1982.
Melvin R. Seiden (67)--Director--780 Third Avenue, Suite 2502, New York, New
York 10017. Director of Silbanc Properties, Ltd. (real estate, consulting and
investments) since 1996 and President thereof since 1987; Chairman and
President of Seiden & de Cuevas, Inc. (private investment firm) from 1964 to
1987.
Stephen B. Swensrud (63)--Director--24 Federal Street, Suite 400, Boston,
Massachusetts 02110. Chairman of Fernwood Associates (financial consultants)
since 1996 and Principal thereof since 1975.
Joe Grills (62)--Director--183 Soundview Lane, New Canaan, Connecticut
06840. Member of the Committee of Investment of Employee Benefit Assets of the
Financial Executives Institute ("CIEBA") since 1986, member of CIEBA's
Executive Committee since 1988 and its Chairman from 1991 to 1992; Assistant
Treasurer of International Business Machines Incorporated ("IBM") and Chief
Investment Officer of IBM Retirement Funds from 1986 until 1993; Member of the
Investment Advisory Committee of the State of New York Common Retirement Fund;
Director, Duke Management Company since 1993; Director, LaSalle Street Fund
since 1995; Director, Kimco Realty Corporation since January 1997.
Robert S. Salomon, Jr. (60)--Director--106 Dolphin Cove Quay, Stamford,
Connecticut 06902. Principal of STI Management (investment adviser); Director,
Common Fund and the Norwalk Community Technical College Foundation; Chairman
and CEO of Salomon Brothers Asset Management from 1992 until 1995; Chairman of
Salomon Brothers equity mutual funds from 1992 until 1995; Director of Stock
Research and U.S. Equity Strategist at Salomon Brothers from 1975 until 1991.
Terry K. Glenn (56)--Executive Vice President(1)(2)--Executive Vice
President of the Investment Adviser and FAM since 1983; Executive Vice
President and Director of Princeton Services since 1993; President of the
Distributor since 1986 and Director thereof since 1991; President of Princeton
Administrators, L.P. since 1988.
Norman Harvey (63)--Senior Vice President(1)(2)--Senior Vice President of
the Investment Adviser and FAM since 1982.
Peter A. Lehman (38)--Senior Vice President(1)(2)--Vice President of the
Investment Adviser since 1994 and employee of the Investment Adviser since
1992.
Joseph T. Monagle, Jr. (48)--Senior Vice President(1)(2)--Senior Vice
President of the Investment Adviser since 1990; Vice President of MLAM from
1978 to 1990.
Donald C. Burke (36)--Vice President(1)(2)--Vice President of the Investment
Adviser since 1990.
Vincent T. Lathbury, III (56)--Vice President(1)(2)--Vice President of the
Investment Adviser and FAM and Portfolio Manager of the Investment Adviser and
FAM since 1982.
Thomas R. Robinson (53)--Vice President(1)(2)--Senior Portfolio Manager of
the Investment Adviser since November 1995; Manager of International Equity
Strategy of ML&Co.'s Global Securities Research and Economics Group from 1989
to 1995.
Kevin Rendino (30)--Vice President(1)(2)--Vice President of the Investment
Adviser since December 1993; Senior Research Analyst from 1990 to 1992;
Corporate Analyst from 1988 to 1990.
Walter D. Rogers (54)--Vice President(1)(2)--Vice President of the
Investment Adviser since 1987; Vice President of Continental Insurance Asset
Management from 1984 to 1987.
Grace Pineda (40)--Vice President(1)(2)--Vice President of the Investment
Adviser since 1989. Prior to joining the Investment Adviser, Ms. Pineda was a
portfolio manager with Clemente Capital, Inc.
12
<PAGE>
Andrew John Bascand (33)--Vice President(1)(2)--Director of Merrill Lynch
Asset Management U.K. Limited since 1993 and Director of Merrill Lynch Global
Asset Management Limited since 1994; Senior Economist of A.M.P. Asset
Management plc in London from 1992 to 1993 and Chief Economist of A.M.P.
Investments (NZ) in New Zealand from 1989 to 1991; Economic Adviser to the
Chief Economist of the Reserve Bank of New Zealand from 1987 to 1989.
Robert Parish (42)--Vice President(1)(2)--Vice President and Portfolio
Manager of the Investment Adviser since 1991; Portfolio Manager of Templeton
International from 1986 to 1991 and Vice President thereof from 1989.
Jay C. Harbeck (62)--Vice President(1)(2)--Vice President of the Investment
Adviser since 1986.
Jacqueline Rogers (38)--Vice President(1)(2)--Vice President of the
Investment Adviser since January 1986.
Aldona A. Schwartz (48)--Vice President(1)(2)--Vice President of the
Investment Adviser since 1991 and an employee of the Investment Adviser since
1986.
Sean Casey (41)--Vice President--Vice President of the Investment Adviser
since 1995; Chief Investment Officer, Chase Asset Management from 1990 to
1995.
P. Valle (39)--Vice President--Vice President of the Investment Adviser
since 1992.
Gerald M. Richard (47)--Treasurer(1)(2)--Senior Vice President and Treasurer
of the Investment Adviser and FAM since 1984; Treasurer of the Distributor
since 1984 and Vice President since 1981; and Senior Vice President and
Treasurer of Princeton Administrators, Inc. since 1988.
Ira P. Shapiro (34)--Secretary(1)(2)--Vice President of the Investment
Adviser since 1997 and Attorney associated with the Investment Adviser and FAM
since 1993. Prior to 1993 Mr. Shapiro was an attorney in private practice.
- -------------------------
(1) Interested person, as defined in the Investment Company Act of 1940, of
the Company.
(2) The Officers of the Company are officers of certain other investment
companies for which the Investment Adviser or FAM acts as investment
adviser.
The following table sets forth for the fiscal year ended December 31, 1996,
compensation paid by the Fund to the non-interested Directors and for the
calendar year ended December 31, 1996, the aggregate compensation paid by all
investment companies (including the Company) advised by the Investment Adviser
and its affiliate, FAM ("MLAM/FAM Advised Funds") to the non-interested
Directors:
<TABLE>
<CAPTION>
PENSION OR RETIREMENT TOTAL COMPENSATION FROM
AGGREGATE BENEFITS ACCRUED COMPANY AND
COMPENSATION AS PART OF MLAM/FAM ADVISED
NAME OF DIRECTOR FROM COMPANY COMPANY EXPENSE FUNDS PAID TO DIRECTORS(1)
---------------- ------------ --------------------- --------------------------
<S> <C> <C> <C>
Walter Mintz(1)......... $20,000 NONE $164,000
Melvin R. Seiden(1)..... $20,000 NONE $164,000
Stephen B. Swensrud(1).. $17,500 NONE $154,250
Joe Grills(1)........... $20,000 NONE $164,000
Robert S. Salomon,
Jr.(1)................. $18,750 NONE $187,167
</TABLE>
- -------------------------
(1) The Directors serve on the boards of other MLAM/FAM Advised Funds as
follows: Mr. Grills (18 registered investment companies consisting of 37
portfolios); Mr. Mintz (18 registered investment companies consisting of
37 portfolios); Mr. Salomon (18 registered investment companies consisting
of 37 portfolios); Mr. Seiden (18 registered investment companies
consisting of 38 portfolios); and Mr. Swensrud (24 registered investment
companies consisting of 52 portfolios).
13
<PAGE>
Mr. Zeikel and the officers of the Company owned on March 31, 1997 in the
aggregate less than 1% of the outstanding Common Stock of Merrill Lynch & Co.,
Inc. The Company has an Audit Committee consisting of all of the directors of
the Company who are not interested persons of the Company.
Pursuant to the terms of the Investment Advisory Agreements, the Investment
Adviser pays all compensation of officers and employees of the Company as well
as the fees of all directors of the Company who are affiliated persons of
Merrill Lynch & Co., Inc. or its subsidiaries. The fees payable by the Company
to non-interested directors are $5,000 per year plus $1,250 per quarterly
meeting of the Board of Directors attended, $5,000 per year for serving on the
Audit Committee of the Board of Directors plus $1,250 per meeting of the Audit
Committee attended if such meeting is held on a day other than a day on which
the Board of Directors meets, and reimbursement of out-of-pocket expenses. For
the year ended December 31, 1996, such fees and expenses aggregated $88,545.
14
<PAGE>
INVESTMENT ADVISORY ARRANGEMENTS
The Company has entered into seven separate investment advisory agreements
(the "Investment Advisory Agreements") relating to the Funds with the
Investment Adviser, which is a wholly owned subsidiary of Merrill Lynch & Co.,
Inc. The principal business address of the Investment Adviser is 800 Scudders
Mill Road, Plainsboro, New Jersey 08536. The Investment Adviser and FAM
currently act as the investment adviser to over 130 other registered
investment companies.
The principal executive officers and directors of the Investment Adviser are
Arthur Zeikel, President; Terry K. Glenn, Executive Vice President; Vincent R.
Giordano, Senior Vice President; Elizabeth Griffin, Senior Vice President;
Norman R. Harvey, Senior Vice President; Michael J. Hennewinkel, Senior Vice
President; N. John Hewitt, Senior Vice President; Philip L. Kirstein, Senior
Vice President, General Counsel, Director and Secretary; Ronald M. Kloss,
Senior Vice President and Controller; Richard L. Reller, Senior Vice
President; Stephen M. M. Miller, Senior Vice President; Joseph T. Monagle,
Senior Vice President; Michael L. Quinn, Senior Vice President; Gerald M.
Richard, Senior Vice President and Treasurer; Ronald L. Welburn, Senior Vice
President; and Anthony Wiseman, Senior Vice President.
Securities held by any Fund may also be held by other funds for which the
Investment Adviser or FAM acts as an adviser or by investment advisory clients
of the Investment Adviser. Because of different investment objectives or other
factors, a particular security may be bought for one or more clients when one
or more clients are selling the same security. If purchases or sales of
securities for any Fund or other funds for which the Investment Adviser or FAM
acts as investment adviser or for their advisory clients arise for
consideration at or about the same time, transactions in such securities will
be made, insofar as feasible, for the respective funds and clients in a manner
deemed equitable to all. To the extent that transactions on behalf of more
than one client of the Investment Adviser or FAM during the same period may
increase the demand for securities being purchased or the supply of securities
being sold, there may be an adverse effect on price.
Advisory Fee. As compensation for its services to the Company and its Funds,
the Investment Adviser receives a fee from the Company at the end of each
month at an annual rate of 0.75% of the average daily net assets of the Equity
Growth Fund and International Equity Focus Fund, 0.65% of the average daily
net assets of each of the Natural Resources Focus Fund and Global Strategy
Focus Fund, 0.55% of the average daily net assets of the American Balanced
Fund, 0.50% of the average daily net assets of the Domestic Money Market Fund
and Government Bond Fund, 0.60% of the average daily net assets of the Basic
Value Focus Fund, Global Bond Focus Fund and Global Utility Focus Fund, 1.00%
of the average daily net assets of the Developing Capital Markets Focus Fund,
0.30% of the average daily net assets of the Index 500 Fund and at the
following annual rates with respect to the other Funds:
RESERVE ASSETS FUND
Portion of average daily value of net assets of the Fund:
<TABLE>
<CAPTION>
ADVISORY
FEE
--------
<S> <C>
Not exceeding $500 million........................................ 0.500%
In excess of $500 million but not exceeding $750 million.......... 0.425%
In excess of $750 million but not exceeding $1 billion............ 0.375%
In excess of $1 billion but not exceeding $1.5 billion............ 0.350%
In excess of $1.5 billion but not exceeding $2 billion............ 0.325%
In excess of $2 billion but not exceeding $2.5 billion............ 0.300%
In excess of $2.5 billion......................................... 0.275%
</TABLE>
15
<PAGE>
QUALITY EQUITY FUND
Portion of average daily value of net assets of the Fund:
<TABLE>
<S> <C>
Not exceeding $250 million.......................................... 0.500%
In excess of $250 million but not exceeding $300 million............ 0.450%
In excess of $300 million but not exceeding $400 million............ 0.425%
In excess of $400 million........................................... 0.400%
</TABLE>
PRIME BOND FUND AND HIGH CURRENT INCOME FUND
Portion of aggregate average daily value of net assets of both Funds:
<TABLE>
<CAPTION>
ADVISORY FEE
-----------------------
HIGH CURRENT PRIME BOND
INCOME FUND FUND
------------ ----------
<S> <C> <C>
Not exceeding $250 million............................ 0.55% 0.50%
In excess of $250 million but not more than $500 mil-
lion................................................. 0.50% 0.45%
In excess of $500 million but not more than $750 mil-
lion................................................. 0.45% 0.40%
In excess of $750 million............................. 0.40% 0.35%
</TABLE>
These fee rates are applied to the average daily net assets of each Fund,
with the reduced rates shown below applicable to portions of each Fund to the
extent that the aggregate of the average daily net assets of the combined Fund
exceed $250 million, $300 million, $400 million and $800 million (each such
amount being a "breakpoint level"). The portion of the assets of a Fund to
which the rate at each breakpoint level applies will be determined on a
"uniform percentage" basis. The uniform percentage applicable to a breakpoint
level is determined by dividing the amount of the aggregate of the average
daily net assets of the combined Fund that falls within that breakpoint level
by the aggregate of the average daily net assets of the combined Fund. The
amount of the fee for a Fund at each breakpoint level is determined by
multiplying the average daily net assets of that Fund by the uniform
percentage applicable to that breakpoint level and multiplying the product by
the advisory fee rate.
The Investment Adviser and Merrill Lynch Life Agency, Inc. ("MLLA") entered
into two reimbursement agreements, dated April 30, 1985 and February 11, 1992
(the "Reimbursement Agreements"), that provide that the expenses paid by each
Fund (excluding interest, taxes, brokerage fees and commissions and
extraordinary charges such as litigation costs) will be limited to 1.25% of
its average net assets. Any expenses in excess of this percentage will be
reimbursed to the Fund by the Investment Adviser which, in turn, will be
reimbursed by MLLA. The Reimbursement Agreements may be amended or terminated
by the parties thereto upon prior written notice to the Company. For the
fiscal year ended December 31, 1994, the Investment Adviser earned fees of
$16,313,767 from the Company and reimbursed $8,915 for the Developing Capital
Markets Focus Fund, $55,475 for the International Bond Fund (now part of the
Global Bond Focus Fund) and $50,942 for the Government Bond Fund. For the
fiscal year ended December 31, 1995, the Investment Adviser earned fees of
$21,376,742 and reimbursed $49,477 for the Developing Capital Markets Focus
Fund, $190,005 for the Government Bond Fund, and $112,261 for the
International Bond Fund (now part of the Global Bond Focus Fund). Except to
the extent required pursuant to the aforementioned agreements, the Investment
Adviser does not intend to reimburse the Global Bond Focus Fund for such
Fund's operating expenses. For the fiscal year ended December 31, 1996, the
Investment Adviser earned fees of $765,718 for the Developing Capital Markets
Focus Fund of which $52,388 was voluntarily waived, $297,926 for the
Government Bond Fund of which $264,214 was voluntarily waived, and $1,638 for
the Index 500 Fund, all of which was voluntarily waived. In addition, the
Investment Adviser has also reimbursed the Index 500 Fund $1,651 in additional
expenses.
The Investment Advisory Agreements relating to the Company's Funds, unless
earlier terminated as described below, will continue in effect from year to
year if approved annually (a) by the Board of Directors of the Company or by a
majority of the outstanding shares of the respective Funds, and (b) by a
majority of the directors who are not parties to such contracts or interested
persons (as defined in the Investment Company Act of 1940) of any such party.
The Board of Directors of the Company approved the continuation of the
Investment
16
<PAGE>
Advisory Agreements relating to all Funds, other than the Index 500 Fund, at a
meeting held on March 26, 1997. The Board of Directors of the Company approved
the Investment Advisory Agreement relating to the Index 500 Fund at a meeting
held on October 16, 1996. The Investment Advisory Agreements are not
assignable and may be terminated without penalty on 60 days' written notice at
the option of either party or by the vote of the shareholders of the
respective Funds.
The Investment Adviser has entered into a sub-advisory agreement (the "Sub-
Advisory Agreement") with MLAM U.K., an indirect wholly owned subsidiary of ML
& Co., and an affiliate of the Investment Adviser, pursuant to which the
Investment Adviser pays MLAM U.K. a fee for providing investment advisory
services to the Investment Adviser with respect to the Funds in an amount to
be determined from time to time by the Investment Adviser and MLAM U.K. but in
no event in excess of the amount that the Investment Adviser actually receives
for providing services to the Funds pursuant to the Investment Advisory
Agreement.
The Investment Adviser has entered into administrative services agreements
with certain Insurance Companies, including MLLIC and ML of New York, pursuant
to which the Investment Adviser compensates such companies for administrative
responsibilities relating to the Company which are performed by such Insurance
Companies.
Payment of Expenses. The Investment Advisory Agreements obligate the
Investment Adviser to provide investment advisory services and to pay all
compensation of and furnish office space for officers and employees of the
Company connected with investment and economic research, trading and
investment management of the Funds, as well as the fees of all directors of
the Company who are affiliated persons of Merrill Lynch & Co., Inc. or any of
its subsidiaries. Each Fund will pay all other expenses incurred in its
operation, including a portion of the Company's general administrative
expenses allocated on the basis of the Fund's asset size. Expenses that will
be borne directly by the Funds include redemption expenses, expenses of
portfolio transactions, shareholder servicing costs, expenses of registering
the shares under federal and state securities laws, pricing costs (including
the daily calculation of net asset value), interest, certain taxes, charges of
the Custodian and Transfer Agent and other expenses attributable to a
particular Fund. Expenses which will be allocated on the basis of size of the
respective Funds include directors' fees, legal expenses, state franchise
taxes, auditing services, costs of printing proxies and stock certificates,
Securities and Exchange Commission fees, accounting costs and other expenses
properly payable by the Company and allocable on the basis of size of the
respective Funds. Accounting services are provided for the Company by the
Investment Adviser, and the Company reimburses the Investment Adviser for its
costs in connection with such services. For the fiscal year ended December 31,
1996, the amount of such reimbursement was $903,975. Depending upon the nature
of the lawsuit, litigation costs may be directly applicable to the Funds or
allocated on the basis of the size of the respective Funds. The Board of
Directors has determined that this is an appropriate method of allocation of
expenses.
DETERMINATION OF NET ASSET VALUE
As set forth in the Prospectus, since the net investment income of the
Domestic Money Market and Reserve Assets Funds (including realized gains and
losses on its portfolio securities) is declared as a dividend each time the
net income of the Funds are determined (see "Dividends, Distributions and
Taxes"), the net asset value per share of the Funds normally remains at $1.00
per share immediately after each such determination and dividend declaration.
The Board of Directors of the Company expects that the Domestic Money Market
and Reserve Assets Funds will have a positive net income at the time of each
determination. If for any reason the net income of either Fund is a negative
amount (i.e., net realized and unrealized losses and expenses exceed interest
income), that Fund will reduce the number of its outstanding shares. This
reduction will be effected by having the Separate Accounts of the Insurance
Companies proportionately contribute to the capital of the Fund the necessary
shares that represent the amount of the excess upon such determination. It is
anticipated that the Insurance Companies will agree to such contribution in
these circumstances. Any such contribution will be treated as a negative
dividend for purposes of the Net Investment Factor under the Contracts
described in the Prospectus for the Contracts. See "Dividends, Distributions
and Taxes" for a discussion of the tax effect of such a reduction. This
procedure will permit the net asset value per share of the Domestic Money
Market and Reserve Assets Funds to be maintained at a constant value of $1.00
per share.
17
<PAGE>
If in the view of the Board of Directors of the Company it is inadvisable to
continue the practice of maintaining the net asset value of the Domestic Money
Market and Reserve Assets Funds at $1.00 per share, the Board of Directors of
the Company reserves the right to alter the procedure. The Company will notify
the Insurance Companies of any such alteration.
Each of the International Equity Focus Fund, Global Utility Focus Fund,
Global Bond Focus Fund and Developing Capital Markets Focus Fund may invest a
substantial portion of its assets in foreign securities which are traded on
days on which such Fund's net asset value is not computed. On any such day,
shares of such a Fund may not be purchased or redeemed since shares of a Fund
may only be purchased or redeemed on days on which the Fund's net asset value
is computed.
As set forth in the Prospectus, securities held by the Domestic Money Market
and Reserve Assets Funds with a remaining maturity of 60 days or less are
valued on an amortized cost basis, unless particular circumstances dictate
otherwise. Under this method of valuation, the security is initially valued at
cost on the date of purchase (or in the case of securities purchased with more
than 60 days remaining to maturity, the market value on the 61st day prior to
maturity); and thereafter the Domestic Money Market and Reserve Assets Funds
assume a constant proportionate amortization in value until maturity of any
discount or premium, regardless of the impact of fluctuating interest rates on
the market value of the security. For purposes of this method of valuation,
the maturity of a variable rate certificate of deposit is deemed to be the
next coupon date on which the interest rate is to be adjusted. If, due to the
impairment of the creditworthiness of the issuer of a security held by either
Fund or to other factors with respect to such security, the fair value of such
security is not fairly reflected through the amortized cost method of
valuation, such security will be valued at fair value as determined in good
faith by the Board of Directors.
PORTFOLIO TRANSACTIONS AND BROKERAGE
If the securities in which a particular Fund of the Company invests are
traded primarily in the over-the-counter market, where possible, the Fund will
deal directly with the dealers who make a market in the securities involved,
except in those circumstances where better prices and execution are available
elsewhere. Such dealers usually are acting as principals for their own
account. On occasions, securities may be purchased directly from the issuer.
Bonds and money market securities are generally traded on a net basis and do
not normally involve either brokerage commissions or transfer taxes. The cost
of executing portfolio securities transactions of each Fund will primarily
consist of brokerage commissions or underwriter or dealer spreads. Under the
Investment Company Act of 1940, persons affiliated with the Company are
prohibited from dealing with the Company as a principal in the purchase and
sale of the Company's portfolio securities unless an exemptive order allowing
such transactions is obtained from the Securities and Exchange Commission.
Since over-the-counter transactions are usually principal transactions,
affiliated persons of the Company, including Merrill Lynch Government
Securities Inc. ("GSI"), Merrill Lynch Money Markets Inc. ("MMI") and Merrill
Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch"), may not serve as
the Company's dealer in connection with such transactions except pursuant to
exemptive orders from the Securities and Exchange Commission, such as the one
described below. However, affiliated persons of the Company may serve as its
broker in over-the-counter transactions conducted on an agency basis, subject
to the Company's policy of obtaining best price and execution. The Company may
not purchase securities from any underwriting syndicate of which Merrill Lynch
is a member except in accordance with rules and regulations under the
Investment Company Act of 1940.
The Securities and Exchange Commission has issued an exemptive order
permitting the Company to conduct principal transactions with respect to the
Domestic Money Market and Reserve Assets Funds with GSI and MMI in U.S.
Government and government agency securities, and certain other money market
securities, subject to a number of conditions, including conditions designed
to insure that the prices to the Funds available from GSI and MMI are equal to
or better than those available from other sources. GSI and MMI have informed
the Company that they will in no way, at any time, attempt to influence or
control the activities of the Company or the Investment Adviser in placing
such principal transactions. The exemptive order allows GSI and MMI to receive
a dealer spread on any transaction with the Company no greater than their
customary dealer spreads for
18
<PAGE>
transactions of the type involved. Certain court decisions have raised
questions as to whether investment companies should seek to "recapture"
brokerage commissions and underwriting and dealer spreads by effecting their
purchases and sales through affiliated entities. In order to effect such an
arrangement, the Company would be required to seek an exemption from the
Investment Company Act so that it could engage in principal transactions with
affiliates. The Board of Directors has considered the possibilities of seeking
to recapture spreads for the benefit of the Company and, after reviewing all
factors deemed relevant, has made a determination not to seek such recapture
at this time. The Board will reconsider this matter from time to time. The
Company will take such steps as may be necessary to effect recapture,
including the filing of applications for exemption under the Investment
Company Act of 1940, if the Directors should determine that recapture is in
the best interests of the Company or otherwise required by developments in the
law.
While the Investment Adviser seeks to obtain the most favorable net results
in effecting transactions in the Funds' portfolio securities, dealers who
provide supplemental investment research of the Investment Adviser may receive
orders for transactions by the Funds. Such supplemental research services
ordinarily consist of assessments and analysis of the business or prospects of
a company, industry or economic sector. If, in the judgement of the Investment
Adviser, a particular Fund or Funds will be benefited by such supplemental
research services, the Investment Adviser is authorized to pay spreads or
commissions to brokers or dealers furnishing such services which are in excess
of spreads or commissions which another broker or dealer may charge for the
same transaction. Information so received will be in addition to and not in
lieu of the services required to be performed by the Investment Adviser under
the Investment Advisory Agreements. The expenses of the Investment Adviser
will not necessarily be reduced as a result of the receipt of such
supplemental information. In some cases, the Investment Adviser may use such
supplemental research in providing investment advice to its other investment
advisory accounts. For the fiscal year ended December 31, 1995, the Company
paid brokerage commissions of $5,789,335, of which $264,999 was paid to
Merrill Lynch. For the fiscal year ended December 31, 1996, the Company paid
brokerage commissions of $6,656,814 of which $266,405 was paid to Merrill
Lynch.
PORTFOLIO TURNOVER
Each Fund has a different expected rate of portfolio turnover; however, rate
of portfolio turnover will not be a limiting factor when management of the
Company deems it appropriate to purchase or sell securities for a Fund.
Because of the short-term nature of the securities in which the Domestic Money
Market and Reserve Assets Funds will invest, and because such Funds'
investments will be constantly changing in response to market conditions, no
portfolio turnover rate may be accurately stated for the Domestic Money Market
and Reserve Assets Funds.
Below are portfolio turnover rates for each of the Funds for the fiscal
years ended December 31, 1996 and December 31, 1995:
<TABLE>
<CAPTION>
1996 1995
------- -------
<S> <C> <C>
American Balanced Fund..................................... 236.50% 38.40%
Basic Value Focus Fund..................................... 68.41% 74.10%
Developing Capital Markets Focus Fund...................... 87.33% 62.53%
Equity Growth Fund......................................... 80.84% 96.79%
Global Bond Focus Fund*.................................... 267.13% 132.57%
Global Strategy Focus Fund*................................ 173.44% 27.23%
Global Utility Focus Fund.................................. 11.39% 11.05%
Government Bond Fund*...................................... 21.23% 45.39%
High Current Income Fund................................... 48.92% 41.60%
International Equity Focus Fund............................ 49.87% 100.02%
Natural Resources Focus Fund............................... 31.11% 30.15%
Prime Bond Fund............................................ 91.88% 90.12%
Quality Equity Fund........................................ 88.30% 140.32%
Index 500 Fund............................................. .04%** --
</TABLE>
19
<PAGE>
- -------------------------
* In connection with a reorganization on December 6, 1996 conducted by the
Company with respect to certain of its Funds, the Company, with the
approval of the affected shareholders of the Funds, caused (i) Global Bond
Focus Fund (a) to acquire substantially all of the assets and assume
substantially all the liabilities of the International Bond Fund, a
separate Fund of the Company, (b) to implement a change in its investment
objective and policies from seeking high current income from a global
portfolio of fixed income securities, including non-investment grade
securities, to seeking a high total investment return by investing in a
global portfolio of investment grade fixed income securities and (c) to
change its name from the World Income Focus Fund to its current name; (ii)
the Government Bond Fund (x) to implement a change in its investment
objective so that the Fund may invest in any debt securities issued or
guaranteed by the U.S. Government, its agencies or instrumentalities
without regard to remaining maturity and (y) to change its name from the
Intermediate Government Bond Fund to its current name; and (iii) the Global
Strategy Focus Fund to acquire substantially all of the assets and assume
substantially all the liabilities of the Flexible Strategy Fund, a separate
Fund of the Company. As a result, the portfolio turnover rates for the
fiscal years set forth in the table for the Global Bond Focus Fund, the
Global Strategy Focus Fund and the Government Bond Fund may not be
indicative of future portfolio turnover rates of such Funds.
** For the period from December 13, 1996 (commencement of operations) to
December 31, 1996.
REDEMPTION OF SHARES
The right to redeem shares or to receive payment with respect to any
redemption may only be suspended for any period during which trading on the
New York Stock Exchange is restricted as determined by the Securities and
Exchange Commission or such Exchange is closed (other than customary weekend
and holiday closings), for any period during which an emergency exists as
defined by the Securities and Exchange Commission as a result of which
disposal of portfolio securities or determination of the net asset value of
each Fund is not reasonably practicable, and for such other periods as the
Securities and Exchange Commission may by order permit for the protection of
shareholders of each Fund.
DIVIDENDS, DISTRIBUTIONS AND TAXES
DIVIDENDS AND DISTRIBUTIONS
Reference is made to "Dividends, Distributions and Taxes" in the Prospectus.
FEDERAL INCOME TAXES
Under the Internal Revenue Code of 1986, as amended (the "Code"), each Fund
of the Company will be treated as a separate corporation for federal income
tax purposes and, thus, each Fund is required to satisfy the qualification
requirements under the Code for treatment as a regulated investment company.
There will be no offsetting of capital gains and losses among the Funds. Each
Fund intends to continue to qualify as a regulated investment company under
certain provisions of the Code. Under such provisions, a Fund will not be
subject to federal income tax on such part of its net ordinary income and net
realized capital gains which it distributes to shareholders. To qualify for
treatment as a regulated investment company, a Fund must, among other things,
derive in each taxable year at least 90% of its gross income from dividends,
interest, payments with respect to securities loans, and gains from the sale
or other disposition of securities and derive less than 30% of its gross
income in each taxable year from the gains (without deduction for losses) from
the sale or other disposition of stocks, securities, certain options, futures
or forward contracts and certain foreign currencies held for less than three
months. In addition, the Code requires that each Fund meet certain
diversification requirements, including the requirement that not more than 25%
of the value of a Fund's total assets be invested in the securities (other
than U.S. Government securities or the securities of other regulated
investment companies) of any one issuer.
20
<PAGE>
Each of the Company's Funds, including the Natural Resources Focus Fund,
intends to comply with the above-described requirements.
On occasion, some amount of the distributions of the Domestic Money Market
Fund or the Reserve Assets Fund for a fiscal year may constitute a return of
capital, in which case such amount would be applied against and reduce the
Separate Account's tax basis in shares of such Fund. If such amount were to
exceed the Separate Account's tax basis for shares of the Domestic Money
Market Fund or the Reserve Assets Fund, the excess would be treated as gain
from the sale or exchange of such shares.
On occasion the net income of the Domestic Money Market Fund or the Reserve
Assets Fund may be a negative amount as a result of a net decline in the value
of the portfolio securities of the Fund which is in excess of the interest
earned. Consequently, the Fund will reduce the number of its outstanding
shares to reflect the negative net income. The adjustment may result in gross
income to shareholders in excess of the net dividend credited to such
shareholders for a period. In such a case, such shareholders' tax basis in the
shares of the Domestic Money Market Fund or the Reserve Assets Fund may be
adjusted to reflect the difference between taxable income and net dividends
actually distributed. Such difference may be realized as a capital loss when
the shares are liquidated.
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and Treasury Regulations presently in effect. For the
complete provisions, reference should be made to the pertinent Code sections
and the Treasury Regulations promulgated thereunder. The Code and these
Regulations are subject to change by legislative or administrative action, and
such change may apply retroactively.
DISTRIBUTION ARRANGEMENTS
The Company has entered into a distribution agreement (the "Distribution
Agreement") with Merrill Lynch Funds Distributor, Inc. with respect to the
sale of the Company's shares to the Distributor for resale to Insurance
Companies' accounts. Such shares will be sold at their respective net asset
values and therefore will involve no sales charge. The Distributor is a wholly
owned subsidiary of the Investment Adviser. The continuation of the
Distribution Agreement was approved by the Company's Board of Directors at a
meeting held on March 26, 1997 and will continue in effect until June 30,
1998.
The Distribution Agreement is subject to the same renewal requirements and
termination provisions as the Investment Advisory Agreements described above.
PERFORMANCE DATA
From time to time the average annual total return and other total return
data, as well as yield, of one or more of the Company's Funds may be included
in advertisements or information furnished to present or prospective Contract
Owners. Total return and yield figures are based on the Fund's historical
performance and are not intended to indicate future performance. Average
annual total return and yield are determined in accordance with formulas
specified by the Securities and Exchange Commission. In connection with its
reorganization on December 6, 1996, the Global Bond Focus Fund (i) acquired
substantially all of the assets and assumed substantially all the liabilities
of the International Bond Fund, a separate Fund of the Company, (ii)
implemented a change in its investment objective and policies from seeking
high current income from a global portfolio of fixed income securities,
including non-investment grade securities, to seeking a high total investment
return by investing in a global portfolio of investment grade fixed income
securities and (iii) changed its name from the World Income Focus Fund to its
current name. For the period from the commencement of the World Income Focus
Fund's operations through its reorganization on December 6, 1996, the
portfolio of the Fund included debt securities rated below investment grade
(i.e., junk bonds). On December 6, 1996, the Government Bond Fund (i)
implemented a change in its investment objective so that the Fund may invest
in any debt securities issued or guaranteed by the U.S. Government, its
agencies or instrumentalities without regard to remaining maturity and (ii)
changed its name from the Intermediate Government Bond Fund to its current
name.
21
<PAGE>
For the period from the commencement of the Fund's operations through December
6, 1996, the portfolio of the Intermediate Government Bond Fund consisted
primarily of intermediate-term debt securities issued or guaranteed by the
U.S. Government, its agencies or instrumentalities with a maximum maturity not
to exceed fifteen years. As a result of the foregoing changes in the
investment objective of each of the Global Bond Focus Fund and the Government
Bond Fund, the performance information set forth herein and in the Prospectus
for the period prior to December 6, 1996 may not be indicative of future
performance of each Fund.
Average annual total return quotations for the specified periods are
computed by finding the average annual compounded rates of return (based on
net investment income and any realized and unrealized capital gains or losses
on portfolio investments over such periods) that would equate the initial
amount invested to the redeemable value of such investment at the end of each
period. Average annual total return is computed assuming all dividends and
distributions are reinvested and taking into account all applicable recurring
and nonrecurring expenses.
The Reserve Assets Fund and the Domestic Money Market Fund normally compute
annualized yield by determining the net change for a seven-day base period,
exclusive of capital changes, in the value of a hypothetical pre-existing
account having a balance of one share at the beginning of the period, dividing
the net change in account value by the value of the account at the beginning
of the base period to obtain the base period return, and multiplying the base
period return by 365 and then dividing by seven. Under this calculation, the
yield does not reflect realized and unrealized gains and losses on portfolio
securities. The Funds may also include its yield in advertisements, calculated
in the same manner as set forth above but including realized and unrealized
gains and losses. The Securities and Exchange Commission also permits the
calculation of a standardized effective or compounded yield. This is computed
by compounding the unannualized base period return by dividing the base period
by seven, adding one to the quotient, raising the sum to the 365th power, and
subtracting one from the result. This compounded yield calculation also
excludes realized or unrealized gains or losses on portfolio securities.
Set forth below is average annual total return information for the shares of
each of the Company's Funds, other than the Reserve Assets Fund and Domestic
Money Market Fund. The total return quotations may be of limited use for
comparative purposes because they do not reflect charges imposed at the
Separate Account level which, if included, would decrease total return.
AVERAGE ANNUAL TOTAL RETURN
<TABLE>
<CAPTION>
REDEEMABLE VALUE
EXPRESSED AS A OF A HYPOTHETICAL
PERCENTAGE BASED $1,000 INVESTMENT
ON A HYPOTHETICAL AT THE END
$1,000 INVESTMENT OF THE PERIOD
----------------- -----------------
<S> <C> <C>
PRIME BOND FUND:
One Year Ended December 31, 1996............ 2.21% $1,022.10
Five Years Ended December 31, 1996.......... 7.04 1,404.90
Ten Years Ended December 31, 1996........... 7.68 2,095.50
HIGH CURRENT INCOME FUND:
One Year Ended December 31, 1996............ 11.27% $1,112.70
Five Years Ended December 31, 1996.......... 12.21 1,778.70
Ten Years Ended December 31, 1996........... 11.42 2,948.00
QUALITY EQUITY FUND:
One Year Ended December 31, 1996............ 17.90% $1,179.00
Five Years Ended December 31, 1996.......... 10.94 1,680.20
Ten Years Ended December 31, 1996........... 12.50 3,246.10
EQUITY GROWTH FUND:
One Year Ended December 31, 1996............ 8.11% $1,081.10
Five Years Ended December 31, 1996.......... 11.38 1,713.80
Ten Years Ended December 31, 1996........... 7.83 2,124.80
</TABLE>
22
<PAGE>
<TABLE>
<CAPTION>
REDEEMABLE VALUE
EXPRESSED AS A OF A HYPOTHETICAL
PERCENTAGE BASED $1,000 INVESTMENT
ON A HYPOTHETICAL AT THE END
$1,000 INVESTMENT OF THE PERIOD
----------------- -----------------
<S> <C> <C>
INDEX 500 FUND:
December 13, 1996 (commencement of opera-
tions)*
Through December 31, 1996.................. 1.70% $1,017.00
NATURAL RESOURCES FOCUS FUND:
One Year Ended December 31, 1996........... 13.52% $1,135.20
Five Years Ended December 31, 1996......... 7.76 1,452.80
Inception* Through December 31, 1996....... 5.35 1,564.10
AMERICAN BALANCED FUND:
One Year Ended December 31, 1996........... 9.73% $1,097.30
Five Years Ended December 31, 1996......... 8.79 1,524.10
Inception* Through December 31, 1996....... 10.12 2,288.30
GLOBAL STRATEGY FOCUS FUND:
One Year Ended December 31, 1996........... 13.17% $1,131.70
Inception* Through December 31, 1996....... 9.21 1,532.00
BASIC VALUE FOCUS FUND:
One Year Ended December 31, 1996........... 20.69% $1,206.90
Inception* Through December 31, 1996....... 16.32 1,697.60
GLOBAL BOND FOCUS FUND:
One Year Ended December 31, 1996........... 8.02% $1,080.20
Inception* Through December 31, 1996....... 7.27 1,278.70
GLOBAL UTILITY FOCUS FUND:
One Year Ended December 31, 1996........... 12.96% $1,129.60
Inception* Through December 31, 1996....... 9.47 1,372.90
INTERNATIONAL EQUITY FOCUS FUND:
One Year Ended December 31, 1996........... 6.62% $1,066.20
Inception* Through December 31, 1996....... 6.51 1,247.20
DEVELOPING CAPITAL MARKETS FOCUS FUND:
One Year Ended December 31, 1996........... 10.59% $1,105.90
Inception* Through December 31, 1996....... 1.49 1,040.30
GOVERNMENT BOND FUND:
One Year Ended December 31, 1996........... 2.86% $1,028.60
Inception* Through December 31, 1996....... 7.15 1,202.30
</TABLE>
- -------------------------
* Inception for Natural Resources Focus Fund is June 1, 1988; American
Balanced Fund is June 1, 1988; and Global Strategy Focus Fund is February
28, 1992; Basic Value Focus Fund is July 1, 1993; Global Bond Focus Fund is
July 1, 1993; Global Utility Focus Fund is July 1, 1993; International
Equity Focus Fund is July 1, 1993; Developing Capital Markets Focus Fund is
May 2, 1994; Government Bond Fund is May 2, 1994; and Index 500 Fund is
December 13, 1996.
23
<PAGE>
ADDITIONAL INFORMATION
Under a separate agreement Merrill Lynch has granted the Company the right
to use the "Merrill Lynch" name and has reserved the right to withdraw its
consent to the use of such name by the Company at any time, or to grant the
use of such name to any other company, and the Company has granted Merrill
Lynch, under certain conditions, the use of any other name it might assume in
the future, with respect to any corporation organized by Merrill Lynch.
24
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders,
Merrill Lynch Variable Series Funds, Inc.:
We have audited the accompanying statements of assets and liabilities,
including the schedules of investments, of American Balanced, Basic Value
Focus, Developing Capital Markets Focus, Domestic Money Market, Equity Growth,
Global Bond Focus, Global Strategy Focus, Global Utility Focus, Government
Bond, High Current Income, Index 500, International Equity Focus, Natural
Resources Focus, Prime Bond, Quality Equity, and Reserve Assets Funds of
Merrill Lynch Variable Series Funds, Inc. as of December 31, 1996, the related
statements of operations for the periods then ended and changes in net assets
for each of the periods in the two-year period then ended, and the financial
highlights for each of the periods presented. These financial statements and
the financial highlights are the responsibility of the Funds's management. Our
responsibility is to express an opinion on these financial statements and the
financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements and the
financial highlights are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. Our procedures included confirmation of securities
owned at December 31, 1996, by correspondence with the custodians and brokers
or other alternative procedures. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial positions of American
Balanced, Basic Value Focus, Developing Capital Markets Focus, Domestic Money
Market, Equity Growth, Global Bond Focus, Global Strategy Focus, Global
Utility Focus, Government Bond, High Current Income, Index 500, International
Equity Focus, Natural Resources Focus, Prime Bond, Quality Equity, and Reserve
Assets Funds of Merrill Lynch Variable Series Funds, Inc. as of December 31,
1996, the results of their operations, the changes in their net assets, and
the financial highlights for the respective stated periods in conformity with
generally accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
February 21, 1997
25
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--American Balanced Fund
Schedule of Investments as of December 31, 1996
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Value Percent of
Industry Held Common Stocks Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Aerospace 24,000 Northrop Grumman Corp. ..... $ 1,590,745 $ 1,986,000 0.9%
22,460 United Technologies
Corp. .................... 721,552 1,482,360 0.7
------------ ------------ ------
2,312,297 3,468,360 1.6
- ---------------------------------------------------------------------------------------------------------------------
Auto & Truck 26,000 General Motors Corp. ....... 1,421,298 1,449,500 0.7
- ---------------------------------------------------------------------------------------------------------------------
Automobile Parts 61,000 +Lear Corporation........... 2,043,500 2,081,625 1.0
- ---------------------------------------------------------------------------------------------------------------------
Banking 58,500 Bank of New York, Co.,
Inc. ..................... 1,383,399 1,974,375 0.9
8,500 BankAmerica Corporation..... 869,637 847,875 0.4
18,800 Citicorp.................... 1,441,474 1,936,400 0.9
------------ ------------ ------
3,694,510 4,758,650 2.2
- ---------------------------------------------------------------------------------------------------------------------
Building & Construction 35,900 Oakwood Homes Corp. ........ 817,893 821,213 0.4
- ---------------------------------------------------------------------------------------------------------------------
Building Products 59,500 Spieker Properties, Inc. ... 1,580,921 2,142,000... 1.0
- ---------------------------------------------------------------------------------------------------------------------
Chemicals 25,000 +FMC Corporation............ 1,771,815 1,753,125 0.8
33,000 PPG Industries, Inc. ....... 1,634,499 1,852,125 0.9
------------ ------------ ------
3,406,314 3,605,250 1.7
- ---------------------------------------------------------------------------------------------------------------------
Computer 24,000 +Compaq Computer
Corporation............... 1,774,301 1,782,000 0.8
- ---------------------------------------------------------------------------------------------------------------------
Computer Services 29,000 +cisco Systems, Inc. ....... 1,300,503 1,845,125 0.9
12,000 International Business
Machines Corp. ........... 1,318,751 1,812,000 0.8
------------ ------------ ------
2,619,254 3,657,125 1.7
- ---------------------------------------------------------------------------------------------------------------------
Computer Software 39,750 +Oracle Corp. .............. 1,251,044 1,654,594 0.8
- ---------------------------------------------------------------------------------------------------------------------
Computer Technology 41,000 +Gulfstream Aerospace
Corporation............... 1,012,865 994,250 0.5
- ---------------------------------------------------------------------------------------------------------------------
Congolomerates 12,000 AlliedSignal Inc. .......... 882,039 804,000 0.4
- ---------------------------------------------------------------------------------------------------------------------
Consumer Goods 12,000 Philip Morris Companies,
Inc. ..................... 1,190,498 1,351,500 0.6
- ---------------------------------------------------------------------------------------------------------------------
Diversified 43,500 Corning, Inc. .............. 1,231,615 2,011,875 0.9
- ---------------------------------------------------------------------------------------------------------------------
Electric & Gas 83,100 Edison International........ 1,548,607 1,651,612 0.8
- ---------------------------------------------------------------------------------------------------------------------
Electronic Equipment 15,000 General Electric Co. ....... 1,161,154 1,483,125 0.7
9,400 Linear Technology
Corporation............... 385,494 411,250 0.2
------------ ------------ ------
1,546,648 1,894,375 0.9
- ---------------------------------------------------------------------------------------------------------------------
Engineering & Construction 42,400 Foster Wheeler Corp. ....... 1,786,990 1,574,100 0.7
- ---------------------------------------------------------------------------------------------------------------------
Financial Services 36,500 American Express Company.... 1,707,587 2,062,250 1.0
49,000 First Data Corp. ........... 1,732,206 1,788,500 0.8
------------ ------------ ------
3,439,793 3,850,750 1.8
- ---------------------------------------------------------------------------------------------------------------------
Food 52,000 Heinz (H.J.) Company........ 1,702,574 1,859,000 0.9
- ---------------------------------------------------------------------------------------------------------------------
Hospital Management 62,600 +Health Management
Associates, Inc. (Class
A)........................ 1,414,154 1,408,500 0.7
- ---------------------------------------------------------------------------------------------------------------------
Industrial Equipment 34,000 +American Standard
Companies, Inc. .......... 1,109,533 1,300,500 0.6
- ---------------------------------------------------------------------------------------------------------------------
Insurance 16,000 Aetna Inc. ................. 1,190,736 1,280,000 0.6
33,300 Allstate Corp. ............. 1,363,042 1,927,238 0.9
28,000 UNUM Corporation............ 1,787,306 2,023,000 1.0
------------ ------------ ------
4,341,084 5,230,238 2.5
- ---------------------------------------------------------------------------------------------------------------------
Leisure/Tourism 64,000 Brunswick Corporation....... 1,583,557 1,536,000 0.7
11,105 TCI Pacific Communications
(Convertible Preferred)... 1,054,744 1,007,779 0.5
------------ ------------ ------
2,638,301 2,543,779 1.2
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-26-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--American Balanced Fund
Schedule of Investments as of December 31, 1996 (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Value Percent of
Industry Held Common Stocks Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Machinery 49,900 Deere & Co. ................ $ 2,076,934 $ 2,027,188 1.0%
- ---------------------------------------------------------------------------------------------------------------------
Natural Gas 44,000 Enron Corp. ................ 1,698,696 1,897,500 0.9
- ---------------------------------------------------------------------------------------------------------------------
Natural Gas Pipelines 22,000 IMC Global, Inc............. 852,715 860,750 0.4
- ---------------------------------------------------------------------------------------------------------------------
Oil Services 60,300 Dresser Industries, Inc..... 1,197,521 1,869,300 0.9
- ---------------------------------------------------------------------------------------------------------------------
Paper 20,300 Kimberly-Clark
Corporation............... 1,560,117 1,933,575 0.9
- ---------------------------------------------------------------------------------------------------------------------
Petroleum 35,400 Pennzoil Co................. 1,462,787 2,000,100 0.9
49,000 Unocal Corp. ............... 1,649,549 1,990,625 0.9
------------ ------------ ------
3,112,336 3,990,725 1.8
- ---------------------------------------------------------------------------------------------------------------------
Pharmaceuticals 34,900 Abbott Laboratories......... 1,110,169 1,771,175 0.8
23,900 Merck & Co., Inc. .......... 734,284 1,894,075 0.9
------------ ------------ ------
1,844,453 3,665,250 1.7
- ---------------------------------------------------------------------------------------------------------------------
Railroads 18,500 Burlington Northern Santa Fe
Inc....................... 1,499,672 1,597,937 0.8
- ---------------------------------------------------------------------------------------------------------------------
Real Estate Investment Trust 41,300 Prentiss Properties Trust... 844,062 1,032,500 0.5
- ---------------------------------------------------------------------------------------------------------------------
Recreation 58,746 +Viacom, Inc. (Class B)..... 2,151,340 2,048,767 1.0
- ---------------------------------------------------------------------------------------------------------------------
Retail 48,000 Sears, Roebuck & Co. ....... 2,003,303 2,214,000 1.0
- ---------------------------------------------------------------------------------------------------------------------
Retail--Drug Stores 32,760 Rite Aid Corporation........ 976,203 1,302,210 0.6
- ---------------------------------------------------------------------------------------------------------------------
Retail Specialty 67,500 +Toys 'R' Us, Inc. ......... 2,100,037 2,025,000 1.0
- ---------------------------------------------------------------------------------------------------------------------
Scientific Equipment 25,000 Fisher Scientific
International, Inc. ...... 783,673 1,178,125 0.6
- ---------------------------------------------------------------------------------------------------------------------
Software--Computer 45,000 +BMC Software, Inc. ........ 1,677,378 1,861,875 0.9
- ---------------------------------------------------------------------------------------------------------------------
Steel 52,000 AK Steel Holding Corp. ..... 2,145,624 2,060,500 1.0
- ---------------------------------------------------------------------------------------------------------------------
Telecommunications 75,000 +AirTouch Communications,
Inc. ..................... 2,147,192 1,893,750 0.9
20,000 Bell Atlantic Corp. ........ 1,043,470 1,295,000 0.6
------------ ------------ ------
3,190,662 3,188,750 1.5
- ---------------------------------------------------------------------------------------------------------------------
Travel & Lodging 60,000 Carnival Corp. (Class A).... 1,697,029 1,980,000 0.9
- ---------------------------------------------------------------------------------------------------------------------
Utilities--Gas 18,000 El Paso Natural Gas
Company................... 882,267 909,000 0.4
- ---------------------------------------------------------------------------------------------------------------------
Total Common Stocks 77,060,055 89,537,748 42.2
- ---------------------------------------------------------------------------------------------------------------------
Face
Amount US Government & Agency Obligations
---------------------------------------------------------------------------------------------------------------------
US Government & Federal National
Agency Obligations Mortgage Association:
$ 4,352,547 6.00% due 6/01/2001......... 4,309,022 4,299,500 2.0
9,546,755 6.00% due 6/06/2001......... 9,449,796 9,416,979 4.5
5,818,867 6.00% due 2/01/2004......... 5,749,767 5,729,765 2.7
US Treasury Notes:
18,550,000 5.00% due 1/31/1998......... 18,386,238 18,419,593 8.7
24,225,000 6.25% due 4/30/2001......... 24,540,891 24,278,053 11.4
30,000,000 7.25% due 5/15/2004......... 31,727,344 31,565,700 14.9
24,075,000 7.00% due 7/15/2006......... 25,060,930 25,011,758 11.8
- ---------------------------------------------------------------------------------------------------------------------
Total US Government & Agency
Obligations 119,223,988 118,721,348 56.0
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-27-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--American Balanced Fund
Schedule of Investments as of December 31, 1996 (concluded)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Face Value Percent of
Amount Short-Term Securities Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Commercial Paper* $ 262,000 General Motors Acceptance
Corp., 7.50% due
1/02/1997................. $ 261,891 $ 261,891 0.1%
2,029,000 Preferred Receivable Funding
Corp., 5.65% due
1/15/1997................. 2,024,223 2,024,223 1.0
- ---------------------------------------------------------------------------------------------------------------------
Total Short-Term Securities 2,286,114 2,286,114 1.1
- ---------------------------------------------------------------------------------------------------------------------
Total Investments........... $198,570,157 210,545,210 99.3
============
Other Assets Less
Liabilities............... 1,501,804 0.7
------------ ------
Net Assets.................. $212,047,014 100.0%
============ ======
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* Commercial Paper is traded on a discount basis; the interest rates shown
are the discount rates paid at the time of purchase by the Fund.
+ Non-income producing security.
See Notes to Financial Statements.
-28-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Basic Value Focus Fund
Schedule of Investments as of December 31, 1996
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Value Percent of
Industry Held Stocks Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Low Price to Book Value
- ---------------------------------------------------------------------------------------------------------------------
Metals--Non Ferrous 375,000 ASARCO Inc. ................ $ 10,204,510 $ 9,328,125 1.8%
Software--Computer 400,000 +Advanced Micro Devices,
Inc....................... 5,528,488 10,300,000 2.0
Banking 125,000 Bankers Trust New York
Corp. .................... 7,946,060 10,781,250 2.0
Home--Builders 350,000 +Beazer Homes USA, Inc.
(b)....................... 5,392,282 6,475,000 1.2
Retail 1,700,000 +Charming Shoppes, Inc. .... 7,011,954 8,500,000 1.6
Savings & Loans 753,100 Greater N.Y. Savings
Bank (b).................. 7,674,112 10,072,713 1.9
Conglomerates 808,200 Hanson PLC (ADR) (a)........ 6,795,411 5,455,350 1.0
Retail 1,200,000 Hechinger Company
(Class A)................. 5,038,275 2,400,000 0.5
Entertainment 105,900 +ITT Corporation............ 4,710,982 4,593,412 0.9
Software 622,700 +Mentor Graphics
Corporation............... 6,403,414 6,071,325 1.2
Airlines 800,000 +Mesa Airlines, Inc. ....... 6,790,323 5,400,000 1.0
Technology 1,150,000 +Micronics Computers,
Inc. (b).................. 4,168,442 2,228,125 0.4
Chemicals 297,700 +Millennium Chemicals
Inc. ..................... 6,093,804 5,284,175 1.0
Savings and Loans 500,000 +PFF Bancorp, Inc. ......... 5,715,000 7,312,500 1.4
Metals--Non Ferrous 116,000 Phelps Dodge Corporation.... 6,867,280 7,830,000 1.5
Computer Services 801,800 Scitex Corp. Ltd. (ADR)
(a)....................... 11,364,879 7,617,100 1.4
Beverage & Entertainment 200,000 Seagram Company
Ltd. (The)................ 6,791,149 7,750,000 1.5
Technology 150,000 +Storage Technology
Corp. .................... 5,098,314 7,143,750 1.4
Oil--Refiners 700,000 Total Petroleum Ltd. ....... 7,941,281 7,262,500 1.4
Healthcare 900,000 +Transitional Hospitals
Co. ...................... 7,924,083 8,662,500 1.6
Steel 809,300 +WHX Corp................... 8,623,208 7,182,537 1.4
------------ ------------ ------
144,083,251 147,650,362 28.1
- ---------------------------------------------------------------------------------------------------------------------
Below-Average Price/Earnings Ratio
- ---------------------------------------------------------------------------------------------------------------------
Oil--Domestic 450,000 +American Exploration
Co. ...................... 5,028,426 7,200,000 1.4
Technology 950,000 +Computervision Corp. ...... 9,196,567 8,787,500 1.7
Retail 300,000 Dillard Department Stores
Inc. ..................... 9,320,727 9,262,500 1.8
Automotive 200,000 General Motors Corp. ....... 9,267,984 11,150,000 2.1
Banking 650,000 Hibernia Corporation (Class
A)........................ 7,468,466 8,612,500 1.6
Machinery 300,000 ITT Industries Inc. ........ 6,899,739 7,350,000 1.4
Forest Products & Paper 220,000 International Paper Co. .... 8,418,780 8,882,500 1.7
Electronics 200,000 Micron Technology, Inc. .... 4,888,098 5,825,000 1.1
Auto-Related 581,000 National Auto Credit,
Inc. ..................... 5,918,046 6,972,000 1.3
Athletic Footwear 175,000 Reebok International
Ltd. ..................... 4,847,939 7,350,000 1.4
Information Processing 900,000 +Tandem Computers, Inc...... 10,279,044 12,375,000 2.4
Steel 350,000 +USX-US Steel Group......... 10,551,925 10,981,250 2.1
------------ ------------ ------
92,085,741 104,748,250 20.0
- ---------------------------------------------------------------------------------------------------------------------
Above-Average Yield
- ---------------------------------------------------------------------------------------------------------------------
Pharmaceuticals 70,000 Bristol-Myers Squibb Co. ... 5,315,433 7,612,500 1.4
Real Estate Investment Trust 253,500 Evans Withycombe
Residential, Inc. ........ 5,128,207 5,323,500 1.0
Automotive 275,000 Ford Motor Co. ............. 8,244,320 8,765,625 1.7
Telecommunications 150,000 GTE Corporation............. 6,366,750 6,825,000 1.3
Retail 800,000 +Kmart Corporation.......... 8,463,269 8,300,000 1.6
Forest Products & Paper 300,000 Louisiana-Pacific Corp. .... 7,657,924 6,337,500 1.2
Oil--Domestic 450,000 Occidental Petroleum
Corp. .................... 9,447,997 10,518,750 2.0
Financial Services 90,000 Student Loan Marketing
Association............... 4,439,450 8,381,250 1.6
Oil--International 450,000 Yacimientos Petroliferos
Fiscales S.A. (ADR)(a).... 8,832,840 11,362,500 2.2
------------ ------------ ------
63,896,190 73,426,625 14.0
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-29-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Basic Value Focus Fund
Schedule of Investments as of December 31, 1996 (concluded)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Value Percent of
Industry Held Stocks Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Special Situations
- ---------------------------------------------------------------------------------------------------------------------
Environmental Services 1,025,000 +Allwaste, Inc. ............ $ 5,187,397 $ 5,253,125 1.0%
Information Processing 500,000 +Apple Computer, Inc. ...... 11,412,685 10,375,000 2.0
Household Products 400,000 Black & Decker Corporation
(The)..................... 13,217,404 12,050,000 2.3
Photography 80,000 Eastman Kodak Co. .......... 4,672,300 6,420,000 1.2
Technology 500,000 +Exabyte Corp. ............. 6,796,977 6,687,500 1.3
Health Maintenance
Organization 375,000 +Humana, Inc. .............. 7,062,358 7,171,875 1.4
Information Processing 70,000 International Business
Machines Corp............. 6,661,756 10,570,000 2.0
Semiconductors 350,000 +National Semiconductor
Corp. .................... 6,214,269 8,531,250 1.6
Medical Services 450,000 +Pharmaceutical Product
Development, Inc. ........ 7,292,590 11,250,000 2.1
Electronics 150,000 Texas Instruments Inc. ..... 7,316,356 9,562,500 1.8
Telecommunications 450,000 +US West Media Group,
Inc. ..................... 7,815,940 8,325,000 1.6
Retail 500,000 +Woolworth Corp. ........... 6,339,630 10,937,500 2.1
------------ ------------ ------
89,989,662 107,133,750 20.4
- ---------------------------------------------------------------------------------------------------------------------
Total Stocks 390,054,844 432,958,987 82.5
- ---------------------------------------------------------------------------------------------------------------------
Face
Amount Short-Term Securities
---------------------------------------------------------------------------------------------------------------------
Commercial Paper* $10,000,000 Eureka Securitization, Inc.,
5.38% due 1/30/1997....... 9,955,167 9,955,167 1.9
20,045,000 General Electric Capital
Corp., 7.10% due
1/02/1997................. 20,037,093 20,037,093 3.8
10,000,000 Lehman Brothers Holdings,
Inc., 5.45% due
2/14/1997................. 9,931,875 9,931,875 1.9
10,000,000 Three Rivers Funding, Corp.,
5.60% due 1/15/1997....... 9,976,667 9,976,667 1.9
------------ ------------ ------
49,900,802 49,900,802 9.5
- ---------------------------------------------------------------------------------------------------------------------
US Government & 7,000,000 Federal Home Loan Bank,
Agency Obligations* 5.22% due 1/09/1997....... 6,990,865 6,990,865 1.3
Federal National Mortgage
Association:
10,000,000 5.24% due 2/03/1997....... 9,950,511 9,950,511 1.9
23,000,000 5.26% due 2/10/1997....... 22,862,217 22,862,217 4.4
------------ ------------ ------
39,803,593 39,803,593 7.6
- ---------------------------------------------------------------------------------------------------------------------
Total Short-Term Securities 89,704,395 89,704,395 17.1
- ---------------------------------------------------------------------------------------------------------------------
Total Investments........... $479,759,239 522,663,382 99.6
============
Other Assets Less
Liabilities............... 2,266,782 0.4
------------ ------
Net Assets.................. $524,930,164 100.0%
============ ======
- ---------------------------------------------------------------------------------------------------------------------
+ Non-income producing security.
* Commercial Paper and certain US Government & Agency Obligations are traded
on a discount basis; the interest rates shown are the discount rates paid
at the time of purchase by the Fund.
(a) American Depositary Receipts (ADR).
(b) Investment in companies 5% or more of whose outstanding securities are
held by the Fund (such companies are defined as "Affiliated Companies" in
Section 2(a)(3) of the Investment Company Act of 1940) are as follows:
---------------------------------------------------------------------------------------------------------------------
Net Share Net Dividend
Industry Affiliate Activity Cost Income
- ---------------------------------------------------------------------------------------------------------------------
Home--Builders Beazer Homes USA, Inc. .............................. 50,000 $ 665,558 --
Savings & Loans Greater N.Y. Savings Bank............................ 328,100 3,770,476 $37,500
Technology Micronics Computers, Inc. ........................... 257,500 206,942 --
- ---------------------------------------------------------------------------------------------------------------------
Total $4,642,976
==========
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
-30-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Developing Capital Markets Focus
Fund
Schedule of Investments as of December 31, 1996 (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Value Percent of
AFRICA Industries Held Investments Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Morocco Banking 7,050 Wafa Bank................... $ 337,444 $ 445,329 0.4%
- ---------------------------------------------------------------------------------------------------------------------
Total Investments in Morocco 337,444 445,329 0.4
- ---------------------------------------------------------------------------------------------------------------------
South Africa Beverage & 15,241 South African Breweries
Ltd....................... 352,755 386,240 0.4
14,688 South African Breweries Ltd.
(ADR) (a)................. 467,719 370,872 0.4
----------- ------
820,474 757,112 0.8
------------------------------------------------------------------------------------------------------
Coal 120,300 Ingwe Coal Corporation
Ltd....................... 909,851 861,858 0.9
------------------------------------------------------------------------------------------------------
Entertainment 574,700 Sun International, Ltd. .... 789,589 460,891 0.5
------------------------------------------------------------------------------------------------------
Financial Services 6,200 Anglo American Corp. of
South Africa, Ltd. (ADR)
(a)....................... 389,005 336,350 0.3
39,785 Nedcor Ltd. (Ordinary)...... 483,190 544,534 0.6
----------- ------
872,195 880,884 0.9
------------------------------------------------------------------------------------------------------
Mining 78,700 Beatrix Mines Ltd........... 679,625 492,296 0.5
23,300 De Beers Centenary AG....... 619,984 667,707 0.7
4,687 Vaal Reefs Exploration &
Mining Co. Ltd............ 403,774 300,706 0.3
24,238 +Western Areas Gold Mining
Company Ltd............... 384,854 334,335 0.4
----------- ------
2,088,237 1,795,044 1.9
------------------------------------------------------------------------------------------------------
Total Investments in South
Africa 5,480,346 4,755,789 5.0
- ---------------------------------------------------------------------------------------------------------------------
Zimbabwe Beverage & Tobacco 327,843 Delta Corporation Ltd....... 781,291 1,152,988 1.2
------------------------------------------------------------------------------------------------------
Total Investments in
Zimbabwe 781,291 1,152,988 1.2
- ---------------------------------------------------------------------------------------------------------------------
Total Investments in Africa 6,599,081 6,354,106 6.6
- ---------------------------------------------------------------------------------------------------------------------
EUROPE
---------------------------------------------------------------------------------------------------------------------
Czech Republic Broadcast--Media 17,500 +Central European Media
Enterprises Ltd. (Class
A)(GDR) (b)............... 481,250 546,875 0.6
------------------------------------------------------------------------------------------------------
Total Investments in the
Czech Republic 481,250 546,875 0.6
- ---------------------------------------------------------------------------------------------------------------------
France Utilities--Water 14,700 Compagnie Generale des Eaux
S.A....................... 1,607,353 1,821,916 1.9
------------------------------------------------------------------------------------------------------
Total Investments in France 1,607,353 1,821,916 1.9
- ---------------------------------------------------------------------------------------------------------------------
Greece Banking 13,680 Ergo Bank S.A. (Ordinary)... 611,797 694,102 0.7
------------------------------------------------------------------------------------------------------
Beverage 11,010 Hellenic Bottling Co.
S.A....................... 215,402 353,137 0.4
------------------------------------------------------------------------------------------------------
Telecommunications 23,400 Hellenic Telecommunication
Organization S.A.......... 387,013 400,191 0.4
------------------------------------------------------------------------------------------------------
Total Investments in Greece 1,214,212 1,447,430 1.5
- ---------------------------------------------------------------------------------------------------------------------
Hungary Health/Personal 31,600 Gedeon Richter Ltd. (GDR)
Care (b)....................... 724,600 1,832,800 1.9
1,000 Gedeon Richter Ltd. (GDR)
(b)(e).................... 40,875 58,000 0.1
----------- ------
765,475 1,890,800 2.0
------------------------------------------------------------------------------------------------------
Telecommunications 1,100 +Magyar TarKozlesi
Reszvenytarsasag
(Ordinary) (e)............ 174,885 238,243 0.2
------------------------------------------------------------------------------------------------------
Total Investments in Hungary 940,360 2,129,043 2.2
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-31-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series, Inc.--Developing Capital Markets Focus Fund
Schedule of Investments as of December 31, 1996 (continued) (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
EUROPE Shares Value Percent of
(concluded) Industries Held Investments Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Italy Automobiles 300,000 Fiat S.p.A.................. 884,110 906,965 0.9
------------------------------------------------------------------------------------------------------
Broadcast--Media 168,000 Mediaset S.p.A.............. 805,116 774,576 0.8
------------------------------------------------------------------------------------------------------
Total Investments in Italy 1,689,226 1,681,541 1.7
- ---------------------------------------------------------------------------------------------------------------------
Netherlands Electronics 11,250 Philips Electronics N.V..... 457,905 456,257 0.5
11,250 Philips Electronics N.V. (NY
Registered Shares)........ 438,600 450,000 0.4
------------------------------------------------------------------------------------------------------
Total Investments in the
Netherlands 896,505 906,257 0.9
- ---------------------------------------------------------------------------------------------------------------------
Poland Automotive 10,000 +T.C. Debica S.A............ 211,943 223,339 0.2
------------------------------------------------------------------------------------------------------
Banking 58,118 Wielkopolsky Bank Kredytowy
S.A....................... 350,009 393,457 0.4
------------------------------------------------------------------------------------------------------
Electrical & 4,400 Elektrim Towarzystow
Electronics Handlowe S.A.............. 25,742 39,922 0.1
------------------------------------------------------------------------------------------------------
Financial Services 9,207 Bank Rozwoju Eksportu S.A.
(BRE)..................... 247,903 276,313 0.3
------------------------------------------------------------------------------------------------------
Multi-Industry 114,551 Mostostal-Export S.A........ 302,975 271,827 0.3
------------------------------------------------------------------------------------------------------
Total Investments in Poland 1,138,572 1,204,858 1.3
- ---------------------------------------------------------------------------------------------------------------------
Portugal Building Products 45,000 Cimpor-Cimentos de Portugal
S.A....................... 916,303 969,097 1.0
------------------------------------------------------------------------------------------------------
Multi-Industry 35,100 Sonae Investimentos-SGPS
S.A....................... 866,343 1,111,877 1.2
------------------------------------------------------------------------------------------------------
Total Investments in
Portugal 1,782,646 2,080,974 2.2
- ---------------------------------------------------------------------------------------------------------------------
Russia Energy Sources 56,100 A.O. Mosenergo (ADR) (a).... 1,567,968 1,697,025 1.8
1,980,000 +Irkutskenergo (GDR) (b).... 249,592 261,360 0.2
----------- ------
1,817,560 1,958,385 2.0
------------------------------------------------------------------------------------------------------
Multi-Industry 7,600 Templeton Russia Fund,
Inc....................... 115,344 167,200 0.2
------------------------------------------------------------------------------------------------------
Natural Gas 27,000 +RAO Gazprom (ADR) (a)(e)... 425,250 479,250 0.5
------------------------------------------------------------------------------------------------------
Oil & Related 8,000 Lukoil Oil Company (ADR)
(a)....................... 331,050 368,000 0.4
------------------------------------------------------------------------------------------------------
Telecommunications 16,500 +Vimpel-Communications (ADR)
(a)....................... 395,943 389,813 0.4
------------------------------------------------------------------------------------------------------
Total Investments in Russia 3,085,147 3,362,648 3.5
- ---------------------------------------------------------------------------------------------------------------------
Turkey Metal Fabricating 7,800,000 Eregli Demir Ve Celik
Fabrikalari T.A.S......... 983,792 936,288 1.0
------------------------------------------------------------------------------------------------------
Total Investments in Turkey 983,792 936,288 1.0
- ---------------------------------------------------------------------------------------------------------------------
Total Investments in Europe 13,819,063 16,117,830 16.9
- ---------------------------------------------------------------------------------------------------------------------
LATIN AMERICA
---------------------------------------------------------------------------------------------------------------------
Argentina Banking 64,384 Banco Frances del Rio de la
Plata S.A. (ADR) (a)...... 1,346,566 1,770,557 1.8
60,500 +Bansud S.A. (Class B)...... 710,916 724,935 0.8
----------- ------
2,057,482 2,495,492 2.6
------------------------------------------------------------------------------------------------------
Oil & Related 236,390 Companhia Naviera Perez
Companc S.A.C.F.I.M.F.A.
(Class B)................. 1,156,335 1,662,154 1.7
------------------------------------------------------------------------------------------------------
Telecommunications 17,354 Telefonica de Argentina S.A.
(Class B) (ADR) (a)....... 497,806 449,035 0.5
------------------------------------------------------------------------------------------------------
Total Investments in
Argentina 3,711,623 4,606,681 4.8
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-32-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series, Inc.--Developing Capital Markets Focus Fund
Schedule of Investments as of December 31, 1996 (continued) (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
LATIN AMERICA Shares Value Percent of
(continued) Industries Held Investments Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Brazil Banking 103,086,523 Banco Bradesco S.A.
(Preferred)............... 696,489 747,176 0.8
------------------------------------------------------------------------------------------------------
Beverage 2,452,525 Companhia Cervejaria Brahma
S.A. PN (Preferred)....... 993,758 1,340,874 1.4
------------------------------------------------------------------------------------------------------
Mining 10,296 Companhia Vale do Rio Doce
S.A. (Preferred).......... 227,523 198,210 0.2
------------------------------------------------------------------------------------------------------
Oil & Related 11,658,000 Petroleo Brasileiro S.A.
(Preferred)............... 1,641,531 1,857,156 2.0
------------------------------------------------------------------------------------------------------
Steel 8,410,000 Companhia Siderurgica
Nacional S.A.............. 202,969 238,805 0.2
1,256,100,000 Usinas Siderurgicas de Minas
Gerais - Usiminas S.A.
(Preferred)............... 1,313,468 1,281,611 1.4
----------- ------
1,516,437 1,520,416 1.6
------------------------------------------------------------------------------------------------------
Telecommuni- 29,685 Telecomunicacoes Brasileiras
cations S.A.--Telebras PN
(ADR)(a).................. 1,629,450 2,270,903 2.4
13,972,227 Telecomunicacoes Brasileiras
S.A.--Telebras PN
(Preferred)............... 737,840 1,075,925 1.1
7,227,925 Telecomunicacoes de Minas
Gerais S.A.--TELEMIG
(Class B) (Preferred)..... 652,510 894,011 0.9
----------- ------
3,019,800 4,240,839 4.4
------------------------------------------------------------------------------------------------------
Utilities--Electrical 1,060,000 Centrais Eletricas
& Gas Brasileiras
S.A.--Eletrobras.......... 367,723 379,555 0.4
155,000 Centrais Eletricas
Brasileiras
S.A.--Eletrobras 'B'
(Preferred)............... 54,645 57,590 0.1
7,513 Companhia Energetica de
Minas Gerais S.A. (CEMIG)
(ADR)(a).................. 169,798 253,564 0.2
20,000 Companhia Energetica de
Minas Gerais S.A. (CEMIG)
(ADR)(a)(e)............... 426,315 675,000 0.7
----------- ------
1,018,481 1,365,709 1.4
------------------------------------------------------------------------------------------------------
Total Investments in Brazil 9,114,019 11,270,380 11.8
- ---------------------------------------------------------------------------------------------------------------------
Mexico Banking 10,650 Grupo Financiero Banamex
--Accival, S.A. de C.V.
(BANACCI)
(Class L)................. 18,179 20,973 0.0
------------------------------------------------------------------------------------------------------
Beverage & Tobacco 16,100 Panamerican Beverages, Inc.
(Class A)................. 644,974 754,687 0.8
------------------------------------------------------------------------------------------------------
Building & 126,000 Apasco, S.A. de C.V......... 458,715 864,439 0.9
Construction
------------------------------------------------------------------------------------------------------
Building Materials 154,000 Cementos Mexicanos, S.A. de
C.V....................... 665,660 600,661 0.6
------------------------------------------------------------------------------------------------------
Financial Services 77,000 +Banca Quadrum, S.A. de C.V.
(ADR)(a).................. 510,125 279,125 0.3
355,000 Banco Nacional de Mexico,
S.A. de C.V. (Class B)
(BANAMEX)................. 660,134 749,600 0.8
----------- ------
1,170,259 1,028,725 1.1
------------------------------------------------------------------------------------------------------
Health/Personal 100,000 Kimberly-Clark de Mexico,
Care S.A. de C.V............... 1,333,327 1,975,607 2.1
------------------------------------------------------------------------------------------------------
Leisure 445,787 Grupo Carso, S.A. de C.V.
'A1'...................... 2,700,380 2,350,421 2.5
------------------------------------------------------------------------------------------------------
</TABLE>
-33-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series, Inc.--Developing Capital Markets Focus Fund
Schedule of Investments as of December 31, 1996 (continued) (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
LATIN
AMERICA Shares Value Percent of
(concluded) Industries Held Investments Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Mexico Retail 30,000 +Cifra, S.A. de C.V. 'B'
(concluded) (ADR)(a).................. 40,599 35,400 0.0
996,200 +Cifra, S.A. de C.V. 'C'.... 1,558,437 1,215,032 1.3
----------- ------
1,599,036 1,250,432 1.3
------------------------------------------------------------------------------------------------------
Telecommunications 35,979 Telefonos de Mexico, S.A. de
C.V. (ADR) (a)............ 1,145,507 1,187,307 1.2
------------------------------------------------------------------------------------------------------
Total Investments in Mexico 9,736,037 10,033,252 10.5
- ---------------------------------------------------------------------------------------------------------------------
Total Investments in Latin
America 22,561,679 25,910,313 27.1
- ---------------------------------------------------------------------------------------------------------------------
MIDDLE EAST
---------------------------------------------------------------------------------------------------------------------
Egypt Banking 2,962 +Commercial International
Bank (Egypt) S.A.E........ 350,673 447,622 0.5
------------------------------------------------------------------------------------------------------
Cement 7,375 Tora Portland Cement Co..... 149,085 149,111 0.1
------------------------------------------------------------------------------------------------------
Total Investments in Egypt 499,758 596,733 0.6
- ---------------------------------------------------------------------------------------------------------------------
Israel Banking 6,000 +Bank Hapoalim Ltd. ........ 8,651 9,518 0.0
653,600 +Bank Leumi Israel.......... 894,162 899,625 0.9
----------- ------
902,813 909,143 0.9
------------------------------------------------------------------------------------------------------
Merchandising 72,000 +Blue Square Chain Stores
Properties & Investments
Ltd. ..................... 522,937 564,392 0.6
4,800 +Blue Square Chain Stores
Properties & Investments
Ltd. (ADR)(a)............. 66,380 68,400 0.1
----------- ------
589,317 632,792 0.7
------------------------------------------------------------------------------------------------------
Multi-Industry 10,578 Koor Industries Ltd. ....... 968,604 922,812 1.0
3,500 Koor Industries Ltd.
(ADR)(a).................. 67,069 59,500 0.1
----------- ------
1,035,673 982,312 1.1
------------------------------------------------------------------------------------------------------
Total Investments in Israel 2,527,803 2,524,247 2.7
- ---------------------------------------------------------------------------------------------------------------------
Total Investments in the
Middle East 3,027,561 3,120,980 3.3
- ---------------------------------------------------------------------------------------------------------------------
PACIFIC
BASIN/ASIA
---------------------------------------------------------------------------------------------------------------------
Australia Merchandising 19,740 Amway Asia Pacific Ltd.(GDR)
(b)....................... 690,260 836,482 0.9
------------------------------------------------------------------------------------------------------
Total Investments in
Australia 690,260 836,482 0.9
- ---------------------------------------------------------------------------------------------------------------------
China Telecommunications 622,000 +Eastern Communications Co.,
Ltd. (Class B)............ 502,576 553,580 0.6
------------------------------------------------------------------------------------------------------
Total Investments in China 502,576 553,580 0.6
- ---------------------------------------------------------------------------------------------------------------------
Hong Kong Automotive 377,000 Sime Darby (Hong Kong)
Ltd. ..................... 448,773 475,272 0.5
------------------------------------------------------------------------------------------------------
Banking 440,000 JCG Holdings, Ltd. ......... 400,979 429,532 0.4
65,000 +Wing Hang Bank Ltd......... 239,973 294,996 0.3
----------- ------
640,952 724,528 0.7
------------------------------------------------------------------------------------------------------
Food 2,659,000 C.P. Pokphand Co. Ltd.
(Ordinary)................ 1,024,250 1,040,015 1.1
7,991,000 +Tingyi (Cayman Islands)
Holdings Co............... 2,041,042 2,092,291 2.2
----------- ------
3,065,292 3,132,306 3.3
------------------------------------------------------------------------------------------------------
Industrial 5,066,000 Sinocan Holdings Ltd. ...... 1,328,338 2,489,113 2.6
------------------------------------------------------------------------------------------------------
Real Estate 3,699,000 China Overseas Land &
Investment................ 1,047,051 1,877,240 2.0
------------------------------------------------------------------------------------------------------
Total Investments in Hong
Kong 6,530,406 8,698,459 9.1
- ------------------------------------------------------------------------------------------------------------
</TABLE>
-34-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series, Inc.--Developing Capital Markets Focus Fund
Schedule of Investments as of December 31, 1996 (continued) (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PACIFIC
BASIN/ASIA Shares Held/ Value Percent of
(continued) Industries Face Amount Investments Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
India Automotive 89,000 Ashok Leyland Ltd.
(GDR)(b).................. 947,250 825,475 0.8
39,000 Ashok Leyland Ltd.
(GDR)(b)(e)............... 532,185 361,725 0.4
----------- ------
1,479,435 1,187,200 1.2
------------------------------------------------------------------------------------------------------
Building Materials 71,600 Larsen & Toubro Ltd.
(GDR)(b)(e)............... 1,124,562 1,031,040 1.1
------------------------------------------------------------------------------------------------------
Energy Sources 37,900 Bombay Suburban Electric
Supply Co. Ltd.(GDR)(b)... 694,175 776,950 0.8
------------------------------------------------------------------------------------------------------
Leisure 51,800 East India Hotels Ltd.
(GDR)(b)(e)............... 820,294 1,217,300 1.3
------------------------------------------------------------------------------------------------------
Total Investments in India 4,118,466 4,212,490 4.4
- ---------------------------------------------------------------------------------------------------------------------
Indonesia Broadcasting & US$ 750,000 P.T. Surya Citra Television,
Publishing 4% due 7/01/1997
(Convertible)............. 785,697 750,452 0.8
US$ 15,000 P.T. Surya Citra Television,
4% due 7/01/1997
(Convertible)(e).......... 15,000 15,009 0.0
----------- ------
800,697 765,461 0.8
------------------------------------------------------------------------------------------------------
Food 208,000 P.T. Indofood Sukses
Makmur.................... 434,008 414,062 0.4
------------------------------------------------------------------------------------------------------
Multi--Industry 632,000 P.T. Bimantara Citra........ 822,513 843,202 0.9
------------------------------------------------------------------------------------------------------
Real Estate 1,008,000 P.T. Ciputra Development.... 899,550 1,045,997 1.1
------------------------------------------------------------------------------------------------------
Telecommunications 164,000 P.T. Telekomunikasi
Indonesia................. 246,872 283,058 0.3
4,000 P.T. Telekomunikasi
Indonesia (ADR)(a)........ 126,560 138,000 0.1
----------- ------
373,432 421,058 0.4
------------------------------------------------------------------------------------------------------
Telecommunications 21,000 P.T. Kabelmetal Indonesia
& Equipment (Rights)(d)............... 0 0 0.0
------------------------------------------------------------------------------------------------------
Total Investments in
Indonesia 3,330,200 3,489,780 3.6
- ---------------------------------------------------------------------------------------------------------------------
Malaysia Airlines 151,000 Malaysian Airline System
BHD....................... 426,861 391,703 0.4
------------------------------------------------------------------------------------------------------
Banking 66,000 Commerce Asset Holdings
BHD....................... 422,451 496,634 0.5
360,000 Public Bank BHD 'Foreign'... 507,714 762,772 0.8
----------- ------
930,165 1,259,406 1.3
------------------------------------------------------------------------------------------------------
Broadcasting & 110,000 New Straits Times Press
Publishing BHD....................... 579,672 636,040 0.7
134,000 Sistem Televisyen Malaysia
BHD (Class A)............. 195,771 248,364 0.2
----------- ------
775,443 884,404 0.9
------------------------------------------------------------------------------------------------------
Building Materials US$ 455,000 Aokam Perdana BHD, 3.50% due
6/13/2004 (Convertible)... 365,816 277,550 0.3
82,000 Hume Industries (Malaysia)
BHD (Class A)............. 435,693 516,356 0.5
----------- ----------- -------
801,509 793,906 0.8
------------------------------------------------------------------------------------------------------
Chemicals 135,000 Nylex (Malaysia) BHD........ 354,841 304,752 0.3
------------------------------------------------------------------------------------------------------
Consumer Products & 8,500 +Amway (Malaysia) Holdings
Services BHD (GDR)(b).............. 50,682 48,139 0.1
------------------------------------------------------------------------------------------------------
Diversified 42,300 OYL Industries BHD.......... 438,242 443,941 0.5
Holdings
------------------------------------------------------------------------------------------------------
Engineering & 125,000 Malaysian Resources Corp.
Construction BHD....................... 437,809 492,574 0.5
------------------------------------------------------------------------------------------------------
Food 54,000 Nestle (Malaysia) BHD....... 420,759 434,139 0.5
------------------------------------------------------------------------------------------------------
</TABLE>
-35-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series, Inc.--Developing Capital Markets Focus Fund
Schedule of Investments as of December 31, 1996 (continued) (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PACIFIC
BASIN/ASIA Shares Held/ Value Percent of
(continued) Industries Face Amount Investments Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Malaysia Multi-Industry 96,000 Ekran BHD................... 429,945 403,010 0.4
(concluded) 427,000 Renong BHD.................. 723,102 757,608 0.8
130,000 Sime Darby BHD.............. 432,179 512,277 0.6
98,000 Sungei Way Holdings BHD..... 255,634 291,089 0.3
----------- ----------- ----------
1,840,860 1,963,984 2.1
------------------------------------------------------------------------------------------------------
Natural Gas 103,000 Petronas Gas BHD............ 425,739 428,317 0.4
------------------------------------------------------------------------------------------------------
Oil & Related 78,000 Petronas Dagangan BHD....... 227,916 200,792 0.2
------------------------------------------------------------------------------------------------------
Telecommunications 341,400 +Technology Resources
Industries BHD (TRI)...... 1,233,355 673,335 0.7
- ---------------------------------------------------------------------------------------------------------------------
Total Investments in
Malaysia 8,364,181 8,319,392 8.7
- ---------------------------------------------------------------------------------------------------------------------
Pakistan Chemicals--Fertilizers 15,000 Fauji Fertilizer Co.
Ltd. ..................... 31,246 25,262 0.0
------------------------------------------------------------------------------------------------------
Telecommunications 2,800 +Pakistan Telecommunications
Corp...................... 258,800 175,350 0.2
------------------------------------------------------------------------------------------------------
Total Investments in
Pakistan 290,046 200,612 0.2
- ---------------------------------------------------------------------------------------------------------------------
Philippines International Trade 637,500 International Container
Terminal Services, Inc.... 278,784 333,801 0.3
------------------------------------------------------------------------------------------------------
Total Investments in the
Philippines 278,784 333,801 0.3
- ---------------------------------------------------------------------------------------------------------------------
South Korea Automotive 6,940 +Dong Ah Tire Industries.... 581,436 485,182 0.5
------------------------------------------------------------------------------------------------------
Banking 69,330 Cho Hung Bank Co. Ltd....... 746,446 559,413 0.6
2,740 Shinhan Bank................ 50,472 44,881 0.1
----------- ----------- ----------
796,918 604,294 0.7
------------------------------------------------------------------------------------------------------
Telecommunications 127,967 Korea Mobile Telecom-
munications
Corp.(ADR)(a)(e).......... 1,993,680 1,641,179 1.7
------------------------------------------------------------------------------------------------------
Total Investments in South
Korea 3,372,034 2,730,655 2.9
- ---------------------------------------------------------------------------------------------------------------------
Thailand Banking 132,000 Krung Thai Bank Public Co.
Ltd....................... 623,254 254,767 0.3
93,400 Phatra Thanakit Public Co.
Ltd....................... 893,341 265,848 0.3
11,000 Siam Commercial Bank Public
Co. Ltd. "Foreign"........ 175,656 79,775 0.1
140,000 +Thai Farmers Bank Co.,
Ltd....................... 1,521,890 873,396 0.9
17,500 Thai Farmers Bank Co., Ltd.
"Foreign" (Warrants)(c)... 17,292 16,547 0.0
----------- ----------- ----------
3,231,433 1,490,333 1.6
------------------------------------------------------------------------------------------------------
Finance 148,400 Finance One Public Company
Ltd. "Foreign"............ 1,045,477 300,885 0.3
------------------------------------------------------------------------------------------------------
Merchandising 19,300 Siam Makro Public Co.
Ltd....................... 92,578 81,273 0.1
------------------------------------------------------------------------------------------------------
Real Estate Chf 1,300,000 Bangkok Land Public Co.
Ltd., 3.125% due 3/31/2001
(Convertible)............. 456,864 388,408 0.4
US$ 184,000 Bangkok Land Public Co.,
Ltd., 4.50% due 10/13/2003
(Convertible)............. 135,825 115,920 0.1
US$ 433,000 Hemaraj Land and Development
Public Co., Ltd., 3.50%
due 9/09/2003............. 425,104 441,660 0.5
US$ 163,000 Tanayong Public Co. Ltd.,
3.50% due 3/01/2004
(Convertible)............. 148,167 145,477 0.1
----------- ----------- ----------
1,165,960 1,091,465 1.1
------------------------------------------------------------------------------------------------------
</TABLE>
-36-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series, Inc.--Developing Capital Markets Focus Fund
Schedule of Investments as of December 31, 1996 (concluded) (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PACIFIC
BASIN/ASIA Shares Value Percent of
(concluded) Industries Held Investments Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Thailand Telecommunications 62,900 Advanced Info Service Public
(concluded) Company Ltd. 'Foreign'.... 1,150,003 534,651 0.6
454,000 +TelecomAsia Corporation
Public Company Ltd.
'Foreign'................. 859,481 947,050 1.0
----------- ----------- ----------
2,009,484 1,481,701 1.6
------------------------------------------------------------------------------------------------------
Total Investments in
Thailand 7,544,932 4,445,657 4.7
- ---------------------------------------------------------------------------------------------------------------------
Total Investments in the
Pacific Basin/Asia 35,021,885 33,820,908 35.4
- ---------------------------------------------------------------------------------------------------------------------
Face
Amount Short-Term Securities
---------------------------------------------------------------------------------------------------------------------
Commercial US$1,000,000 American Brands, Inc., 5.30%
Paper* due 1/06/1997............. 999,117 999,117 1.0
2,884,000 General Motors Acceptance
Corp., 7.50% due
1/02/1997................. 2,882,798 2,882,798 3.0
3,000,000 Riverwoods Funding Corp.,
5.40% due 1/15/1997....... 2,993,250 2,993,250 3.2
----------- ----------- ----------
6,875,165 6,875,165 7.2
- ---------------------------------------------------------------------------------------------------------------------
US Government & 2,000,000 Federal Home Loan Mortgage
Agency Corp., 5.60% due
Obligations* 1/07/1997................. 1,997,822 1,997,822 2.1
2,000,000 Federal National Mortgage
Association, 5.55% due
1/16/1997................. 1,995,067 1,995,067 2.1
----------- ----------- ----------
3,992,889 3,992,889 4.2
- ---------------------------------------------------------------------------------------------------------------------
Total Investments in Short-
Term Securities 10,868,054 10,868,054 11.4
- ---------------------------------------------------------------------------------------------------------------------
Total Investments........... $91,897,323 96,192,191 100.6
===========
Liabilities in Excess of
Other Assets.............. (593,289) (0.6)
----------- ----------
Net Assets.................. $95,598,902 100.0
=========== ===========
- ---------------------------------------------------------------------------------------------------------------------
* Commercial Paper and certain US Government & Agency Obligations are traded
on a discount basis; the interest rates shown are the discount rates paid
at the time of purchase of the Fund.
+ Non-income producing security.
(a) American Depositary Receipts (ADR).
(b) Global Depositary Receipts (GDR).
(c) Warrants entitle the Fund to purchase a predetermined number of shares of
common stock. The purchase price and the number of shares are subject to
adjustment under certain conditions until the expiration date.
(d) The rights may be exercised until 2/14/1997.
(e) Restricted security as to resale. The value of the Fund's investment in
restricted securities was approximately $5,717,000 representing 6.0% of
net assets.
- ------------------------------------------------------------------------------
Acquisition Value
Issue Date(s) Cost (Note 1a)
- ---------------------------------------------------------------------------------------------------------------------
Ashok Leyland Ltd. (GDR)............................................. 3/09/1995-5/22/1996 $ 532,185 $ 361,725
Companhia Energetica de Minas Gerais S.A. (CEMIG) (ADR).............. 7/20/1995-8/01/1995 426,315 675,000
East India Hotels Ltd. (GDR)......................................... 12/12/1994-7/10/1995 820,294 1,217,300
RAO Gazprom (ADR).................................................... 10/21/1996 425,250 479,250
Gedeon Richter Ltd. (GDR)............................................ 7/03/1996 40,875 58,000
Korea Mobile Telecommunications Corp.(ADR)........................... 1/18/1996 1,993,680 1,641,179
Larsen & Toubro Ltd. (GDR)........................................... 3/22/1996-3/26/1996 1,124,562 1,031,040
Magyar TarKozlesi Reszvenytarsasag (Ordinary)........................ 12/01/1995 174,885 238,243
P.T. Surya Citra Television, 4% due 7/01/1997 (Convertible).......... 6/24/1994 15,000 15,009
- ---------------------------------------------------------------------------------------------------------------------
Total $5,553,046 $5,716,746
========== ==========
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
-37-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Domestic Money Market Fund
Schedule of Investments as of December 31, 1996
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Face Interest Maturity Value
Amount Issue Rate* Date (Note 1a)
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Certificate of Deposit--1.8% $ 5,000,000 Chase Manhattan Bank USA (Delaware)... 5.60 % 4/01/97 $ 5,001,002
- ---------------------------------------------------------------------------------------------------------------------
Total Certificate of Deposit (Cost--$5,000,000) 5,001,002
- ---------------------------------------------------------------------------------------------------------------------
Commercial Paper--46.9% 6,338,000 Allomon Funding Corp. ................ 5.31 2/10/97 6,301,094
7,691,000 Bear Stearns Companies, Inc. ......... 5.35 1/31/97 7,657,699
5,000,000 Beta Finance Inc. .................... 5.44 3/28/97 4,936,014
4,500,000 Beta Finance Inc. .................... 5.32 5/01/97 4,419,675
4,649,000 CSW Credit, Inc. ..................... 5.35 1/22/97 4,635,311
5,000,000 CSW Credit, Inc. ..................... 5.45 3/14/97 4,946,553
5,000,000 Eureka Securitization Inc. ........... 5.33 1/17/97 4,988,958
4,188,000 Eureka Securitization Inc. ........... 5.35 1/28/97 4,171,969
7,815,000 Finova Capital Corp. ................. 5.38 2/24/97 7,752,756
5,096,000 Finova Capital Corp. ................. 5.48 3/20/97 5,036,923
10,000,000 Ford Motor Credit Co. ................ 5.30 2/07/97 9,946,250
4,000,000 General Electric Capital Corp. ....... 5.55 1/10/97 3,995,271
2,000,000 General Electric Capital Corp. ....... 5.50 3/03/97 1,981,933
6,665,000 General Electric Capital Corp. ....... 5.64 3/05/97 6,602,786
426,000 General Motors Acceptance Corp. ...... 5.33 1/13/97 425,310
4,600,000 General Motors Acceptance Corp. ...... 5.34 1/23/97 4,585,778
5,402,000 General Motors Acceptance Corp. ...... 5.32 2/05/97 5,374,577
2,000,000 General Motors Acceptance Corp. ...... 5.34 5/14/97 1,960,400
2,500,000 Goldman Sachs Group, L.P. ........... 5.68 1/06/97 2,498,522
1,857,000 International Securitization Corp. ... 5.35 1/29/97 1,849,514
5,000,000 International Securitization Corp. ... 5.58 2/28/97 4,957,171
7,000,000 Lehman Brothers Holdings Inc. ........ 5.75 1/31/97 6,967,576
4,000,000 Lehman Brothers Holdings Inc. ........ 5.40 3/03/97 3,963,867
2,000,000 Morgan Stanley Group, Inc. ........... 5.41 1/27/97 1,992,639
6,000,000 New Center Asset Trust................ 5.43 1/29/97 5,975,813
7,000,000 New Center Asset Trust................ 5.40 2/07/97 6,962,375
4,000,000 Transamerica Finance Corp. ........... 5.60 3/11/97 3,959,049
- ---------------------------------------------------------------------------------------------------------------------
Total Commercial Paper (Cost--$128,841,542) 128,845,783
- ---------------------------------------------------------------------------------------------------------------------
Bank Notes--1.3% 3,500,000 Bank of America, Illinois............. 5.63 12/30/97 3,498,247
- ---------------------------------------------------------------------------------------------------------------------
Total Bank Notes (Cost--$3,499,667) 3,498,247
- ---------------------------------------------------------------------------------------------------------------------
Corporate Notes--7.6% 7,000,000 Asset Backed Securities Investment
Trust 1996-M+....................... 5.605 10/15/97 7,000,000
5,000,000 CIT Group Holdings, Inc. (The)+....... 5.36 10/27/97 4,997,158
9,000,000 SMM Trust 1995-Q+..................... 5.605 1/08/97 9,000,000
- ---------------------------------------------------------------------------------------------------------------------
Total Corporate Notes (Cost--$20,997,144) 20,997,158
- ---------------------------------------------------------------------------------------------------------------------
Funding Agreements--1.8% 5,000,000 Jackson National Life Insurance
Co.+................................ 5.41 4/08/97 5,000,000
- ---------------------------------------------------------------------------------------------------------------------
Total Funding Agreements (Cost--$5,000,000) 5,000,000
- ---------------------------------------------------------------------------------------------------------------------
Master Notes--1.1% 3,000,000 Goldman Sachs Group L.P.+............. 5.88 8/01/97 3,000,000
- ---------------------------------------------------------------------------------------------------------------------
Total Master Notes (Cost--$3,000,000) 3,000,000
- ---------------------------------------------------------------------------------------------------------------------
US Government, Agency & 32,000 Federal Home Loan Mortgage Corp. ..... 5.35 2/03/97 31,851
Instrumentality Obligations-- 115,000 Federal National Mortgage
Discount--0.2% Association......................... 5.35 2/11/97 114,332
380,000 Federal National Mortgage
Association......................... 5.33 3/27/97 375,239
- ---------------------------------------------------------------------------------------------------------------------
Total US Government, Agency & Instrumentality
Obligations--Discount (Cost--$521,438) 521,422
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-38-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Domestic Money Market Fund
Schedule of Investments as of December 31, 1996 (concluded)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Face Interest Maturity Value
Amount Issue Rate* Date (Note 1a)
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
US Government, Agency & 1,500,000 Federal Farm Credit Bank.............. 5.85 % 10/01/97 $ 1,502,580
Instrumentality Obligations-- 5,000,000 Federal Farm Credit Bank+............. 5.38 11/25/97 4,999,062
Non-Discount--38.7% 4,000,000 Federal Home Loan Bank+............... 5.41 12/10/97 3,998,191
1,040,000 Federal Home Loan Bank+............... 5.60 1/26/98 1,040,299
1,500,000 Federal Home Loan Bank................ 6.12 4/15/98 1,499,530
1,000,000 Federal Home Loan Bank................ 6.17 11/06/98 999,375
5,000,000 Federal National Mortgage
Association+........................ 5.85 2/14/97 5,002,473
12,000,000 Federal National Mortgage
Association+........................ 5.44 2/21/97 12,000,000
2,000,000 Federal National Mortgage
Association+........................ 5.385 5/14/97 1,999,365
9,500,000 Federal National Mortgage
Association+........................ 5.521 5/22/97 9,497,525
5,000,000 Federal National Mortgage
Association+........................ 5.40 7/16/97 4,998,194
2,000,000 Federal National Mortgage
Association+........................ 5.42 8/01/97 1,999,497
2,000,000 Federal National Mortgage
Association+........................ 5.405 9/03/97 1,999,022
1,000,000 Federal National Mortgage
Association+........................ 5.41 9/09/97 999,533
1,000,000 Federal National Mortgage
Association+........................ 5.41 9/29/97 999,559
3,200,000 Federal National Mortgage
Association*........................ 5.47 12/30/97 3,196,016
2,000,000 Federal National Mortgage
Association*........................ 5.19 1/08/98 1,991,380
5,500,000 Federal National Mortgage
Association+........................ 5.46 4/24/98 5,497,250
5,000,000 Student Loan Marketing Association+... 5.62 1/23/97 5,000,249
2,000,000 Student Loan Marketing Association+... 5.54 3/03/97 2,000,038
6,500,000 Student Loan Marketing Association+... 5.57 10/30/97 6,501,136
2,000,000 US Treasury Notes..................... 6.625 3/31/97 2,005,624
2,000,000 US Treasury Notes..................... 8.50 4/15/97 2,017,186
1,750,000 US Treasury Notes..................... 6.50 4/30/97 1,756,563
1,750,000 US Treasury Notes..................... 6.50 5/15/97 1,757,109
1,500,000 US Treasury Notes..................... 6.125 5/31/97 1,503,750
1,800,000 US Treasury Notes..................... 6.00 8/31/97 1,805,062
4,800,000 US Treasury Notes..................... 5.75 9/30/97 4,808,621
3,500,000 US Treasury Notes..................... 5.625 10/31/97 3,502,188
3,800,000 US Treasury Notes..................... 5.375 11/30/97 3,792,278
2,200,000 US Treasury Notes..................... 5.25 12/31/97 2,192,951
1,170,000 US Treasury Notes..................... 5.00 1/31/98 1,161,773
1,200,000 US Treasury Notes..................... 5.625 11/30/98 1,194,937
1,000,000 US Treasury Notes..................... 5.75 12/31/98 998,359
- ---------------------------------------------------------------------------------------------------------------------
Total US Government, Agency & Instrumentality
Obligations--Non-Discount (Cost--$106,239,960) 106,216,675
- ---------------------------------------------------------------------------------------------------------------------
Repurchase Agreements**--2.1% 5,780,000 Lehman Brothers Inc., purchased on
12/31/1996 to yield 7.10% to
1/02/1997........................... 5,780,000
- ---------------------------------------------------------------------------------------------------------------------
Total Repurchase Agreement (Cost--$5,780,000) 5,780,000
- ---------------------------------------------------------------------------------------------------------------------
Total Investments (Cost--
$278,879,751)--101.5%................. 278,860,287
Liabilities in Excess of Other
Assets--(1.5%)........................ (4,104,273)
------
Net Assets--100.0%.................... $274,756,014
======
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* Commercial Paper and certain US Government Obligations are traded on a
discount basis; the interest rates shown are the discount rates paid at the
time of purchase by the Fund. Other securities bear interest at the rates
shown, payable at fixed dates or upon maturity. The interest rates on
variable rate securities are adjusted periodically based upon appropriate
indexes; the interest rates shown are the rates in effect at December 31,
1996.
** Repurchase Agreements are fully collateralized by US Government
Obligations.
+ Variable Rate Notes.
See Notes to Financial Statements.
-39-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Equity Growth Fund
Schedule of Investments as of December 31, 1996
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Value Percent of
Industry Held Common Stocks Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Advertising 75,000 +Outdoor Systems Inc. ...... $ 1,725,000 $ 2,100,000 0.5%
50,000 +Universal Outdoor Holdings
Inc. ..................... 1,850,000 1,150,000 0.2
------------ ------------ ------
3,575,000 3,250,000 0.7
- ---------------------------------------------------------------------------------------------------------------------
Automotive 57,000 +United Auto Group, Inc. ... 1,710,000 1,467,750 0.3
- ---------------------------------------------------------------------------------------------------------------------
Banking 159,300 TCF Financial Corp. ........ 4,274,782 6,929,550 1.5
- ---------------------------------------------------------------------------------------------------------------------
Biotechnology 75,000 +CN Biosciences Inc. ....... 937,500 1,368,750 0.3
350,000 +COR Therapeutics Inc. ..... 3,820,630 3,456,250 0.8
320,000 +Neoprobe Corp. ............ 5,810,262 4,800,000 1.0
------------ ------------ ------
10,568,392 9,625,000 2.1
- ---------------------------------------------------------------------------------------------------------------------
Broadcast, Radio & TV 197,000 +Jacor Communications, Inc.
......................... 5,516,000 5,392,875 1.2
- ---------------------------------------------------------------------------------------------------------------------
Building Materials 150,000 Apogee Enterprises, Inc.
......................... 2,153,512 5,925,000 1.3
265,000 Ply-Gem Industries, Inc. ... 4,750,765 3,279,375 0.7
------------ ------------ ------
6,904,277 9,204,375 2.0
- ---------------------------------------------------------------------------------------------------------------------
Business Services 240,000 +Accustaff, Inc. ........... 6,340,514 5,070,000 1.1
244,000 Reynolds & Reynolds Co.
(The) (Class A)........... 3,386,946 6,344,000 1.4
------------ ------------ ------
9,727,460 11,414,000 2.5
- ---------------------------------------------------------------------------------------------------------------------
Chemicals 255,000 Crompton & Knowles Corp. ... 4,062,361 4,908,750 1.1
- ---------------------------------------------------------------------------------------------------------------------
Commercial Services 155,000 Rollins Inc. ............... 3,898,215 3,100,000 0.7
- ---------------------------------------------------------------------------------------------------------------------
Computer Software 265,000 +Activision Inc. ........... 3,858,754 3,312,500 0.7
- ---------------------------------------------------------------------------------------------------------------------
Computers & Peripherals 112,500 +3d Systems Corp. .......... 1,988,750 1,434,375 0.3
100,000 +Adtran, Inc. .............. 4,873,162 4,150,000 0.9
90,000 +Cabletron Systems, Inc. ... 2,882,223 2,992,500 0.7
262,500 +MicroAge Inc. ............. 2,860,757 5,217,187 1.1
100,000 +SCI Systems, Inc. ......... 4,467,211 4,462,500 1.0
50,000 +U.S. Robotics Corp. ....... 3,213,125 3,600,000 0.8
------------ ------------ ------
20,285,228 21,856,562 4.8
- ---------------------------------------------------------------------------------------------------------------------
Diversified 75,400 Harsco Corp. ............... 4,007,056 5,164,900 1.2
150,000 Lancaster Colony Corp. ..... 5,148,124 6,825,000 1.5
------------ ------------ ------
9,155,180 11,989,900 2.7
- ---------------------------------------------------------------------------------------------------------------------
Drug Stores 100,000 +Revco D.S., Inc. .......... 2,555,874 3,700,000 0.8
185,000 Rite Aid Corporation ....... 5,592,412 7,353,750 1.6
------------ ------------ ------
8,148,286 11,053,750 2.4
- ---------------------------------------------------------------------------------------------------------------------
Electrical Equipment 190,000 Belden, Inc. ............... 5,864,294 7,030,000 1.6
217,500 Methode Electronics Inc.
(Class A)................. 2,705,417 4,295,625 0.9
200,750 +Vishay Intertechnology,
Inc. ..................... 5,506,140 4,692,531 1.0
------------ ------------ ------
14,075,851 16,018,156 3.5
- ---------------------------------------------------------------------------------------------------------------------
Electronic/Instruments 250,500 BMC Industries, Inc. ....... 2,162,900 7,890,750 1.8
- ---------------------------------------------------------------------------------------------------------------------
Electronics 170,000 Fisher Scientific International
Inc. ..................... 5,111,731 8,011,250 1.8
133,300 +ITI Technologies, Inc. .... 3,796,760 1,999,500 0.4
200,000 +Kemet Corp. ............... 4,131,252 4,575,000 1.0
200,000 +Semitool Inc. ............. 3,381,041 1,900,000 0.4
------------ ------------ ------
16,420,784 16,485,750 3.6
- ---------------------------------------------------------------------------------------------------------------------
Environmental 186,718 +TETRA Technologies, Inc. .. 2,121,250 3,641,001 0.8
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-40-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Equity Growth Fund
Schedule of Investments as of December 31, 1996 (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Value Percent of
Industry Held Common Stocks Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Financial Services 115,000 FINOVA Group, Inc. ......... 4,281,177 7,388,750 1.6
200,000 +Imperial Credit Industries,
Inc. ..................... 2,581,376 4,175,000 0.9
240,000 +National Auto Credit,
Inc. ..................... 2,690,561 2,880,000 0.7
130,000 +Southern Pacific Funding
Corp. .................... 2,266,125 4,046,250 0.9
------------ ------------ ----------
11,819,239 18,490,000 4.1
- ---------------------------------------------------------------------------------------------------------------------
Healthcare-- 110,000 +Thermedics, Inc. .......... 1,535,333 1,993,750 0.4
Products & Services
- ---------------------------------------------------------------------------------------------------------------------
Hospital Management 170,000 +Emcare Holdings Inc........ 4,693,754 3,846,250 0.9
190,500 +Health Care & Retirement
Corp. .................... 4,001,067 5,453,063 1.2
185,000 +OrNda Health Corp. ........ 3,182,121 5,411,250 1.2
------------ ------------ ----------
11,876,942 14,710,563 3.3
- ---------------------------------------------------------------------------------------------------------------------
Hotels 200,000 +Extended Stay America
Inc. ..................... 3,567,050 4,000,000 0.9
200,000 La Quinta Inns, Inc. ....... 3,919,340 3,825,000 0.8
------------ ------------ ----------
7,486,390 7,825,000 1.7
- ---------------------------------------------------------------------------------------------------------------------
Leisure 167,500 Royal Caribbean Cruises
Ltd. ..................... 3,905,376 3,915,313 0.9
- ---------------------------------------------------------------------------------------------------------------------
Manufactured Housing 312,812 Clayton Homes, Inc. ........ 3,590,402 4,222,962 0.9
175,000 Oakwood Homes Corporation... 3,867,933 4,003,125 0.9
------------ ------------ ----------
7,458,335 8,226,087 1.8
- ---------------------------------------------------------------------------------------------------------------------
Medical 200,000 +Paracelsus Healthcare
Corp. .................... 1,700,000 725,000 0.2
- ---------------------------------------------------------------------------------------------------------------------
Medical Equipment 435,000 +Angeion Corp. ............. 2,509,688 1,495,313 0.3
175,000 +Physio-Control
International Corp. ...... 3,710,000 3,850,000 0.9
------------ ------------ ----------
6,219,688 5,345,313 1.2
- ---------------------------------------------------------------------------------------------------------------------
Medical Services 100,000 +Collaborative Clinical
Research, Inc. .......... 1,414,250 1,075,000 0.2
330,000 +Mariner Health Group,
Inc. ..................... 4,886,250 2,722,500 0.6
250,000 +Medpartners/Mullikin
Inc. ..................... 4,971,078 5,250,000 1.2
465,000 +North American Biologicals,
Inc. ..................... 4,211,875 4,068,750 0.9
------------ ------------ ----------
15,483,453 13,116,250 2.9
- ---------------------------------------------------------------------------------------------------------------------
Medical Supplies 285,000 +ATS Medical, Inc. ......... 1,845,625 2,208,750 0.5
170,000 Beckman Instruments, Inc. .. 4,949,331 6,523,750 1.5
250,000 +Cholestech Corp. .......... 1,250,000 1,375,000 0.3
165,000 Dentsply International,
Inc. ..................... 6,162,500 7,837,500 1.7
320,000 +Healthdyne Technologies
Inc. ..................... 3,805,625 2,840,000 0.6
130,000 Meridan Diagnostics,
Inc. ..................... 1,315,875 1,690,000 0.4
85,300 +Urologix, Inc. ............ 1,281,050 1,364,800 0.3
------------ ------------ ----------
20,610,006 23,839,800 5.3
- ---------------------------------------------------------------------------------------------------------------------
Metal Fabricating 112,500 Valmont Industries, Inc. ... 2,398,750 4,584,375 1.0
- ---------------------------------------------------------------------------------------------------------------------
Office Equipment 145,000 Danka Business Systems PLC
(ADR)*.................... 5,003,689 5,129,375 1.1
- ---------------------------------------------------------------------------------------------------------------------
Oil & Gas 135,000 Vintage Petroleum, Inc. .... 3,056,706 4,657,500 1.0
- ---------------------------------------------------------------------------------------------------------------------
Oil & Gas Producers 175,000 +Barrett Resources Corp. ... 4,132,342 7,459,375 1.7
200,000 +Belden & Blake Energy
Co. ...................... 3,248,647 5,100,000 1.1
125,000 NICOR Inc. ................. 3,068,051 4,468,750 1.0
150,000 +Seagull Energy Corp. ...... 2,956,364 3,300,000 0.7
------------ ------------ ----------
13,405,404 20,328,125 4.5
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-41-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Equity Growth Fund
Schedule of Investments as of December 31, 1996 (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Value Percent of
Industry Held Common Stocks Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Oil/Gas-- Equipment & Services 300,000 +Pride Petroleum Services,
Inc. ..................... 2,347,880 6,900,000 1.5
100,000 +Trico Marine Services,
Inc. ..................... 1,600,000 4,800,000 1.1
156,000 +Weatherford Enterra,
Inc. ..................... 4,362,012 4,680,000 1.0
------------ ------------ ----------
8,309,892 16,380,000 3.6
- ---------------------------------------------------------------------------------------------------------------------
Pharmaceuticals 95,000 +Flamel Technologies
S.A.(ADR)*................ 1,140,000 688,750 0.2
310,000 Mylan Laboratories Inc. .... 5,551,352 5,192,500 1.2
290,000 +NeXstar Pharmaceuticals,
Inc. ..................... 6,138,688 4,241,250 0.9
100,000 +Sano Corporation........... 1,356,875 1,475,000 0.3
------------ ------------ ----------
14,186,915 11,597,500 2.6
- ---------------------------------------------------------------------------------------------------------------------
Printing & Publishing 122,000 Banta Corp. ................ 2,822,042 2,745,000 0.6
- ---------------------------------------------------------------------------------------------------------------------
Railroads 68,000 +Genesee & Wyoming Inc.
(Class A)................. 1,209,749 2,227,000 0.5
- ---------------------------------------------------------------------------------------------------------------------
Real Estate Investment Trusts 175,000 Brandywine Realty Trust..... 3,010,862 3,412,500 0.8
162,000 Cali Realty Corp. .......... 3,928,250 5,001,750 1.1
115,000 National Golf Properties
Inc. ..................... 2,565,430 3,636,875 0.8
120,450 National Health Investors,
Inc. ..................... 3,561,600 4,562,044 1.0
------------ ------------ ----------
13,066,142 16,613,169 3.7
- ---------------------------------------------------------------------------------------------------------------------
Restaurants 150,000 Apple South, Inc. .......... 2,079,375 1,968,750 0.4
260,000 Applebee's International,
Inc. ..................... 5,459,375 7,085,000 1.5
100,000 +Boston Chicken, Inc. ...... 3,114,250 3,575,000 0.8
170,000 +Outback Steakhouse,
Inc. ..................... 4,681,565 4,505,000 1.0
50,000 +Rainforest Cafe, Inc. ..... 1,741,250 1,175,000 0.3
------------ ------------ ----------
17,075,815 18,308,750 4.0
- ---------------------------------------------------------------------------------------------------------------------
Retail Specialty 220,000 +Discount Auto Parts,
Inc. ..................... 5,463,948 5,142,500 1.1
135,000 +Moovies, Inc. ............. 1,552,500 700,312 0.2
150,000 +Movie Gallery, Inc. ....... 3,620,623 1,950,000 0.4
------------ ------------ ----------
10,637,071 7,792,812 1.7
- ---------------------------------------------------------------------------------------------------------------------
Retail Stores 180,800 +Barnes & Noble, Inc. ...... 6,046,946 4,881,600 1.1
- ---------------------------------------------------------------------------------------------------------------------
Semiconductors 130,000 +Asyst Technologies,
Inc. ..................... 4,072,189 2,177,500 0.5
100,000 +Electro Scientific
Industries, Inc. ......... 2,437,502 2,600,000 0.6
110,000 +Lattice Semiconductor
Corp. .................... 3,002,906 5,032,500 1.1
70,000 +Microchip Technology,
Inc. ..................... 1,984,438 3,552,500 0.8
------------ ------------ ----------
11,497,035 13,362,500 3.0
- ---------------------------------------------------------------------------------------------------------------------
Telecommunications 50,000 +LCC International, Inc.
(Class A)................. 800,000 881,250 0.2
- ---------------------------------------------------------------------------------------------------------------------
Textiles 138,800 +Galey & Lord, Inc. ........ 1,688,953 2,064,650 0.5
185,000 Unifi, Inc. ................ 4,347,516 5,943,125 1.3
------------ ------------ ----------
6,036,469 8,007,775 1.8
- ---------------------------------------------------------------------------------------------------------------------
Toys 140,000 +Galoob Toys, Inc. ......... 3,752,652 1,960,000 0.4
- ---------------------------------------------------------------------------------------------------------------------
Utilities--Gas 150,000 MCN Corp. .................. 3,004,324 4,331,250 1.0
- ---------------------------------------------------------------------------------------------------------------------
Total Common Stocks 336,869,083 389,515,726 86.0
- ---------------------------------------------------------------------------------------------------------------------
Face
Amount Corporate Bonds
---------------------------------------------------------------------------------------------------------------------
Environmental $ 3,500,000 Sanifill, Inc., 5% due
3/01/2006................. 3,500,000 4,410,000 0.9
- ---------------------------------------------------------------------------------------------------------------------
Total Corporate Bonds 3,500,000 4,410,000 0.9
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-42-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Equity Growth Fund
Schedule of Investments as of December 31, 1996 (concluded)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Face Value Percent of
Amount Short-Term Securities Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Commercial Paper** $10,275,000 General Motors Acceptance
Corp., 7.50% due
1/02/1997................. 10,270,719 10,270,719 2.3
15,000,000 Xerox Credit Corporation,
5.28% due 1/10/1997....... 14,978,000 14,978,000 3.3
------------ ------------ ----------
25,248,719 25,248,719 5.6
- ---------------------------------------------------------------------------------------------------------------------
US Government & 12,755,000 Federal Home Loan Bank:
Agency Obligations** 5.20% due 1/08/1997....... 12,740,261 12,740,261 2.8
Federal National Mortgage
Association:
10,000,000 5.24% due 2/03/1997....... 9,950,511 9,950,511 2.2
10,000,000 5.26% due 2/10/1997....... 9,940,094 9,940,094 2.2
------------ ------------ ----------
32,630,866 32,630,866 7.2
- ---------------------------------------------------------------------------------------------------------------------
Total Short-Term Securities 57,879,585 57,879,585 12.8
- ---------------------------------------------------------------------------------------------------------------------
Total Investments........... $398,248,668 451,805,311 99.7
=============
Other Assets Less
Liabilities............... 1,223,954 0.3
------------ ----------
Net Assets.................. $453,029,265 100.0%
============= ===========
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* American Depositary Receipts (ADR).
** Commercial Paper and certain US Government & Agency Obligations are traded
on a discount basis; the interest rates shown are the discount rates paid
at the time of purchase by the Fund.
+ Non-income producing security.
See Notes to Financial Statements.
-43-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Global Bond Focus Fund
Schedule of Investments as of December 31, 1996 (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Face Value Percent of
NORTH AMERICA Industry Amount Fixed-Income Investments Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Canada Foreign Canadian Government Bonds:
Government
Obligations C$ 550,000 7% due 9/01/2001........... 408,652 426,752 0.5
350,000 7% due 12/01/2006.......... 248,559 266,843 0.3
5,000,000 8% due 6/01/2023........... 4,080,888 4,072,993 4.3
------------------------------------------------------------------------------------------------------
Total Fixed-Income
Investments in Canada 4,738,099 4,766,588 5.1
- ---------------------------------------------------------------------------------------------------------------------
United States Broadcasting/ US$ 1,011,242 American Telecasting Inc.,
Cable 12.59%* due
6/15/2004(c)............. 729,105 414,609 0.4
1,000,000 Bell Cablemedia PLC,
12.03%* due 9/15/2005.... 646,110 802,500 0.9
1,000,000 Videotron Holdings PLC,
11.05%* due 7/01/2004.... 731,219 870,000 0.9
------------ ----------- ------
2,106,434 2,087,109 2.2
------------------------------------------------------------------------------------------------------
Communications 1,375,000 PanAmSat L.P., 11.35%* due
8/01/2003................ 1,108,623 1,278,750 1.4
------------------------------------------------------------------------------------------------------
Energy 250,000 Consolidated-Hydro Inc.,
16.05%* due 7/15/2003.... 209,492 80,000 0.1
------------------------------------------------------------------------------------------------------
Gaming 1,100,000 Greate Bay Properties,
Inc., 10.875% due
1/15/2004................ 990,750 924,000 1.0
500,000 +Harrah's Jazz Company,
14.25% due 11/15/2001.... 482,500 245,625 0.2
------------ ----------- ------
1,473,250 1,169,625 1.2
------------------------------------------------------------------------------------------------------
Specialty 500,000 +Bradlees Inc., 11% due
Retailing 8/01/2002................ 489,375 52,500 0.1
------------------------------------------------------------------------------------------------------
US Government 2,000,000 US Treasury Notes, 6.50%
Obligations due 10/15/2006........... 2,031,875 2,010,940 2.2
------------------------------------------------------------------------------------------------------
Utilities 233,382 ++Tucson Electric Power
Co., 10.732% due
1/01/2013................ 223,464 228,713 0.2
------------------------------------------------------------------------------------------------------
Total Fixed-Income
Investments in the United
States 7,642,513 6,907,637 7.4
- ---------------------------------------------------------------------------------------------------------------------
Shares
Held Stocks & Warrants
- ---------------------------------------------------------------------------------------------------------------------
United States Broadcasting & 1 K-III Communications Corp.
Publishing (Non-Convertible
Preferred)............... 79 80 0.0
9,608 On Command Corporation..... 279,101 152,527 0.2
3,057 On Command Corporation
(Warrants)(a)............ 24,456 20,635 0.0
------------ ----------- ------
303,636 173,242 0.2
------------------------------------------------------------------------------------------------------
Broadcasting/Cable 4,700 American Telecasting Inc.
(Warrants)(a)............ 11,222 10,575 0.0
------------------------------------------------------------------------------------------------------
Entertainment 13 Time Warner Inc. (Non-
Convertible Preferred)
(Series M)............... 13,650 14,105 0.0
------------------------------------------------------------------------------------------------------
Supermarkets 17,674 Grand Union Co............. 917,438 86,161 0.1
- ---------------------------------------------------------------------------------------------------------------------
Total Stocks & Warrants in
the United States 1,245,946 284,083 0.3
- ---------------------------------------------------------------------------------------------------------------------
Total Investments in North
America 13,626,558 11,958,308 12.8
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-44-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series, Inc.--Global Bond Focus Fund
Schedule of Investments as of December 31, 1996 (continued) (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Face Value Percent of
PACIFIC BASIN Industry Amount Fixed-Income Investments Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Australia Foreign Australian Government
Government Bonds:
Obligations A$ 6,000,000 9.75% due 3/15/2002...... 5,435,527 5,318,773 5.7
353,000 9.50% due 8/15/2003...... 298,116 313,588 0.3
4,200,000 9% due 9/15/2004......... 3,633,191 3,662,566 3.9
3,000,000 Queensland Treasury Corp.,
8% due 8/14/2001......... 2,479,656 2,472,162 2.7
------------------------------------------------------------------------------------------------------
Total Fixed-Income
Investments in Australia 11,846,490 11,767,089 12.6
- ---------------------------------------------------------------------------------------------------------------------
Japan Banking Y 65,000,000 Asian Development Bank,
5.625% due 2/18/2002..... 750,697 662,349 0.7
50,000,000 Export Import Bank of
Japan, 4.375% due
10/01/2003............... 503,455 486,399 0.5
225,000,000 IBRD World Bank, 4.75% due
12/20/2004............... 2,336,316 2,258,938 2.4
112,000,000 World Bank, 4.50% due
3/20/2003................ 1,137,254 1,100,850 1.2
------------ ----------- ----------
4,727,722 4,508,536 4.8
------------------------------------------------------------------------------------------------------
Foreign 90,000,000 Federal National Mortgage
Government Association, 2% due
Obligations 12/20/1999............... 844,636 798,964 0.8
82,600,000 Japanese Government Bond,
3% due 9/20/2005......... 756,992 735,126 0.8
60,000,000 Republic of Finland, 6% due
1/29/2002................ 654,914 619,689 0.7
------------ ----------- ----------
2,256,542 2,153,779 2.3
------------------------------------------------------------------------------------------------------
Total Fixed-Income
Investments in Japan 6,984,264 6,662,315 7.1
- ---------------------------------------------------------------------------------------------------------------------
New Zealand Foreign NZ$ 6,200,000 New Zealand Government
Government Bond, 8% due 2/15/2001... 4,523,325 4,536,150 4.8
Obligations
- ---------------------------------------------------------------------------------------------------------------------
Total Fixed-Income
Investments in New Zealand 4,523,325 4,536,150 4.8
- ---------------------------------------------------------------------------------------------------------------------
Total Investments in the
Pacific Basin 23,354,079 22,965,554 24.5
- ---------------------------------------------------------------------------------------------------------------------
WESTERN EUROPE
- ---------------------------------------------------------------------------------------------------------------------
Denmark Finance Dkr 15,940,000 Nykredit, 6% due
10/01/2026............... 2,306,331 2,348,839 2.5
------------------------------------------------------------------------------------------------------
Foreign Denmark Government Bonds:
Government
Obligations 2,800,000 8% due 5/15/2003......... 516,582 526,953 0.6
33,200,000 8% due 3/15/2006......... 6,119,857 6,201,919 6.6
------------ ----------- ----------
6,636,439 6,728,872 7.2
------------------------------------------------------------------------------------------------------
Total Fixed-Income
Investments in Denmark 8,942,770 9,077,711 9.7
- ---------------------------------------------------------------------------------------------------------------------
France Foreign Frf 2,000,000 French Government 'B-Tan',
Government 7% due 10/12/2000........ 420,453 422,205 0.5
Obligations 2,300,000 French OAT, 7.25% due
4/25/2006................ 483,739 490,279 0.5
------------------------------------------------------------------------------------------------------
Total Fixed-Income
Investments in France 904,192 912,484 1.0
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-45-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series, Inc.--Global Bond Focus Fund
Schedule of Investments as of December 31, 1996 (continued) (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
WESTERN EUROPE Face Value Percent of
(concluded) Industry Amount Fixed-Income Investments Cost (Note 1a) Net Assets
<S> <C> <C> <C> <C> <C> <C>
---------------------------------------------------------------------------------------------------------------------
Germany Finance DM 2,450,000 KFW International Finance
Inc., 6.25% due
10/15/2003............... $ 1,644,147 $ 1,660,936 1.8%
------------------------------------------------------------------------------------------------------
Foreign Bundesrepublik Deutschland:
Government 625,000 7.50% due 11/11/2004..... 452,947 453,729 0.5
Obligations 500,000 6.25% due 4/26/2006...... 337,334 335,912 0.3
2,000,000 Deutschland Republic, 6.75%
due 4/22/2003............ 1,385,871 1,401,365 1.5
1,900,000 German Unity Fund,
8% due 1/21/2002......... 1,416,586 1,404,407 1.5
------------ ----------- ----------
3,592,738 3,595,413 3.8
------------------------------------------------------------------------------------------------------
Total Fixed-Income
Investments in Germany 5,236,885 5,256,349 5.6
- ---------------------------------------------------------------------------------------------------------------------
Italy Foreign Skr Buoni Poliennali del Tesoro
Government (Italian Government
Obligations Bonds):
Lit 4,000,000,000 9.50% due 5/01/2001...... 2,857,054 2,912,827 3.1
4,000,000,000 8.75% due 7/01/2006...... 2,841,855 2,870,673 3.1
Government of Italy:
2,200,000,000 10.50% due 7/15/2000..... 1,456,374 1,624,080 1.7
750,000,000 8.50% due 4/01/2004...... 515,391 529,261 0.6
------------------------------------------------------------------------------------------------------
Total Fixed-Income
Investments in Italy 7,670,674 7,936,841 8.5
- ---------------------------------------------------------------------------------------------------------------------
Spain Foreign Government of Spain:
Government Pta 75,000,000 10.10% due 2/28/2001..... 650,217 664,414 0.7
Obligations 290,000,000 10.50% due 10/30/2003.... 2,694,264 2,713,544 2.9
135,000,000 8% due 5/30/2004......... 1,094,423 1,127,339 1.2
------------------------------------------------------------------------------------------------------
Total Fixed-Income
Investments in Spain 4,438,904 4,505,297 4.8
- ---------------------------------------------------------------------------------------------------------------------
Sweden Finance L 4,300,000 Swedish Export Credit
Corp., 7.625% due
12/27/2001............... 7,148,129 7,366,739 7.8
------------------------------------------------------------------------------------------------------
Foreign Government of Sweden:
Government Skr 8,500,000 10.25% due 5/05/2000..... 1,411,881 1,438,926 1.5
Obligations 17,500,000 6% due 2/09/2005......... 2,407,211 2,489,545 2.7
18,100,000 8% due 8/15/2007......... 2,854,379 2,899,028 3.1
------------ ----------- ----------
6,673,471 6,827,499 7.3
------------------------------------------------------------------------------------------------------
Total Fixed-Income
Investments in Sweden 13,821,600 14,194,238 15.1
- ---------------------------------------------------------------------------------------------------------------------
United Kingdom Foreign United Kingdom Treasury
Government Gilt:
Obligations L 2,000,000 8% due 12/07/2000........ 3,344,163 3,516,763 3.7
2,500,000 7% due 11/06/2001........ 4,113,200 4,230,220 4.5
300,000 8% due 6/10/2003......... 490,794 529,279 0.6
530,000 8.50% due 12/07/2005..... 945,081 965,661 1.0
150,000 9% due 7/12/2011......... 252,238 286,693 0.3
------------------------------------------------------------------------------------------------------
Total Fixed-Income
Investments in the United
Kingdom 9,145,476 9,528,616 10.1
- ---------------------------------------------------------------------------------------------------------------------
Total Investments in
Western Europe 50,160,501 51,411,536 54.8
- ---------------------------------------------------------------------------------------------------------------------
Short-Term Securities
- ---------------------------------------------------------------------------------------------------------------------
Commercial Paper** US$ 4,161,000 General Electric Capital
Corp., 7.10% due
1/02/1997................ 4,160,179 4,160,179 4.4
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-46-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Global Bond Focus Fund
Schedule of Investments as of December 31, 1996 (concluded) (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Face Value Percent of
Amount Short-Term Securities Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
US Government & Federal Home Loan Mortgage
Agency Obligations** Corp.:
US$1,000,000 6.50% due 1/02/1997........ $ 999,819 $ 999,819 1.1%
4,545,000 5.33% due 1/06/1997........ 4,541,635 4,541,635 4.8
Federal National Mortgage
Association:
1,000,000 5.25% due 1/10/1997........ 998,688 998,688 1.1
3,000,000 5.37% due 1/22/1997........ 2,990,603 2,990,603 3.2
United States Treasury
Bills(b):
125,000 4.82% due 3/13/1997........ 123,812 123,793 0.1
200,000 5.27% due 3/13/1997........ 197,921 198,068 0.2
------------ ----------- ----------
9,852,478 9,852,606 10.5
- ---------------------------------------------------------------------------------------------------------------------
Total Investments in
Short-Term Securities 14,012,657 14,012,785 14.9
- ---------------------------------------------------------------------------------------------------------------------
Total Investments................................ $101,153,795 100,348,183 107.0
=============
Variation Margin on Financial Futures
Contracts***..................................... (17,464) 0.0
Unrealized Depreciation on Forward Foreign
Exchange Contracts****........................... (78,492) (0.1)
Liabilities in Excess of Other Assets............ (6,462,317) (6.9)
----------- ----------
Net Assets....................................... $93,789,910 100.0%
=========== ===========
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Warrants entitle the Fund to purchase a predetermined number of shares of
common stock. The purchase price and number of shares are subject to
adjustments under certain conditions until the expiration date.
(b) Security held as collateral in connection with open financial futures
contracts.
(c) Subject to principal paydowns.
* Represents a zero coupon or step bond; the interest rate shown is the
effective yield at the time of purchase by the Fund.
** Commercial Paper and certain US Government & Agency Obligations are traded
on a discount basis; the interest rates shown are the discount rates paid
at the time of purchase by the Fund.
*** Financial futures contracts sold as of December 31, 1996 were as follows:
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Value
Number of Expiration (Notes 1a &
Contracts Issue Exchange Date 1b)
- --------------------------------------------------------------------------
<S> <C> <C> <C> <C>
15 Italian BTP LIFFE March 1997 $2,556,891
70 UK Gilt LIFFE March 1997 6,582,838
- --------------------------------------------------------------------------
Total Financial Futures Contracts Sold (Total Contract
Price-$9,069,181) $ 9,139,729
==========
- -----------------------------------------------------------------------
</TABLE>
****Forward foreign exchange contracts as of December 31, 1996 were as
follows:
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Unrealized
Depreciation
Foreign Currency Sold Expiration Date (Note 1b)
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Dkr 10,000,000........................................................... January 1997 $(16,909)
DM 5,436,386............................................................ January 1997 (35,279)
L 4,000,000............................................................ January 1997 (24,948)
Y 500,000,000........................................................... January 1997 (1,356)
- ---------------------------------------------------------------------------------------------------------------------
Total Unrealized Depreciation--Net on Forward Foreign Exchange Contracts (US$
Commitment--$16,323,461) $(78,492)
========
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
+ Non-income producing security.
++ Restricted security as to resale. The value of the Fund's investment in
restricted securities was approximately $229,000, representing 0.2% of net
assets.
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION> Value
Issue Acquisition Date Cost (Note 1a)
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Tucson Electric Power Co., 10.732% due 1/01/2013........................ 8/19/1993 $223,464 $228,713
- ---------------------------------------------------------------------------------------------------------------------
Total $223,464 $228,713
======= ========
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
-47-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Global Strategy Focus Fund
Schedule of Investments as of December 31, 1996 (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Value Percent of
Industry Held US Stocks & Warrants Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Aerospace 64,500 Northrop Grumman Corp......... $ 4,288,238 $ 5,337,375 0.6%
55,000 United Technologies Corp...... 2,256,982 3,630,000 0.4
------------ ------------ ------
6,545,220 8,967,375 1.0
- ---------------------------------------------------------------------------------------------------------------------
Auto & Truck 70,000 General Motors Corp........... 3,775,240 3,902,500 0.4
- ---------------------------------------------------------------------------------------------------------------------
Automobile Parts 173,500 +Lear Corporation............. 5,812,250 5,920,688 0.7
- ---------------------------------------------------------------------------------------------------------------------
Banking 38,000 Bank of New York Co., Inc.
(Warrants)(a)............... 285,875 2,816,750 0.3
115,000 Bank of New York, Co., Inc.... 2,904,748 3,881,250 0.4
28,000 BankAmerica Corp.............. 2,864,806 2,793,000 0.3
57,000 Citicorp...................... 4,452,439 5,871,000 0.7
------------ ------------ ------
10,507,868 15,362,000 1.7
- ---------------------------------------------------------------------------------------------------------------------
Building Products 15,700 Spieker Properties, Inc....... 432,692 565,200 0.1
- ---------------------------------------------------------------------------------------------------------------------
Building & Construction 134,500 Oakwood Homes Corporation..... 3,064,418 3,076,688 0.4
- ---------------------------------------------------------------------------------------------------------------------
Business Services 110,375 +Oracle Corp.................. 3,621,396 4,594,359 0.5
- ---------------------------------------------------------------------------------------------------------------------
Chemicals 92,000 +FMC Corporation.............. 6,520,585 6,451,500 0.7
107,000 PPG Industries, Inc........... 5,294,623 6,005,375 0.7
------------ ------------ ------
11,815,208 12,456,875 1.4
- ---------------------------------------------------------------------------------------------------------------------
Computer Services 97,000 +cisco Systems, Inc........... 4,376,411 6,171,625 0.7
142,200 First Data Corp............... 5,031,267 5,190,300 0.6
------------ ------------ ------
9,407,678 11,361,925 1.3
- ---------------------------------------------------------------------------------------------------------------------
Computer Technology 152,000 +Gulfstream Aerospace
Corporation................. 3,756,241 3,686,000 0.4
- ---------------------------------------------------------------------------------------------------------------------
Computers 81,000 +Compaq Computer Corp......... 6,008,178 6,014,250 0.7
38,500 International Business
Machines Corp............... 4,230,992 5,813,500 0.7
------------ ------------ ------
10,239,170 11,827,750 1.4
- ---------------------------------------------------------------------------------------------------------------------
Conglomerates 45,800 AlliedSignal Inc.............. 3,366,507 3,068,600 0.4
- ---------------------------------------------------------------------------------------------------------------------
Diversified 137,500 Corning, Inc.................. 4,183,441 6,359,375 0.7
- ---------------------------------------------------------------------------------------------------------------------
Electrical Equipment 28,300 Linear Technology
Corporation................. 1,160,935 1,238,125 0.1
- ---------------------------------------------------------------------------------------------------------------------
Electronics 42,000 General Electric Co. ......... 3,325,769 4,152,750 0.5
- ---------------------------------------------------------------------------------------------------------------------
Engineering & Construction 155,900 Foster Wheeler Corp. ......... 6,680,398 5,787,788 0.7
- ---------------------------------------------------------------------------------------------------------------------
Entertainment 162,399 +Viacom, Inc. (Class B)....... 5,963,826 5,663,665 0.7
- ---------------------------------------------------------------------------------------------------------------------
Financial Services 102,500 American Express Company...... 4,852,027 5,791,250 0.7
- ---------------------------------------------------------------------------------------------------------------------
Foods 146,000 Heinz (H.J.) Company.......... 4,731,138 5,219,500 0.6
- ---------------------------------------------------------------------------------------------------------------------
Hospital Management 234,000 +Health Management Associates,
Inc. (Class A).............. 5,276,847 5,265,000 0.6
- ---------------------------------------------------------------------------------------------------------------------
Insurance 58,000 Aetna Inc. ................... 4,082,043 4,640,000 0.5
220,000 +Airtouch Communications,
Inc. ....................... 6,292,837 5,555,000 0.7
91,200 Allstate Corp. ............... 3,747,599 5,278,200 0.6
81,000 UNUM Corporation.............. 5,157,613 5,852,250 0.7
------------ ------------ ------
19,280,092 21,325,450 2.5
- ---------------------------------------------------------------------------------------------------------------------
Leisure 240,000 Brunswick Corporation......... 5,938,252 5,760,000 0.7
- ---------------------------------------------------------------------------------------------------------------------
Leisure & Entertainment 10,500 +Imax Corporation............. 324,543 322,875 0.0
- ---------------------------------------------------------------------------------------------------------------------
Leisure & Tourism 69,177 TCI Pacific Communications
(Convertible Preferred)..... 6,473,121 6,277,813 0.7
- ---------------------------------------------------------------------------------------------------------------------
Machinery 126,000 +American Standard Companies,
Inc. ....................... 4,111,697 4,819,500 0.6
136,200 Deere & Co. .................. 5,770,935 5,533,125 0.6
------------ ------------ ------
9,882,632 10,352,625 1.2
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-48-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Global Strategy Focus Fund
Schedule of Investments as of December 31, 1996 (continued) (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Value Percent of
Industry Held US Stocks & Warrants Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Natural Gas 144,000 Enron Corp.................... $ 5,443,166 $ 6,210,000 0.7%
- ---------------------------------------------------------------------------------------------------------------------
Natural Gas Pipelines 65,000 IMC Global, Inc. ............. 2,519,391 2,543,125 0.3
- ---------------------------------------------------------------------------------------------------------------------
Oil Services 196,000 Dresser Industries, Inc. ..... 4,324,082 6,076,000 0.7
50,000 Schlumberger Ltd. ............ 4,053,012 4,993,750 0.6
------------ ------------ ------
8,377,094 11,069,750 1.3
- ---------------------------------------------------------------------------------------------------------------------
Paper 64,500 Kimberly-Clark Corp. ......... 4,955,548 6,143,625 0.7
- ---------------------------------------------------------------------------------------------------------------------
Petroleum 108,100 Pennzoil Co. ................. 4,485,180 6,107,650 0.7
143,000 Unocal Corp. ................. 4,802,812 5,809,375 0.7
------------ ------------ ------
9,287,992 11,917,025 1.4
- ---------------------------------------------------------------------------------------------------------------------
Pharmaceuticals 85,700 Abbott Laboratories........... 3,516,941 4,349,275 0.5
59,000 Merck & Co., Inc. ............ 3,072,725 4,675,750 0.5
------------ ------------ ------
6,589,666 9,025,025 1.0
- ---------------------------------------------------------------------------------------------------------------------
Railroads 69,000 Burlington Northern Santa Fe
Inc. ....................... 5,638,407 5,959,875 0.7
- ---------------------------------------------------------------------------------------------------------------------
Real Estate Investment Trust 156,000 Prentiss Properties Trust..... 3,189,080 3,900,000 0.4
83,700 Starwood Lodging Trust........ 3,280,230 4,613,962 0.5
------------ ------------ ------
6,469,310 8,513,962 0.9
- ---------------------------------------------------------------------------------------------------------------------
Retail 126,000 Sears, Roebuck & Co. ......... 5,464,285 5,811,750 0.7
- ---------------------------------------------------------------------------------------------------------------------
Retail--Drug Stores 157,105 Rite Aid Corp. ............... 4,914,258 6,244,924 0.7
- ---------------------------------------------------------------------------------------------------------------------
Retail Specialty 190,000 +Toys 'R' Us, Inc. ........... 5,934,584 5,700,000 0.7
- ---------------------------------------------------------------------------------------------------------------------
Scientific Instruments 110,000 Fisher Scientific
International, Inc. ........ 3,579,430 5,183,750 0.6
- ---------------------------------------------------------------------------------------------------------------------
Software--Computer 147,500 BMC Software, Inc. ........... 5,509,418 6,102,812 0.7
- ---------------------------------------------------------------------------------------------------------------------
Steel 110,000 AK Steel Holding Corp. ....... 4,459,883 4,358,750 0.5
- ---------------------------------------------------------------------------------------------------------------------
Telecommunications 95,800 Bell Atlantic Corporation..... 5,396,243 6,203,050 0.7
- ---------------------------------------------------------------------------------------------------------------------
Tobacco 44,000 Philip Morris Companies,
Inc. ....................... 4,329,124 4,955,500 0.6
- ---------------------------------------------------------------------------------------------------------------------
Travel & Lodging 185,100 Carnival Corp. (Class A)...... 5,310,160 6,108,300 0.7
- ---------------------------------------------------------------------------------------------------------------------
Utilities--Communications 260,300 Edison International.......... 4,944,918 5,173,462 0.6
- ---------------------------------------------------------------------------------------------------------------------
Utilities--Gas 54,000 El Paso Natural Gas Co. ...... 2,646,557 2,727,000 0.3
- ---------------------------------------------------------------------------------------------------------------------
Total US Stocks & Warrants 252,186,343 288,257,861 33.2
- ---------------------------------------------------------------------------------------------------------------------
Country Foreign Stocks++
---------------------------------------------------------------------------------------------------------------------
Argentina 373,772 Banco de Galicia y Buenos
Aires S.A. (ADR)* (3)....... 6,990,318 9,017,249 1.0
305,933 Banco Frances del Rio de la
Plata S.A.(ADR)* (3)........ 7,017,779 8,413,144 1.0
355,900 Yacimientos Petroliferos
Fiscales S.A.(ADR)* (21).... 8,033,094 8,986,475 1.0
------------ ------------ ------
22,041,191 26,416,868 3.0
- ---------------------------------------------------------------------------------------------------------------------
Brazil 13,950,000 Companhia Cervejaria Brahma
S.A. PN (Preferred) (34).... 7,955,613 7,626,913 0.9
58,400,000 Petroleo Brasileiro S.A.--
Petrobras (Preferred)
(46)........................ 7,234,138 9,303,302 1.1
108,700 Telecomunicacoes Brasileiras
S.A.--Telebras (ADR)* (27).. 6,472,073 8,315,550 0.9
------------ ------------ ------
21,661,824 25,245,765 2.9
- ---------------------------------------------------------------------------------------------------------------------
Canada 318,600 Canadian Pacific, Ltd.
(52) ....................... 6,091,881 8,442,900 1.0
147,800 Magna International Inc.
(Class A) (1)............... 6,830,595 8,239,850 0.9
100,100 Potash Corp. of Saskatchewan,
Inc. (35)................... 7,437,257 8,508,500 1.0
------------ ------------ ------
20,359,733 25,191,250 2.9
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-49-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Global Strategy Focus Fund
Schedule of Investments as of December 31, 1996 (continued) (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Value Percent of
Country Held Foreign Stocks++ Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Finland 132,000 Finnlines OY (36)............. $ 2,486,828 $ 3,241,129 0.4%
121,500 Nokia Corp. (ADR)* (37)....... 4,287,533 7,001,437 0.8
409,900 +UPM-Kymmene OY (38).......... 8,516,525 8,461,463 1.0
------------ ------------ ------
15,290,886 18,704,029 2.2
- ---------------------------------------------------------------------------------------------------------------------
France 130,600 Michelin (C.G.D.E.) S.A.
(Class B) (47).............. 5,794,743 7,051,091 0.8
126,500 +SGS-Thomson Microelectronics
N.V. (NY Registered Shares)
(51)........................ 4,655,571 8,855,000 1.0
236,000 Scor S.A. (16)................ 8,948,438 8,301,850 1.0
545,000 Usinor-Sacilor S.A. (40)...... 8,643,115 7,931,284 0.9
------------ ------------ ------
28,041,867 32,139,225 3.7
- ---------------------------------------------------------------------------------------------------------------------
Germany 13,500 +Henkel KGaA (9).............. 600,048 647,579 0.1
121,500 Henkel KGaA (Preferred) (9)... 5,163,053 6,104,615 0.7
16,900 Mannesmann AG (17)............ 4,620,775 7,326,812 0.8
35,800 +Puma AG (48)................. 1,176,806 1,214,664 0.1
176,500 Siemens AG (12)............... 8,419,829 8,317,355 1.0
------------ ------------ ------
19,980,511 23,611,025 2.7
- ---------------------------------------------------------------------------------------------------------------------
Hong Kong 404,600 HSBC Holdings PLC (3)......... 6,668,545 8,658,042 1.0
4,873,200 Hong Kong Telecommunications,
Ltd. (27)................... 8,569,151 7,844,756 0.9
------------ ------------ ------
15,237,696 16,502,798 1.9
- ---------------------------------------------------------------------------------------------------------------------
Indonesia 313,380 P.T. Indonesian Satellite
Corp. (ADR)* (27)........... 9,998,585 8,578,777 1.0
- ---------------------------------------------------------------------------------------------------------------------
Italy 1,161,800 Danieli & Company (17)........ 4,276,177 4,859,167 0.5
1,659,000 Societa Finanziara Telefonica
S.p.A. (STET) (27).......... 4,931,175 7,539,667 0.9
------------ ------------ ------
9,207,352 12,398,834 1.4
- ---------------------------------------------------------------------------------------------------------------------
Japan 424,000 Bridgestone Corporation
(47)........................ 7,463,165 8,055,268 0.9
314,000 Canon, Inc. (12).............. 5,242,498 6,941,623 0.8
424,000 Eisai Co., Ltd. (22).......... 7,787,610 8,348,187 1.0
803,000 Maeda Corp. (4)............... 7,177,535 5,942,755 0.7
370,000 Matsushita Electric
Industries, Ltd. (12)....... 5,646,070 6,038,860 0.7
1,395,000 Mitsubishi Electric Corp.
(11)........................ 9,130,689 8,312,176 0.9
1,061,000 Mitsubishi Heavy Industry,
Ltd. (8).................... 7,818,945 8,429,361 1.0
809,000 Mitsui-Soko Co., Ltd. (42).... 6,794,019 5,288,541 0.6
512,000 Nomura Securities Co., Ltd.
(33)........................ 9,448,726 7,693,264 0.9
906,000 Okumura Corp. (4)............. 6,730,420 5,507,979 0.6
124,000 Rohm Company Ltd. (12)........ 7,059,616 8,138,169 0.9
808,000 Tokio Marine and Fire
Insurance Co., Ltd. (16).... 9,454,210 7,605,527 0.9
1,011,000 Toray Industries Ltd. (28).... 6,794,999 6,242,358 0.7
------------ ------------ ------
96,548,502 92,544,068 10.6
- ---------------------------------------------------------------------------------------------------------------------
Mexico 411,400 Carso Global Telecom, S.A. de
C.V. (ADR)*(27)............. 1,954,150 1,851,300 0.2
375,400 Grupo Carso, S.A. de C.V.
(ADR)*(18).................. 5,559,251 3,894,775 0.4
5,741 Grupo Financiero Inbursa, S.A.
de C.V. (ADR)*(18).......... 115,192 97,597 0.0
436,300 Kimberly-Clark de Mexico, S.A.
de C.V. (38)................ 8,018,361 8,619,572 1.0
171,000 Panamerican Beverages, Inc.
(Class A) (34).............. 7,114,640 8,015,625 0.9
------------ ------------ ------
22,761,594 22,478,869 2.5
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-50-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Global Strategy Focus Fund
Schedule of Investments as of December 31, 1996 (continued) (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Value Percent of
Country Held Foreign Stocks++ Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Netherlands 136,000 ABN-AMRO Holdings (3)......... $ 7,835,801 $ 8,856,547 1.0%
466 ABN-AMRO Holdings N.V.
(Convertible Preferred)
(3)......................... 15,383 28,916 0.0
------------ ------------ ------
7,851,184 8,885,463 1.0
- ---------------------------------------------------------------------------------------------------------------------
Norway 641,000 Color Line ASA (36)........... 2,499,223 2,984,125 0.4
- ---------------------------------------------------------------------------------------------------------------------
Philippines 1,650,000 San Miguel Corp. (Class B)
(34)........................ 5,521,217 7,288,652 0.8
- ---------------------------------------------------------------------------------------------------------------------
South Korea 180,600 +Hyundai Engineering &
Construction Co., Ltd.
(GDR)** (44)+++............. 2,353,218 1,128,750 0.1
- ---------------------------------------------------------------------------------------------------------------------
Spain 238,000 Repsol S.A.(ADR)* (21)........ 7,749,030 9,073,750 1.0
- ---------------------------------------------------------------------------------------------------------------------
Sweden 454,100 Bure Investment Aktiebolaget
(45)........................ 3,955,365 5,397,227 0.6
278,000 Sparbanken Sverige AB (Class
A) (3)...................... 3,575,154 4,772,707 0.6
------------ ------------ ------
7,530,519 10,169,934 1.2
- ---------------------------------------------------------------------------------------------------------------------
Switzerland 5,200 BBC Brown Boveri & Cie AG
(11)........................ 4,633,631 6,466,985 0.8
7,000 +Novartis AG (22)............. 6,960,585 8,015,387 0.9
------------ ------------ ------
11,594,216 14,482,372 1.7
- ---------------------------------------------------------------------------------------------------------------------
United Kingdom 801,000 Boots Company PLC (49)........ 7,746,777 8,256,364 0.9
3,085,000 British Steel PLC (50)........ 8,295,968 8,497,287 1.0
1,302,000 General Electric PLC
(Ordinary) (12)............. 7,044,453 8,531,178 1.0
517,500 Glaxo Wellcome PLC (22)....... 7,417,612 8,393,014 1.0
1,012,400 Grand Metropolitan PLC (34)... 7,201,806 7,967,264 0.9
783,900 Imperial Chemical Industries
PLC (43).................... 10,154,513 10,306,324 1.2
720,500 National Westminster Bank PLC
(3)......................... 7,832,617 8,455,851 1.0
2,085,000 Vodafone Group PLC (27)....... 7,541,528 8,810,534 1.0
------------ ------------ ------
63,235,274 69,217,816 8.0
- ---------------------------------------------------------------------------------------------------------------------
Total Foreign Stocks 389,463,622 427,042,370 49.0
- ---------------------------------------------------------------------------------------------------------------------
Face
Amount Foreign Bonds++
- ---------------------------------------------------------------------------------------------------------------------
Denmark Dkr 66,250,000 Government of Denmark,
8% due 3/15/2006(15)........ 12,133,252 12,375,817 1.4
- ---------------------------------------------------------------------------------------------------------------------
Germany DM 6,500,000 Bundesrepublik Deutschland,
7.125% due 12/20/2002(15)... 4,514,124 4,638,934 0.6
- ---------------------------------------------------------------------------------------------------------------------
Italy Lit 27,470,000,000 Buoni Poliennali del Tesoro
(Italian Government Bonds),
8.50% due 1/01/2004 (15).... 19,448,018 19,380,531 2.2
- ---------------------------------------------------------------------------------------------------------------------
Sweden
Government of Sweden (15):
Skr 41,300,000 10.25% due 5/05/2000........ 7,052,190 6,991,487 0.8
163,000,000 8% due 8/15/2007............ 25,654,854 26,107,266 3.0
------------ ------------ ----------
32,707,044 33,098,753 3.8
- ---------------------------------------------------------------------------------------------------------------------
United Kingdom
United Kingdom Treasury Gilt
(15):
L 4,000,000 7% due 11/06/2001........... 6,592,392 6,768,352 0.8
7,475,000 7.50% due 12/07/2006........ 12,576,320 12,772,245 1.5
------------ ------------ ----------
19,168,712 19,540,597 2.3
- ---------------------------------------------------------------------------------------------------------------------
Total Foreign Bonds 87,971,150 89,034,632 10.3
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-51-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Global Strategy Focus Fund
Schedule of Investments as of December 31, 1996 (continued) (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Percent of
Face Value Net
Amount US Government Obligations Cost (Note 1a) Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
US Treasury Notes:
US$ 16,250,000 6.25% due 4/30/2001.................. $ 16,463,906 $ 16,285,587 1.9%
29,750,000 7% due 7/15/2006..................... 31,584,492 30,907,572 3.5
- ---------------------------------------------------------------------------------------------------------------------
Total US Government Obligations 48,048,398 47,193,159 5.4
- ---------------------------------------------------------------------------------------------------------------------
Short-Term Securities
---------------------------------------------------------------------------------------------------------------------
US Government & 15,755,000 Federal Home Loan Mortgage
Agency
Obligations***
Corp. 5.41% due 1/24/1997............ 15,700,545 15,700,545 1.8
- ---------------------------------------------------------------------------------------------------------------------
Total Short-Term Securities 15,700,545 15,700,545 1.8
- ---------------------------------------------------------------------------------------------------------------------
Total Investments.......................................... $793,370,058 867,228,567 99.7
=============
Unrealized Depreciation on Forward Foreign
Exchange Contracts++.............................. (2,598,413) (0.3)
Other Assets Less Liabilities.............................. 5,572,664 0.6
------------ ----------
Net Assets................................................. $870,202,818 100.0%
============= ===========
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* American Depositary Receipts (ADR).
** Global Depositary Receipts (GDR).
*** Certain US Government & Agency Obligations are traded on a discount
basis; the interest rates shown are the discount rates paid at the time
of purchase by the Fund.
(a) Warrants entitle the Fund to purchase a predetermined number of shares of
common stock. The purchase price and number of shares are subject to
adjustment under certain conditions until the expiration date.
+ Non-income producing security.
++ Corresponding industry groups for foreign stocks and bonds:
(1) Automobile--Parts (27) Telecommunications
(2) Automotive Equipment (28) Textiles
(3) Banking (29) Toys
(4) Building & Construction (30) Trading
(5) Building Materials (31) Utilities
(6) Business & Public Service (32) Utilities--Electric
(7) Business Publishing (33) Financial Services
(8) Capital Goods (34) Beverages
(9) Chemicals (35) Mining
(10) Diversified (36) Transportation
(11) Electrical Equipment (37) Communications Equipment
(12) Electronics (38) Paper & Forest Products
(13) Food (39) Industrial Components
(14) Glass (40) Metals
(15) Government (Bonds) (41) Photography
(16) Insurance (42) Warehouse & Storage
(17) Machinery & Equipment (43) Oil--Integrated
(18) Multi--Industry (44) Engineering & Construction
(19) Natural Gas (45) Investment Management
(20) Packaging (46) Oil & Related
(21) Petroleum (47) Tire & Rubber
(22) Pharmaceutical (48) Consumer--Goods
(23) Printing & Publishing (49) Merchandising
(24) Real Estate (50) Steel
(25) Retail Stores (51) Semiconductor Capital Equipment
(26) Shipping (52) Natural Resources
-52-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Global Strategy Focus Fund
Schedule of Investments as of December 31, 1996 (concluded) (in US dollars)
- ------------------------------------------------------------------------------
+++ Restricted security as to resale. The value of the Fund's investment in
restricted securities was approximately $1,129,000, representing 0.1% of
net assets.
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Acquisition Value
Issue Date Cost (Note 1a)
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Hyundai Engineering & Construction Co., Ltd.(GDR)....................... 3/19/1996 $2,353,218 $1,128,750
- ---------------------------------------------------------------------------------------------------------------------
Total $2,353,218 $1,128,750
========== ==========
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
++ Forward foreign exchange contracts as of December 31, 1996 were as
follows:
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------
Unrealized
Foreign Expiration Depreciation
Currency Sold Date (Note 1b)
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
CHF 16,000,000 ......................................................... January 1997 $ 246,564
DM 63,822,188 ......................................................... February 1997 554,813
Frf 90,000,000 ......................................................... January 1997 (106,255 )
L 39,555,000 ......................................................... January 1997 (3,135,589 )
Y10,670,000,000 ......................................................... February 1997 (157,946 )
- ---------------------------------------------------------------------------------------------------------------------
Total Unrealized Depreciation on Forward
Foreign Exchange Contracts (US$ Commitment--$228,531,727) $(2,598,413 )
============
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
-53-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Global Utility Focus Fund
Schedule of Investments as of December 31, 1996 (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Value Percent of
Country Industry Held Common Stocks Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Argentina Telecommunications 7,900 Central Costanera S.A.
(ADR)*(a)............ $ 261,847 $ 238,975 0.2%
25,600 Telecom Argentina STET
S.A. (ADR)*.......... 1,160,819 1,033,600 0.7
44,800 Telefonica de Argentina
S.A. (ADR)*.......... 1,173,168 1,159,200 0.8
------------------------------------------------------------------------------------------------------
Total Common Stocks
in Argentina 2,595,834 2,431,775 1.7
- ---------------------------------------------------------------------------------------------------------------------
Australia Utilities--Gas 434,496 Australian Gas & Light
Co., Ltd............. 1,238,060 2,470,749 1.8
------------------------------------------------------------------------------------------------------
Total Common Stocks
in Australia 1,238,060 2,470,749 1.8
- ---------------------------------------------------------------------------------------------------------------------
Austria Utilities--Gas 13,560 Energie-Versorgung
Niederoesterreich AG
(EVN).................. 1,388,213 2,041,452 1.4
------------------------------------------------------------------------------------------------------
Total Common Stocks
in Austria 1,388,213 2,041,452 1.4
- ---------------------------------------------------------------------------------------------------------------------
Brazil Telecommunications 30,000 Telecomunicacoes
Brasileiras S.A.--
Telebras (ADR)*...... 1,523,979 2,295,000 1.6
------------------------------------------------------------------------------------------------------
Total Common Stocks
in Brazil 1,523,979 2,295,000 1.6
- ---------------------------------------------------------------------------------------------------------------------
Canada Telecommunications 56,000 BC Telecom, Inc........ 1,052,989 1,211,971 0.8
------------------------------------------------------------------------------------------------------
Utilities--Gas 70,100 Transcanada Pipeline
Co., Ltd. (ADR)*..... 1,045,275 1,226,750 0.9
------------------------------------------------------------------------------------------------------
Total Common Stocks
in Canada 2,098,264 2,438,721 1.7
- ---------------------------------------------------------------------------------------------------------------------
Chile Telecommunications 14,400 Compania de Telefonos
de Chile S.A.
(ADR)*............... 1,254,995 1,456,200 1.0
------------------------------------------------------------------------------------------------------
Utilities--Electric 20,000 Chilgener S.A. (ADR)*.. 460,000 417,500 0.3
35,100 Distribuidora Chilectra
Metropolitana,
S.A. (ADR)*(a)......... 1,098,338 1,860,300 1.3
48,300 Enersis S.A. (ADR)*.... 1,026,061 1,340,325 1.0
----------- ------
2,584,399 3,618,125 2.6
------------------------------------------------------------------------------------------------------
Total Common Stocks
in Chile 3,839,394 5,074,325 3.6
- ---------------------------------------------------------------------------------------------------------------------
Denmark Telecommunications 77,000 Tele Danmark A/S
(ADR)*............... 1,826,433 2,098,250 1.5
------------------------------------------------------------------------------------------------------
Total Common Stocks
in Denmark 1,826,433 2,098,250 1.5
- ---------------------------------------------------------------------------------------------------------------------
France Utilities--Water 16,731 Generale des Eaux...... 1,907,473 2,073,638 1.4
7,265 Lyonnaise des Eaux-
Dumez................ 736,741 676,228 0.5
------------------------------------------------------------------------------------------------------
Total Common Stocks
in France 2,644,214 2,749,866 1.9
- ---------------------------------------------------------------------------------------------------------------------
Germany Telecommunications 8,100 +Deutsche Telekom AG... 154,054 170,845 0.1
------------------------------------------------------------------------------------------------------
Utilities--Electric 40,000 Veba AG................ 1,305,397 2,313,942 1.6
------------------------------------------------------------------------------------------------------
Total Common Stocks
in Germany 1,459,451 2,484,787 1.7
- ---------------------------------------------------------------------------------------------------------------------
Hong Kong Utilities--Gas 568,512 The Hong Kong & China
Gas Co., Ltd......... 755,615 1,098,947 0.8
------------------------------------------------------------------------------------------------------
Total Common Stocks
in Hong Kong 755,615 1,098,947 0.8
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-54-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series, Inc.--Global Utility Focus Fund
Schedule of Investments as of December 31, 1996 (continued) (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Value Percent of
Country Industry Held Common Stocks Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
India Utilities--Electric 1,000 Tata Electric Companies
(GDR)**(a)........... $ 710,000 $ 300,000 0.2%
------------------------------------------------------------------------------------------------------
Total Common Stocks
in India 710,000 300,000 0.2
- ---------------------------------------------------------------------------------------------------------------------
Indonesia Telecommunications 1,110 P.T. Indonesian
Satellite Corp.
(ADR)*............... 35,575 30,386 0.0
8,000 P.T. Telekomunikasi
Indonesia
(PERSERO) (ADR)*....... 144,000 276,000 0.2
------------------------------------------------------------------------------------------------------
Total Common Stocks
in Indonesia 179,575 306,386 0.2
- ---------------------------------------------------------------------------------------------------------------------
Italy Telecommunications 761,900 Societa Finanziara
Telefonica S.p.A.
(STET)................. 1,629,934 2,571,867 1.8
729,600 Telecom Italia Mobile
S.p.A................ 684,328 1,842,922 1.3
729,600 Telecom Italia
S.p.A................ 950,865 1,893,380 1.3
----------- ------
3,265,127 6,308,169 4.4
------------------------------------------------------------------------------------------------------
Utilities--Gas 513,400 Italgas Torino......... 1,581,576 2,142,196 1.5
------------------------------------------------------------------------------------------------------
Total Common Stocks
in Italy 4,846,703 8,450,365 5.9
- ---------------------------------------------------------------------------------------------------------------------
Malaysia Telecommunications 139,000 Telekom Malaysia BHD... 962,438 1,238,614 0.9
------------------------------------------------------------------------------------------------------
Total Common Stocks
in Malaysia 962,438 1,238,614 0.9
- ---------------------------------------------------------------------------------------------------------------------
Mexico Telecommunications 29,000 Telefonos de Mexico,
S.A. de C.V.
(Telemex) (ADR)*....... 1,706,306 957,000 0.7
------------------------------------------------------------------------------------------------------
Total Common Stocks
in Mexico 1,706,306 957,000 0.7
- ---------------------------------------------------------------------------------------------------------------------
New Zealand Telecommunications 36,800 Telecom Corporation of
New Zealand Ltd.
(ADR)*................. 1,680,030 2,980,800 2.1
------------------------------------------------------------------------------------------------------
Total Common Stocks
in New Zealand 1,680,030 2,980,800 2.1
- ---------------------------------------------------------------------------------------------------------------------
Peru Telecommunications 73,000 Telefonica del Peru,
S.A. (ADR)*.......... 1,496,500 1,377,875 1.0
------------------------------------------------------------------------------------------------------
Total Common Stocks
in Peru 1,496,500 1,377,875 1.0
- ---------------------------------------------------------------------------------------------------------------------
Philippines Telecommunications 21,800 Philippine Long Distance
Telephone Co.
(ADR)*............... 1,270,791 1,111,800 0.8
------------------------------------------------------------------------------------------------------
Utilities--Electric 74,100 Manila Electric Co.
(MERALCO) 'B'........ 518,117 606,683 0.4
------------------------------------------------------------------------------------------------------
Total Common Stocks
in the Philippines 1,788,908 1,718,483 1.2
- ---------------------------------------------------------------------------------------------------------------------
Portugal Telecommunications 65,720 Portugal Telecom, S.A.
(ADR)*............... 1,417,539 1,856,590 1.3
------------------------------------------------------------------------------------------------------
Total Common Stocks
in Portugal 1,417,539 1,856,590 1.3
- ---------------------------------------------------------------------------------------------------------------------
South Korea Utilities--Electric 40,800 Korea Electric Power
Corp. (ADR)*......... 821,100 836,400 0.6
------------------------------------------------------------------------------------------------------
Total Common Stocks
in South Korea 821,100 836,400 0.6
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-55-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series, Inc.--Global Utility Focus Fund
Schedule of Investments as of December 31, 1996 (continued) (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Value Percent of
Country Industry Held Common Stocks Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Spain Telecommunications 50,700 Telefonica de Espana
S.A. (ADR)*.......... $ 1,942,165 $ 3,510,975 2.5%
------------------------------------------------------------------------------------------------------
Utilities--Electric 36,400 Empresa Nacional de
Electricidad, S.A.
(Endesa) (ADR)*........ 1,634,684 2,548,000 1.8
15,000 HidroCantabrico,
S.A.................. 503,484 572,303 0.4
131,000 Iberdrola I S.A. ...... 879,896 1,856,010 1.3
----------- ------
3,018,064 4,976,313 3.5
------------------------------------------------------------------------------------------------------
Total Common Stocks
in Spain 4,960,229 8,487,288 6.0
- ---------------------------------------------------------------------------------------------------------------------
Switzerland Utilities--Electric 1,500 Elektrowatt AG......... 588,618 597,177 0.4
------------------------------------------------------------------------------------------------------
Total Common Stocks
in Switzerland 588,618 597,177 0.4
- ---------------------------------------------------------------------------------------------------------------------
Thailand Telecommunications 2,000 +TelecomAsia
Corporation Public
Co., Ltd. (ADR)*..... 43,740 40,000 0.0
------------------------------------------------------------------------------------------------------
Utilities--Electric 68,000 Electricity Generating
Company of Thailand
(EGCOMP)............... 60,715 185,597 0.1
------------------------------------------------------------------------------------------------------
Total Common Stocks
in Thailand 104,455 225,597 0.1
- ---------------------------------------------------------------------------------------------------------------------
United Telecommunications 57,000 British Telecom-
Kingdom munications PLC........ 406,712 385,187 0.3
10,000 British Telecommun-
ications PLC (ADR)*.. 741,450 686,250 0.5
87,000 Vodafone Group PLC
(ADR)*............... 2,549,289 3,599,625 2.5
----------- ------
3,697,451 4,671,062 3.3
------------------------------------------------------------------------------------------------------
Utilities--Electric 73,714 London Electricity
PLC.................. 860,944 858,178 0.6
167,500 National Power PLC..... 1,238,839 1,401,274 1.0
92,690 PowerGen PLC........... 678,633 910,215 0.6
----------- ------
2,778,416 3,169,667 2.2
------------------------------------------------------------------------------------------------------
Total Common Stocks
in the United Kingdom 6,475,867 7,840,729 5.5
- ---------------------------------------------------------------------------------------------------------------------
United Independent Power 40,000 Enron Global Power &
States Producers Pipelines L.L.C. .... 930,101 1,080,000 0.8
------------------------------------------------------------------------------------------------------
Telecommunications 10,000 AT&T Corp. ............ 405,165 435,000 0.3
36,400 +AirTouch
Communications,
Inc.................. 879,157 919,100 0.6
25,800 Ameritech Corp. ....... 1,030,404 1,564,125 1.1
8,000 Bell Atlantic Corp. ... 447,000 518,000 0.4
37,400 BellSouth Corp. ....... 1,138,507 1,510,025 1.1
42,000 Frontier Corp. ........ 969,520 950,250 0.7
33,500 GTE Corp. ............. 1,124,815 1,524,250 1.1
3,240 Lucent Technologies.... 159,185 149,850 0.1
20,000 MCI Communications
Corp. ............... 602,500 652,500 0.4
31,000 NYNEX Corp. ........... 1,184,107 1,491,875 1.0
29,300 SBC Communications,
Inc.................. 1,233,299 1,516,275 1.1
30,000 Sprint Corp............ 864,273 1,196,250 0.8
24,900 U S West Com-
munications Group.... 606,619 803,025 0.6
----------- ------
10,644,551 13,230,525 9.3
------------------------------------------------------------------------------------------------------
Utilities--Electric 65,600 Allegheny Power System,
Inc.................. 1,689,846 1,992,600 1.4
25,000 American Electric Power
Company, Inc......... 1,092,125 1,028,125 0.7
72,500 Boston Edison Co....... 2,012,799 1,948,437 1.4
84,192 CINergy Corp........... 2,052,668 2,809,908 2.0
</TABLE>
-56-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series, Inc.--Global Utility Focus Fund
Schedule of Investments as of December 31, 1996 (continued) (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Value Percent of
Country Industry Held Common Stocks Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
United Utilities-- 49,300 Consolidated Edison
States Electric Co. of New York........ $ 1,597,050 $ 1,442,025 1.0%
(concluded) (concluded) 31,500 DTE Energy............. 989,953 1,019,812 0.7
26,400 Dominion Resources,
Inc.................. 1,242,516 1,016,400 0.7
31,000 Duke Power Co.......... 1,172,492 1,433,750 1.0
97,000 Edison International... 1,800,212 1,927,875 1.3
50,000 Enova Corporation
Holding Co........... 1,184,750 1,137,500 0.8
54,300 Entergy Corp........... 1,905,240 1,506,825 1.1
30,000 FPL Group, Inc......... 1,374,501 1,380,000 1.0
85,200 GPU, Inc............... 2,559,840 2,864,850 2.0
146,200 Houston Industries,
Inc.................. 3,215,466 3,307,775 2.3
56,000 NIPSCO Industries,
Inc.................. 1,787,890 2,219,000 1.5
50,700 New York State Electric
& Gas Corp........... 1,537,761 1,096,387 0.8
93,800 PECO Energy Co......... 2,719,313 2,368,450 1.7
72,800 PacifiCorp............. 1,401,416 1,492,400 1.0
44,000 Public Service Co. of
Colorado............. 1,312,146 1,710,500 1.2
86,200 Southern Co............ 1,846,654 1,950,275 1.4
55,000 Texas Utilities Co..... 2,237,675 2,241,250 1.6
----------- ------
36,732,313 37,894,144 26.6
------------------------------------------------------------------------------------------------------
Utilities--Gas 33,100 AGL Resources Inc...... 619,896 699,237 0.5
33,000 The Brooklyn Union Gas
Co................... 855,855 994,125 0.7
52,000 The Coastal Corp....... 1,509,758 2,541,500 1.8
24,800 El Paso Natural Gas
Co................... 895,148 1,252,400 0.9
55,000 MDU Resources Group,
Inc.................. 1,171,945 1,265,000 0.9
26,100 National Fuel Gas
Company.............. 788,314 1,076,625 0.7
25,000 New Jersey Resources
Corp................. 656,623 731,250 0.5
53,500 Questar Corp........... 1,908,628 1,966,125 1.4
72,200 Sonat, Inc............. 2,342,585 3,718,300 2.6
49,800 Washington Gas Light
Co................... 1,046,197 1,126,725 0.8
117,900 Williams Co., Inc...... 2,298,643 4,421,250 3.1
----------- ------
14,093,592 19,792,537 13.9
------------------------------------------------------------------------------------------------------
Utilities--Water 38,000 American Water Works
Co., Inc............. 714,875 783,750 0.5
------------------------------------------------------------------------------------------------------
Total Common Stocks
in the United States 63,115,432 72,780,956 51.1
- ---------------------------------------------------------------------------------------------------------------------
Total Investments in
Common Stocks 110,223,157 135,138,132 94.9
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-57-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series, Inc.--Global Utility Focus Fund
Schedule of Investments as of December 31, 1996 (concluded) (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Face Fixed-Income Value Percent of
Country Industry Amount Securities Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Australia Telecommunications US$1,040,000 Telstra Corp. Ltd.,
6.50% due
7/31/2003(a)....... $ 1,084,062 $ 1,020,240 0.7%
------------------------------------------------------------------------------------------------------
Total Fixed-Income
Securities in
Australia 1,084,062 1,020,240 0.7
- ---------------------------------------------------------------------------------------------------------------------
Korea Utilities--Electric 1,000,000 Korea Electric Power
Corp., 6.375% due
12/01/2003......... 985,510 971,750 0.7
------------------------------------------------------------------------------------------------------
Total Fixed-Income
Securities in Korea 985,510 971,750 0.7
- ---------------------------------------------------------------------------------------------------------------------
Total Investments in
Fixed-Income
Securities 2,069,572 1,991,990 1.4
- ---------------------------------------------------------------------------------------------------------------------
Short-Term Securities
---------------------------------------------------------------------------------------------------------------------
Commercial Paper*** 5,049,000 General Electric
Capital Corp.,
7.10% due
1/02/1997.......... 5,047,008 5,047,008 3.5
------------------------------------------------------------------------------------------------------
Total Investments in
Short-Term Securities 5,047,008 5,047,008 3.5
- ---------------------------------------------------------------------------------------------------------------------
Total Investments.... $117,339,737 142,177,130 99.8
=============
Other Assets Less
Liabilities........ 260,671 0.2
------------ ----------
Net Assets........... $142,437,801 100.0%
============= ===========
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* American Depositary Receipts (ADR).
** Global Depositary Receipts (GDR).
*** Commercial Paper is traded on a discount basis; the interest rate shown is
the discount rate paid at the time of purchase by the Fund.
+ Non-income producing security.
(a) Restricted security as to resale. The value of the Fund's investment in
restricted securities was approximately $3,420,000, representing 2.4% of
net assets.
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Value
Issue Acquisition Date(s) Cost (Note 1a)
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Central Costanera S.A. (ADR)........................................ 12/17/1993 $ 261,847 $ 238,975
Distribuidora Chilectra Metropolitana, S.A. (ADR)................... 8/06/1993-12/21/1993 1,098,338 1,860,300
Tata Electric Companies (GDR)....................................... 2/22/1994 710,000 300,000
Telestra Corp. Ltd., 6.50% due 7/31/2003............................ 7/26/1993-9/29/1993 1,084,062 1,020,240
- ---------------------------------------------------------------------------------------------------------------------
Total $3,154,247 $3,419,515
========== ==========
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
-58-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Government Bond Fund
Schedule of Investments as of December 31, 1996
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Face Value
Amount Issue Cost (Note 1a)
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
US Government & Agency Obligations
- ---------------------------------------------------------------------------------------------------------------------
Federal Home Loan Mortgage $ 3,000,000 Federal Home Loan Mortgage Corp.,
Corporation--3.4% 7.14% due 9/13/2006.......................... $ 3,064,440 $ 3,082,019
- ---------------------------------------------------------------------------------------------------------------------
Total Federal Home Loan Mortgage Corp. 3,064,440 3,082,019
- ---------------------------------------------------------------------------------------------------------------------
Federal National Mortgage Federal National Mortgage Association:
Association--14.8% 2,000,000 8.90% due 6/12/2000........................ 2,171,480 2,161,880
1,045,000 7.50% due 2/11/2002........................ 1,088,232 1,093,007
4,000,000 7.40% due 7/01/2004........................ 4,157,540 4,191,880
500,000 7.85% due 9/10/2004........................ 499,297 511,720
2,000,000 7.65% due 3/10/2005........................ 2,091,140 2,125,320
3,000,000 7.375% due 3/28/2005....................... 3,158,430 3,138,750
- ---------------------------------------------------------------------------------------------------------------------
Total Federal National Mortgage Association 13,166,119 13,222,557
- ---------------------------------------------------------------------------------------------------------------------
US Treasury Notes--72.4% US Treasury Notes:
2,000,000 7.125% due 2/29/2000....................... 2,004,375 2,059,060
1,000,000 6.875% due 3/31/2000....................... 1,019,375 1,022,500
5,000,000 7.50% due 11/15/2001....................... 5,140,469 5,263,300
11,500,000 6.375% due 8/15/2002....................... 11,488,545 11,575,440
2,000,000 6.25% due 2/15/2003........................ 1,992,656 1,997,500
3,000,000 5.75% due 8/15/2003........................ 2,835,781 2,910,000
12,000,000 7.25% due 5/15/2004........................ 12,468,047 12,626,280
3,000,000 7.25% due 8/15/2004........................ 3,219,375 3,157,500
4,000,000 7.875% due 11/15/2004...................... 4,440,000 4,365,000
8,000,000 6.50% due 5/15/2005........................ 7,732,480 8,053,760
3,000,000 6.875% due 5/15/2006....................... 3,082,187 3,091,410
6,000,000 7.00% due 7/15/2006........................ 6,079,687 6,233,460
2,500,000 6.50% due 10/15/2006....................... 2,488,359 2,513,675
- ---------------------------------------------------------------------------------------------------------------------
Total US Treasury Notes 63,991,336 64,868,885
- ---------------------------------------------------------------------------------------------------------------------
Total US Government & Agency
Obligations--90.6% 80,221,895 81,173,461
- ---------------------------------------------------------------------------------------------------------------------
Short-Term Securities
- ---------------------------------------------------------------------------------------------------------------------
Repurchase Agreements*--5.2% 4,661,000 UBS Securities Funding, Inc. purchased on
12/31/1996 to yield 6.75% to 1/02/1997..... 4,661,000 4,661,000
- ---------------------------------------------------------------------------------------------------------------------
US Government US Treasury Bills:
Obligations**--2.2% 1,000,000 4.55% due 1/09/1997........................ 998,863 998,863
1,000,000 4.60% due 1/16/1997........................ 997,956 997,956
-----------
1,996,819 1,996,819
- ---------------------------------------------------------------------------------------------------------------------
Total Short-Term Securities 6,657,819 6,657,819
- ---------------------------------------------------------------------------------------------------------------------
Total Investments--98.0%..................... $86,879,714 87,831,280
===========
Other Assets Less Liabilities--2.0%.......... 1,749,512
Net Assets--100.0%........................... $89,580,792
- ------------------------------------------------------------------------------
</TABLE>
* Repurchase Agreements are fully collateralized by US Government
Obligations.
** Certain US Government Obligations are traded on a discount basis; the
interest rates shown are the discount rates paid at the time of purchase by
the Fund.
See Notes to Financial Statements.
-59-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--High Current Income Fund
Schedule of Investments as of December 31, 1996
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P Moody's Face Value
Industry Ratings Ratings Amount Issue Cost (Note 1a)
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Airlines--1.0% B+ B1 $4,000,000 USAir, Inc., 10.375% due
3/01/2013.................... $ 3,935,000 $ 4,180,000
- ---------------------------------------------------------------------------------------------------------------------
Automotive--0.9% B B3 2,000,000 Collins & Aikman Corp., 11.50%
due 4/15/2006................ 2,000,000 2,180,000
B B2 2,000,000 Exide Corp., 11.64% due
12/15/2004(d)................ 1,817,902 1,840,000
------------ ------------
3,817,902 4,020,000
- ---------------------------------------------------------------------------------------------------------------------
Broadcasting & BB Ba3 4,000,000 Grupo Televisa S.A., 11.375%
Publishing--4.4% due 5/15/2003................ 4,025,000 4,295,000
BB- B1 5,000,000 Hollinger, International Inc.,
9.25% due 2/01/2006.......... 4,961,250 4,950,000
BB- Ba3 1,000,000 K-III Communications Corp.,
10.25% due 6/01/2004......... 995,000 1,040,000
B Caa 4,300,000 NWCG Holding Corp., 13.50% due
6/15/1999(d)................. 3,121,269 3,547,500
Sinclair Broadcasting Group
Inc.:
B B2 2,500,000 10% due 12/15/2003............. 2,436,250 2,537,500
B B2 2,000,000 10% due 9/30/2005.............. 1,993,750 2,030,000
------------ ------------
17,532,519 18,400,000
- ---------------------------------------------------------------------------------------------------------------------
Broadcasting/ CCC+ Caa 5,023,939 American Telecasting, Inc.,
Cable--11.3% 14.38% due 6/15/2004(d)(e)... 3,531,401 2,059,815
B- B2 1,500,000 Argyle Television Inc., 9.75%
due 11/01/2005............... 1,447,500 1,522,500
CCC+ Caa 8,000,000 Australis Media Ltd., 14.59%
due 5/15/2003(d)............. 4,978,793 4,200,000
BB- B2 9,000,000 Bell Cablemedia PLC, 11.74% due
9/15/2005(d)................. 5,917,159 7,222,500
BB- Ba3 3,000,000 Century Communications Corp.,
9.50% due 3/01/2005.......... 2,953,750 3,075,000
CCC+ Caa 5,500,000 Echostar Satellite
Broadcasting, 13.15% due
3/15/2004(d)................. 3,654,874 4,207,500
NR* NR* 2,000,000 +Globo Communicacoes
Participacoes, 10.50% due
12/20/2006................... 2,006,250 2,012,500
B B2 4,000,000 +Intermedia Capital Partners,
11.25% due 8/01/2006......... 3,997,500 4,160,000
BB+ Ba3 5,000,000 Lenfest Communications, Inc.,
8.375% due 11/01/2005........ 4,627,500 4,831,250
B B1 4,000,000 +Olympus Communications L.P.,
10.625% due 11/15/2006....... 4,000,000 4,095,000
B- B3 2,000,000 SFX Broadcasting Inc., 10.75%
due 5/15/2006................ 1,990,000 2,110,000
Videotron Holdings PLC:
B+ B3 5,500,000 11.77% due 7/01/2004(d)........ 4,029,842 4,785,000
BB+ Ba3 2,500,000 10.625% due 2/15/2005.......... 2,559,375 2,750,000
------------ ------------
45,693,944 47,031,065
- ---------------------------------------------------------------------------------------------------------------------
Building BB B1 2,500,000 +Cemex S.A., 12.75% due
Materials--1.5% 7/15/2006.................... 2,500,000 2,793,750
B B3 3,340,000 Pacific Lumber Co., 10.50% due
3/01/2003.................... 3,252,088 3,390,100
------------ ------------
5,752,088 6,183,850
- ---------------------------------------------------------------------------------------------------------------------
Capital Goods--1.6% B+ B1 1,660,000 Essex Group, Inc., 10% due
5/01/2003.................... 1,668,925 1,701,500
B- B3 4,500,000 International Wire Group Inc.,
11.75% due 6/01/2005......... 4,490,625 4,815,000
------------ ------------
6,159,550 6,516,500
- ---------------------------------------------------------------------------------------------------------------------
Chemicals -- 1.9% B+ Ba3 4,100,000 Agricultural Minerals &
Chemicals Co., L.P., 10.75%
due 9/30/2003................ 4,123,188 4,458,750
B+ Ba3 3,500,000 +ISP Holdings Inc., 9.75% due
2/15/2002.................... 3,500,000 3,587,500
------------ ------------
7,623,188 8,046,250
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-60-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series, Inc.--High Current Income Fund
Schedule of Investments as of December 31, 1996 (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P Moody's Face Value
Industry Ratings Ratings Amount Issue Cost (Note 1a)
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Communications-- NR* NR* $3,000,000 +Comtel Brasileira Ltd., 10.75%
8.7% due 9/26/2004................ $ 3,000,000 $ 3,082,500
B- B3 8,000,000 Millicom International Celular
S.A., 13.31% due
6/01/2006(d)................. 4,555,660 4,960,000
CCC- B3 6,000,000 Nextel Communications, Inc.,
14.11% due 8/15/2004(d)...... 3,722,677 4,095,000
B B2 3,000,000 +Paging Network, Inc., 10% due
10/15/2008................... 3,003,750 3,041,250
B B3 3,000,000 Panamsat L.P., 12.16% due
8/01/2003(d)................. 2,413,727 2,790,000
BB- B2 3,000,000 Rogers Communications Inc.,
10.875% due 4/15/2004........ 3,042,500 3,150,000
BB- B1 4,000,000 Telefonica de Argentina S.A.,
11.875% due 11/01/2004....... 3,917,780 4,420,000
BB B1 7,000,000 TeleWest Communications PLC,
11.45% due 10/01/2007(d)..... 4,520,553 4,882,500
B- B2 3,000,000 USA Mobile Communications
Holdings, Inc., 9.50% due
2/01/2004.................... 2,710,000 2,850,000
B+ B1 1,500,000 Vanguard Cellular Systems,
9.375% due 4/15/2006......... 1,500,000 1,522,500
B- B3 1,000,000 Western Wireless Corp., 10.50%
due 2/01/2007................ 990,000 1,046,250
------------ ------------
33,376,647 35,840,000
- ---------------------------------------------------------------------------------------------------------------------
Computer Services-- B- B3 3,000,000 Dictaphone Corp., 11.75% due
0.7% 8/01/2005.................... 2,943,750 2,760,000
- ---------------------------------------------------------------------------------------------------------------------
Congolomerates-- CCC+ B3 2,125,000 Interlake Corp., 12.125% due
2.0% 3/01/2002.................... 2,000,750 2,199,375
B+ B2 2,000,000 JB Poindexter & Co., 12.50% due
5/15/2004.................... 2,000,000 1,950,000
NR* NR* 890,000 MacAndrews & Forbes Group,
Inc.,13% due 3/01/1999....... 868,373 890,000
Sequa Corp.:
B+ B1 750,000 9.625% due 10/15/1999.......... 740,625 772,500
B+ B3 2,500,000 9.375% due 12/15/2003.......... 2,512,813 2,550,000
------------ ------------
8,122,561 8,361,875
- ---------------------------------------------------------------------------------------------------------------------
Consumer-- B NR* 5,000,000 Coleman Holdings, Inc.,
Products--5.7% 11.39% due 5/27/1998(d)........ 4,254,825 4,150,000
B+ Ba3 1,250,000 Coty Inc., 10.25% due
5/01/2005.................... 1,250,000 1,356,250
B+ Ba2 7,000,000 International Semi-Tech
Microelectronics, Inc.,
13.13% due 8/15/2003(d)...... 4,229,935 4,515,000
B- B2 3,619,000 Polymer Group Inc., 12.25% due
7/15/2002.................... 3,678,048 3,953,758
B- B2 4,500,000 Samsonite Corp., 11.125% due
7/15/2005.................... 4,348,750 4,927,500
B+ B1 4,500,000 Sealy Corp., 9.50% due
5/01/2003.................... 4,453,125 4,545,000
------------ ------------
22,214,683 23,447,508
- ---------------------------------------------------------------------------------------------------------------------
Defense--0.7% B+ B1 3,000,000 +Newport News Ship, 9.25% due
12/01/2006................... 3,000,000 3,090,000
- ---------------------------------------------------------------------------------------------------------------------
Diversified--0.6% Foamex L.P.:
B+ B1 530,000 9.50% due 6/01/2000............ 517,413 537,950
B B1 1,950,000 11.25% due 10/01/2002.......... 1,936,375 2,067,000
------------ ------------
2,453,788 2,604,950
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-61-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series, Inc.--High Current Income Fund
Schedule of Investments as of December 31, 1996 (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P Moody's Face Value
Industry Ratings Ratings Amount Issue Cost (Note 1a)
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Energy--6.2% B B2 $4,500,000 Benton Oil & Gas Co, 11.625%
due 05/01/2003............... $ 4,500,000 $ 4,983,750
B+ B1 1,750,000 +Parker Drilling Co., 9.75% due
11/15/2006................... 1,758,750 1,846,250
NR* NR* 3,000,000 +Petroleo Brasileiro S.A.--
Petrobras, 10% due
10/17/2006................... 3,000,313 3,033,750
NR* NR* 4,000,000 +Transamerican Exploration
Corp., 14% due 9/19/1998..... 3,960,000 4,040,000
CCC+ Caa 3,400,000 Transamerican Refining Corp.,
19.11% due 2/15/2002(d)...... 2,731,372 2,805,000
BB- B2 4,500,000 TransTexas Gas Corp., 11.50%
due 6/15/2002................ 4,498,750 4,860,000
BB- B1 4,500,000 Yacimientos Petroliferos
Fiscales S.A., 8% due
2/15/2004.................... 3,694,375 4,342,500
------------ ------------
24,143,560 25,911,250
- ---------------------------------------------------------------------------------------------------------------------
Entertainment--1.1% B B2 5,000,000 Six Flags Theme Parks Corp.,
12.25% due 6/15/2005(d)...... 4,237,019 4,700,000
- ---------------------------------------------------------------------------------------------------------------------
Financial Services--1.0% BB- B1 4,000,000 Reliance Group Holdings Inc.,
9.75% due 11/15/2003......... 3,898,750 4,160,000
- ---------------------------------------------------------------------------------------------------------------------
Food & B+ B1 4,500,000 Chiquita Brands International
Beverage--3.5% Inc., 9.125% due 3/01/2004..... 4,448,750 4,545,000
NR* NR* 1,893,000 Cumberland Farms, Inc., 10.50%
due 10/01/2003............... 1,852,774 1,807,815
CCC+ Caa 2,500,000 Del Monte Corp., 10% due
5/01/2003.................... 2,310,000 2,387,500
B- B3 1,500,000 Envirodyne Industries, Inc.,
10.25% due 12/01/2001........ 1,528,125 1,436,250
B B3 4,500,000 Specialty Foods Corp., 11.125%
due 10/01/2002............... 4,444,375 4,275,000
------------ ------------
14,584,024 14,451,565
- ---------------------------------------------------------------------------------------------------------------------
Foreign Government BB- B1 4,000,000 Republic of Argentina, 8.375%
Obligations--0.9% due 12/20/2003............... 3,175,000 3,765,000
- ---------------------------------------------------------------------------------------------------------------------
Gaming--2.5% B B3 4,000,000 Greate Bay Properties, Inc.,
10.875% due 1/15/2004........ 3,590,000 3,360,000
D Caa 4,500,000 Harrah's Jazz Company, 14.25%
due 11/15/2001(c)............ 4,468,750 2,210,625
BB- B1 5,000,000 Trump Atlantic City
Association, 11.25% due
5/01/2006.................... 4,961,250 4,950,000
------------ ------------
13,020,000 10,520,625
- ---------------------------------------------------------------------------------------------------------------------
Health Services--2.1% B+ B1 4,000,000 Beverly Enterprises, Inc., 9%
due 2/15/2006................ 3,740,000 4,020,000
B+ B2 3,000,000 Quest Diagnostic Inc., 10.75%
due 12/15/2006............... 3,000,000 3,150,000
B B3 2,000,000 Unilab Corp., 11% due
4/01/2006.................... 1,995,000 1,350,000
------------ ------------
8,735,000 8,520,000
- ---------------------------------------------------------------------------------------------------------------------
Home-Builders--0.6% B- B2 2,500,000 Del Webb Corporation, 9% due
2/15/2006.................... 2,497,500 2,437,500
- ---------------------------------------------------------------------------------------------------------------------
Hotels--1.1% BB- Ba3 4,500,000 HMC Acquisition Properties, 9%
due 12/15/2007............... 4,202,500 4,567,500
- ---------------------------------------------------------------------------------------------------------------------
Independent Power BB- Ba3 2,750,000 AES China Generating Co. Ltd.
Producers--2.1% (Class A), 10.125% due
12/15/2006................... 2,747,360 2,860,000
BB B2 2,500,000 California Energy Company,
Inc., 9.875% due 6/30/2003... 2,518,750 2,625,000
NR* NR* 1,500,000 Consolidated Hydro, Inc.,
11.80% due 7/15/2003(d)...... 1,256,950 480,000
Midland Cogeneration Venture
L.P.:
BB Ba3 2,327,454 10.33% due 7/23/2002(e)........ 2,367,215 2,478,739
B- B2 250,000 11.75% due 7/23/2005........... 250,000 276,790
------------ ------------
9,140,275 8,720,529
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-62-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series, Inc.--High Current Income Fund
Schedule of Investments as of December 31, 1996 (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P Moody's Face Value
Industry Ratings Ratings Amount Issue Cost (Note 1a)
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Metals & Mining-- B- B2 $4,500,000 Kaiser Aluminum Corp., 12.75%
1.8% due 2/01/2003................ $ 4,770,000 $ 4,837,500
B- B3 3,000,000 Maxxam Group, Inc., 12.25% due
8/01/2003(d)................. 2,484,169 2,557,500
------------ ------------
7,254,169 7,395,000
- ---------------------------------------------------------------------------------------------------------------------
Packaging--2.1% Owens-Illinois, Inc.:
B+ B2 2,000,000 10% due 8/01/2002............ 2,000,000 2,090,000
BB Ba3 2,000,000 11% due 12/01/2003........... 2,145,312 2,225,000
B B2 4,000,000 Portola Packaging Inc., 10.75%
due 10/01/2005............... 4,000,000 4,170,000
------------ ------------
8,145,312 8,485,000
- ---------------------------------------------------------------------------------------------------------------------
Paper--4.6% B B3 4,000,000 Crown Paper Co., 11% due
9/01/2005.................... 3,663,750 3,760,000
B B2 3,000,000 Fort Howard Corp., 9% due
2/01/2006.................... 2,895,000 3,030,000
BB- B2 3,000,000 Repap Wisconsin Finance, Inc.,
9.25% due 2/01/2002.......... 2,760,000 3,022,500
B B3 4,000,000 Riverwood International Corp.,
10.875% due 4/01/2008........ 3,978,750 3,700,000
B+ B1 2,000,000 S.D. Warren Co., 12% due
12/15/2004................... 2,000,000 2,160,000
Stone Container Corp.:
B+ B1 1,950,000 9.875% due 2/01/2001......... 1,869,375 1,969,500
BB- B1 1,300,000 10.75% due 10/01/2002........ 1,287,000 1,369,875
------------ ------------
18,453,875 19,011,875
- ---------------------------------------------------------------------------------------------------------------------
Real Estate--0.5% NR* NR* 3,000,000 Rockefeller Center Properties,
11.09% Inc., due 12/31/2000
(Convertible)(d)............. 1,965,742 1,852,500
- ---------------------------------------------------------------------------------------------------------------------
Restaurants--1.5% Foodmaker, Inc.:
B B1 4,000,000 9.25% due 3/01/1999.......... 4,010,000 4,090,000
CCC+ B1 2,000,000 9.75% due 11/01/2003......... 1,972,075 1,965,000
------------ ------------
5,982,075 6,055,000
- ---------------------------------------------------------------------------------------------------------------------
Retail Specialty--0.1% D Caa 4,500,000 Bradlees, Inc., 11% due
8/01/2002(c)................. 4,466,562 472,500
- ---------------------------------------------------------------------------------------------------------------------
Steel--0.8% B B2 3,500,000 Weirton Steel Corp., 10.75% due
6/01/2005.................... 3,346,250 3,430,000
- ---------------------------------------------------------------------------------------------------------------------
Supermarkets--1.5% B B2 3,500,000 Penn Traffic American Corp.,
8.625% due 12/15/2003........ 2,888,750 2,878,750
B B1 1,000,000 Ralph's Grocery Co., 10.45% due
6/15/2004.................... 962,500 1,063,750
B B1 2,000,000 Ralph's Grocery Co. (New),
10.45% due 6/15/2004......... 1,897,358 2,125,000
------------ ------------
5,748,608 6,067,500
- ---------------------------------------------------------------------------------------------------------------------
Textiles--2.3% B- Caa 3,000,000 Decorative Home Accents, Inc.
(Class F), 13% due
6/30/2002.................... 2,977,008 1,950,000
BB- Ba3 3,500,000 Tultex Corp., 10.625% due
3/15/2005.................... 3,500,000 3,815,000
B+ B2 3,500,000 Westpoint Stevens Industries,
Inc., 9.375% due 12/15/2005.. 3,291,250 3,605,000
------------ ------------
9,768,258 9,370,000
- ---------------------------------------------------------------------------------------------------------------------
Transportation--2.5% BB- B1 4,000,000 Sea Containers Ltd., 12.50% due
12/01/2004................... 4,380,000 4,400,000
B- B3 3,700,000 Transtar Holdings Inc., 11.02%
due 12/15/2003(d)............ 2,720,132 2,960,000
BB Ba2 3,000,000 Viking Star Shipping Co.,
9.625% due 7/15/2003......... 2,905,937 3,138,750
------------ ------------
10,006,069 10,498,750
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-63-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series, Inc.--High Current Income Fund
Schedule of Investments as of December 31, 1996 (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P Moody's Face Value
Industry Ratings Ratings Amount Issue Cost (Note 1a)
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Utilities--4.8% B+ B1 $3,453,000 Beaver Valley Funding Corp., 9%
due 6/01/2017................ $ 3,252,225 $ 3,297,580
CTC Mansfield Funding Corp.:
B+ Ba3 995,000 10.25% due 3/30/2003......... 978,850 1,009,686
B+ Ba3 2,300,000 11.125% due 9/30/2016........ 2,402,500 2,426,500
BB Ba2 2,000,000 Cleveland Electric Illuminating
Co., 9.50% due 5/15/2005..... 1,996,160 2,108,760
BB- B1 4,000,000 Metrogas S.A., 12% due
8/15/2000.................... 3,935,000 4,390,000
BBB- NR* 3,000,000 +Trans Gas de Occidente S.A.,
9.79% due 11/01/2010......... 3,000,000 3,105,000
+Tucson Electric & Power Co.:
NR* NR* 3,070,687 10.21% due 1/01/2009......... 2,948,074 2,990,357
NR* NR* 500,000 10.732% due 1/01/2013........ 461,050 489,995
------------ ------------
18,973,859 19,817,878
- ---------------------------------------------------------------------------------------------------------------------
Waste D Ca 3,500,000 Mid-American Waste Systems,
Management--0.3% Inc., 12.25% due 2/15/2003... 3,555,000 1,225,000
- ---------------------------------------------------------------------------------------------------------------------
Total Investments in Corporate
Bonds--84.9% 347,925,027 351,916,970
- ---------------------------------------------------------------------------------------------------------------------
Shares
Held Preferred Stocks
---------------------------------------------------------------------------------------------------------------------
Broadcasting & 15,259 K-III Communications Corp.
Publishing--1.8% (Series B)(a)................ 1,513,108 1,533,622
5,375 Time Warner Inc. (Series
M)(a)........................ 5,376,812 5,831,875
------------ ------------
6,889,920 7,365,497
- ---------------------------------------------------------------------------------------------------------------------
Communications--0.7% 3,000 +Paxson Communications(a)...... 2,835,000 2,857,500
- ---------------------------------------------------------------------------------------------------------------------
Industrials--0.7% 30,000 Cablevision Systems Corp.,
(Series M)(a)................ 2,617,500 2,760,000
- ---------------------------------------------------------------------------------------------------------------------
Packaging--0.6% 2,578 +Silgan Holdings Inc.(a)....... 2,581,120 2,758,460
- ---------------------------------------------------------------------------------------------------------------------
Steel--0.7% 120,000 USX Capital Corp............... 3,000,000 3,045,000
- ---------------------------------------------------------------------------------------------------------------------
Total Investments in Preferred
Stocks--4.5% 17,923,540 18,786,457
- ---------------------------------------------------------------------------------------------------------------------
Common Stocks
---------------------------------------------------------------------------------------------------------------------
Broadcasting & 93,747 On Command Corporation (c)..... 2,744,654 1,488,234
Publishing--0.3%
- ---------------------------------------------------------------------------------------------------------------------
Food & Beverage--0.0% 4,300 FoodBrands America, Inc.(c).... 240,909 59,125
- ---------------------------------------------------------------------------------------------------------------------
Gaming--0.0% 2,500 Goldriver Hotel & Casino
Finance Corp. (Class B) (c).. 18,603 0
- ---------------------------------------------------------------------------------------------------------------------
Hotel--0.0% 107 Buckhead America Corp.(c)...... 575 642
- ---------------------------------------------------------------------------------------------------------------------
Industrial Services--0.0% 311 Thermadyne Industries,
Inc.(c)...................... 4,495 8,242
- ---------------------------------------------------------------------------------------------------------------------
Supermarkets--0.1% 53,022 Grand Union Co.(c)............. 3,090,000 258,482
- ---------------------------------------------------------------------------------------------------------------------
Textiles--0.0% 3,000 +Decorative Home Accents, Inc.
(Class F)(c)................. 22,992 16,500
- ---------------------------------------------------------------------------------------------------------------------
Total Investments in Common
Stocks--0.4% 6,122,228 1,831,225
- ---------------------------------------------------------------------------------------------------------------------
Trusts and Warrants
---------------------------------------------------------------------------------------------------------------------
Broadcasting & 29,830 On Command Corporation
Publishing--0.1% (Warrants)(b)................ 238,640 201,353
- ---------------------------------------------------------------------------------------------------------------------
Broadcasting/Cable--0.0% 23,350 American Telecasting, Inc.
(Warrants)(b)................ 4,776 52,537
- ---------------------------------------------------------------------------------------------------------------------
Energy--0.0% 42,733 Transamerican Refining Corp.
(Warrants) (b)............... 99,622 85,466
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-64-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--High Current Income Fund
Schedule of Investments as of December 31, 1996 (concluded)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Value
Industry Held Trusts and Warrants Cost (Note 1a)
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Gaming--0.0% 250 +Goldriver Hotel & Casino
Finance Corp., (Liquidating
Trust)(c)................... $ 6,000 $ 2,141
- ---------------------------------------------------------------------------------------------------------------------
Total Investments in Trusts
and Warrants--0.1% 349,038 341,497
- ---------------------------------------------------------------------------------------------------------------------
Face
Amount Short-Term Securities
---------------------------------------------------------------------------------------------------------------------
Commercial Paper**--3.5% $14,421,000 General Electric Capital
Corp., 7.10% due
1/02/1997................... 14,415,312 14,415,312
- ---------------------------------------------------------------------------------------------------------------------
US Government & Agency Federal Home Loan Bank:
Obligations**--5.7% 8,000,000 5.21% due 1/02/1997......... 7,997,684 7,997,684
8,000,000 5.49% due 1/23/1997......... 7,971,940 7,971,940
2,618,000 Federal Home Loan Mortgage
Corp., 6.50% due 1/02/1997.. 2,617,055 2,617,055
5,000,000 Federal National Mortgage
Association, 5.45% due
1/14/1997................... 4,989,403 4,989,403
------------ ------------
23,576,082 23,576,082
- ---------------------------------------------------------------------------------------------------------------------
Total Investments in Short-
Term Securities--9.2% 37,991,394 37,991,394
- ---------------------------------------------------------------------------------------------------------------------
Total Investments--99.1%...... $410,311,227 410,867,543
=============
Other Assets Less
Liabilities--0.9%........... 3,747,375
------------
Net Assets--100.0%............ $414,614,918
=============
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* Not Rated.
** Commercial Paper and certain US Government & Agency Obligations are traded
on a discount basis; the interest rates shown are the discount rates paid
at the time of purchase by the Fund.
(a) Represents a pay-in-kind security which may pay interest/dividend in
additional face/shares.
(b) Warrants entitle the portfolio to purchase a predetermined number of
shares of common stock/face amount of bonds. The purchase price and
number of shares/face amount are subject to adjustment under certain
conditions until the expiration date.
(c) Non-income producing security.
(d) Represents a zero coupon or step bond; the interest rate shown is the
effective yield at the time of purchase by the Fund.
(e) Subject to principal paydowns.
+ Restricted security as to resale. The value of the Fund's investment in
restricted securities was approximately $47,002,000, representing 11.3% of
net assets.
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------
Value
Issue Acquisition Date(s) Cost (Note 1a)
-----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cemex S.A., 12.75% due 7/15/2006....................... 7/16/1996 $ 2,500,000 $ 2,793,750
Comtel Brasileira Ltd., 10.75% due 9/26/2004........... 9/18/1996 3,000,000 3,082,500
Decorative Home Accents, Inc. (Class F)................ 6/30/1995-9/21/1995 22,992 16,500
Globo Communicacoes Participacoes, 10.50% due
12/20/2006........................................... 12/10/1996-12/12/1996 2,006,250 2,012,500
Goldriver Hotel & Casino Finance Corp. (Liquidating
Trust)............................................... 8/31/1992 6,000 2,141
ISP Holdings Inc., 9.75% due 2/15/2002................. 10/21/1996 3,500,000 3,587,500
Intermedia Capital Partners, 11.25% due 8/01/2006...... 10/30/1996-11/20/1996 3,997,500 4,160,000
Newport News Ship, 9.25% due 12/01/2006................ 11/21/1996 3,000,000 3,090,000
Olympus Communications L.P. 10.625% due 11/15/2006..... 11/06/1996 4,000,000 4,095,000
Paging Network, Inc., 10% due 10/15/2008............... 11/25/1996-1/26/1996 3,003,750 3,041,250
Parker Drilling Co., 9.75% due 11/15/2006.............. 11/6/1996 1,758,750 1,846,250
Paxson Communications.................................. 12/19/1996 2,835,000 2,857,500
Petroleo Brasileiro S.A. -- Petrobras,
10% due 10/17/2006................................... 10/21/1996-11/25/1996 3,000,313 3,033,750
Silgan Holdings Inc. .................................. 7/17/1996-10/3/1996 2,581,120 2,758,460
Trans Gas de Occidente S.A., 9.79% due 11/01/2010...... 11/02/1995 3,000,000 3,105,000
Transamerican Exploration Corp., 14% due 9/19/1998..... 9/19/1996 3,960,000 4,040,000
Tucson Electric & Power Co., 10.21% due 1/01/2009...... 6/16/1993-4/01/1996 2,948,074 2,990,357
Tucson Electric & Power Co., 10.732% due 1/01/2013..... 3/01/1993 461,050 489,995
-----------------------------------------------------------------------------------------------------------------
Total $45,580,799 $47,002,453
=========== ===========
-----------------------------------------------------------------------------------------------------------------
Ratings of issues shown have not been audited by Deloitte & Touche LLP.
</TABLE>
See Notes to Financial Statements.
-65-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Index 500 Fund
Schedule of Investments as of December 31, 1996
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Value
Common Stocks Held (Note 1a)
-------------------------------------------------------
<S> <C> <C>
General Electric Co.++ ...... 2,758 $ 272,697
Coca-Cola Co................. 4,168 219,341
Exxon Corp................... 2,080 203,840
Intel Corp. ................. 1,375 179,953
+Microsoft Corporation....... 2,000 165,250
Merck & Co., Inc. ........... 2,019 160,006
Philip Morris Companies,
Inc. ...................... 1,364 153,620
Royal Dutch Petroleum Co. ... 898 153,333
International Business
Machines Corp. ............ 867 130,917
Procter & Gamble Co. ........ 1,143 122,872
American Telephone &
Telegraph Co. ............. 2,714 118,059
Johnson & Johnson Co. ....... 2,231 110,992
Bristol-Myers Squibb Co. .... 839 91,241
Pfizer, Inc. ................ 1,080 89,505
duPont (E.I.) de Nemours &
Co. ....................... 943 88,996
Wal-Mart Companies, Inc. .... 3,843 87,909
Hewlett-Packard Co. ......... 1,703 85,576
American International
Group, Inc. ............... 787 85,193
Citicorp..................... 788 81,164
Mobil Corp. ................. 660 80,685
Disney (Walt) Company
(The) ..................... 1,136 79,094
PepsiCo, Inc. ............... 2,603 76,138
GTE Corp. ................... 1,611 73,301
Gillette Co. ................ 927 72,074
Chevron Corp. ............... 1,093 71,045
General Motors Corp. ........ 1,266 70,580
+cisco Systems, Inc. ........ 1,100 69,988
Federal National Mortgage
Association................ 1,829 68,130
Lilly (Eli) & Co. ........... 924 67,452
BellSouth Corp. ............. 1,664 67,184
Amoco Corp. ................. 833 67,057
Abbott Laboratories.......... 1,301 66,026
Chase Manhattan Corp. ....... 735 65,599
Boeing Co. .................. 600 63,825
Ford Motor Co. .............. 1,986 63,304
American Home Products
Corp. ..................... 1,070 62,729
Motorola, Inc. .............. 993 60,945
BankAmerica Corp. ........... 601 59,950
Minnesota Mining &
Manufacturing Co........... 700 58,012
Ameritech Corporation........ 920 55,775
McDonald's Corp. ............ 1,169 52,897
SBC Communications, Inc. .... 1,011 52,319
Lucent Technologies, Inc. ... 1,067 49,349
Travelers Corporation........ 1,073 48,687
Bell Atlantic Corp. ......... 733 47,462
NationsBank Corp. ........... 482 47,115
Unilever N.V. ............... 268 46,967
Columbia/HCA Healthcare
Corp. ..................... 1,125 45,844
+Oracle Corporation.......... 1,100 45,787
Kimberly-Clark Corp. ........ 473 45,053
American Express Co. ........ 794 44,861
Eastman Kodak Co. ........... 558 44,780
Texaco Inc. ................. 443 43,469
Allstate Corporation ........ 745 43,117
<CAPTION>
Shares Value
Common Stocks Held (Note 1a)
-------------------------------------------------------
<S> <C> <C>
Wells Fargo & Co. ........... 155 41,811
Schlumberger, Ltd. .......... 413 41,248
Home Depot, Inc. ............ 805 40,351
Chrysler Corp................ 1,221 40,293
Schering-Plough Corp. ....... 619 40,080
Monsanto Co. ................ 985 38,292
MCI Communications Corp. .... 1,150 37,519
+WorldCom, Inc. ............. 1,435 37,310
Emerson Electric Co. ........ 376 36,378
Time Warner, Inc. ........... 953 35,737
Atlantic Richfield Co. ...... 269 35,643
NYNEX Corp. ................. 737 35,468
First Union Corp. ........... 475 35,150
Warner-Lambert Co. .......... 454 34,050
Pharmacia & Upjohn Inc. ..... 851 33,721
+Compaq Computer Corp. ...... 454 33,710
Anheuser-Busch
Companies, Inc. ........... 837 33,480
Federal Home Loan Mortgage
Corp. ..................... 300 33,038
Dow Chemical Co. ............ 407 31,899
AlliedSignal Inc. ........... 474 31,758
Campbell Soup Co. ........... 392 31,458
BancOne Corp. ............... 716 30,788
Morgan (J.P.) & Co., Inc. ... 312 30,459
Computer Associates
International, Inc. ....... 611 30,397
Sears, Roebuck & Co. ........ 656 30,258
Sara Lee Corporation......... 811 30,210
Lockheed Martin Corp. ....... 323 29,554
Nike, Inc. (Class B) ........ 483 28,859
Sprint Corp. ................ 721 28,750
First Chicago Corp. ......... 534 28,702
Xerox Corp. ................. 544 28,628
First Data Corporation....... 750 27,375
Medtronic, Inc. ............. 401 27,268
Norwest Corp. ............... 620 26,970
Northern Telecom Ltd. ....... 433 26,792
United Technologies Corp. ... 403 26,598
WMX Technologies, Inc. ...... 813 26,524
Pacific Telesis Group........ 718 26,386
US West Communications
Group...................... 800 25,800
Southern Co. ................ 1,129 25,544
Union Pacific Corp. ......... 410 24,651
+Amgen, Inc. ................ 450 24,469
Seagram Co. Ltd. ............ 625 24,219
Caterpillar, Inc. ........... 321 24,155
Kellogg Co. ................. 353 23,166
McDonnell Douglas Corp. ..... 355 22,720
Colgate-Palmolive Co. ....... 246 22,694
Merrill Lynch & Co., Inc. ... 276 22,494
+Rockwell International
Corp. ..................... 366 22,280
Bank of New York Co.,
Inc. ...................... 657 22,174
Burlington Northern Santa Fe
Inc. ...................... 256 22,112
Heinz (H.J.) Company......... 616 22,022
+3Com Corp. ................. 300 21,975
Fleet Financial Group,
Inc. ...................... 439 21,895
General Re Corp. ............ 138 21,770
PNC Bank Corp. .............. 571 21,484
</TABLE>
-66-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Index 500 Fund
Schedule of Investments as of December 31, 1996 (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Value
Common Stocks Held (Note 1a)
-------------------------------------------------------
<S> <C> <C>
+Airtouch Communications,
Inc. ...................... 840 21,210
Automatic Data
Processing, Inc............ 486 20,837
Westinghouse Electric
Corp....................... 1,046 20,789
+Viacom, Inc. (Class B)...... 593 20,681
International Paper Co. ..... 503 20,309
Texas Instruments, Inc. ..... 318 20,272
Aetna Inc. .................. 252 20,160
ConAgra, Inc. ............... 403 20,049
Archer-Daniels-Midland
Co. ....................... 911 20,042
May Department Stores Co. ... 422 19,728
Phillips Petroleum Co. ...... 441 19,514
+US West Media Group,
Inc. ...................... 1,046 19,351
CoreStates Financial
Corp. ..................... 373 19,349
KeyCorp...................... 378 19,089
Raytheon Co. ................ 395 19,009
Penney (J.C.) Co. ........... 387 18,866
Baxter International,
Inc. ...................... 457 18,737
CPC International, Inc. ..... 241 18,678
Aluminum Co. of America...... 291 18,551
Sun Trust Banks, Inc. ....... 374 18,419
Norfolk & Southern Corp. .... 210 18,375
Enron Corp. ................. 426 18,371
Loews Corporation............ 193 18,190
+Boston Scientific Corp. .... 298 17,880
Dean Witter, Discover &
Co. ....................... 269 17,821
Corning, Inc. ............... 385 17,806
Gannett Co., Inc. ........... 236 17,671
Deere & Co. ................. 433 17,591
PPG Industries, Inc. ........ 307 17,230
CIGNA Corp. ................. 126 17,215
Barrick Gold Corporation..... 598 17,193
Unocal Corp. ................ 420 17,062
National City Corporation.... 372 16,693
General Mills, Inc. ......... 263 16,668
+Seagate Technology, Inc. ... 420 16,590
Illinois Tool Works Inc. .... 207 16,534
Walgreen Co. ................ 412 16,480
Bank of Boston Corp. ........ 256 16,448
Boatmen's Bancshares,
Inc. ...................... 250 16,094
+Dell Computer Corp. ........ 300 15,938
Weyerhaeuser Co. ............ 332 15,728
Chubb Corp. ................. 292 15,695
+CUC International, Inc. .... 659 15,651
Wachovia Corp. .............. 277 15,650
Duke Power Company........... 338 15,633
MBNA Corp. .................. 373 15,479
Mellon Bank Corp. ........... 217 15,407
+Sun Microsystems, Inc. ..... 600 15,375
First Bank Systems, Inc. .... 225 15,356
CSX Corp. ................... 363 15,337
Texas Utilities Company...... 376 15,322
Albertson's, Inc. ........... 422 15,034
Household International,
Inc. ...................... 162 14,945
Morgan Stanley Group,
Inc. ...................... 255 14,567
Pacific Gas and Electric
Co. ....................... 691 14,511
Edison International......... 726 14,429
Gap, Inc. ................... 475 14,309
+TCI Communications, Inc.
(Class A).................. 1,100 14,300
<CAPTION>
Shares Value
Common Stocks Held (Note 1a)
-------------------------------------------------------
<S> <C> <C>
Dayton Hudson Corporation
(Class A).................. 363 14,248
American Brands, Inc. ....... 285 14,143
AMP, Inc. ................... 368 14,122
FPL Group, Inc. ............. 307 14,122
Honeywell, Inc. ............. 212 13,939
American General Corp. ...... 341 13,938
United Healthcare
Corporation................ 308 13,860
Tyco International, Ltd. .... 262 13,853
+Toys 'R' Us, Inc. .......... 459 13,770
Pitney Bowes, Inc. .......... 249 13,570
Barnett Banks, Inc. ......... 327 13,448
+AMR Corp. .................. 152 13,395
Goodyear Tire & Rubber
Co. ....................... 260 13,357
Conrail, Inc. ............... 134 13,350
ITT Hartford Group Inc. ..... 197 13,297
Textron Inc. ................ 139 13,101
Ralston Purina Co. .......... 177 12,987
Air Products and Chemicals,
Inc. ...................... 187 12,926
+EMC Corporation............. 390 12,919
American Electric Power
Company, Inc. ............. 314 12,913
+HFS Inc. ................... 216 12,906
+Tenneco, Inc. .............. 286 12,906
Occidental Petroleum
Corp. ..................... 551 12,880
Alcan Aluminium, Ltd. ....... 379 12,744
Avon Products, Inc. ......... 223 12,739
Halliburton Co. ............. 210 12,653
Mattel, Inc. ................ 455 12,626
Fifth Third Bank............. 200 12,550
Marsh & McLennan Companies,
Inc. ...................... 120 12,480
Union Pacific Resources
Group...................... 418 12,226
Praxair, Inc. ............... 262 12,085
+Federated Department
Stores, Inc. .............. 348 11,876
Marriott International,
Inc. ...................... 214 11,823
Bankers Trust New York
Corp. ..................... 137 11,816
Crown Company, Inc. ......... 215 11,691
Dominion Resources, Inc. .... 302 11,627
Consolidated Edison Company
of New York................ 394 11,525
USX Marathon Group, Inc. .... 482 11,508
Panenergy Corporation........ 253 11,385
+Tellabs, Inc. .............. 300 11,287
Alco Standard Corp. ......... 218 11,254
Aon Corporation.............. 181 11,245
Hershey Foods Corporation.... 257 11,244
USBANCORP., Inc. ............ 250 11,219
Service Corporation.......... 395 11,060
International Georgia-Pacific
Corp. ..................... 153 11,016
Wrigley (WM) Jr. Co. (Class
B)......................... 195 10,969
Public Service Enterprise
Group, Inc. ............... 399 10,873
Hilton Hotels Corporation.... 414 10,816
+Applied Materials, Inc. .... 300 10,763
Entergy Corp. ............... 387 10,739
TRW Inc. .................... 213 10,543
</TABLE>
-67-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Index 500 Fund
Schedule of Investments as of December 31, 1996 (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Value
Common Stocks Held (Note 1a)
-------------------------------------------------------
<S> <C> <C>
Burlington Resources Inc. ... 209 10,528
+Computer Sciences
Corporation................ 127 10,430
Thermo Electron
Corporation................ 249 10,271
Lowe's Companies, Inc. ...... 289 10,259
Micron Technology, Inc. ..... 350 10,194
PacifiCorp................... 494 10,127
UST, Inc. ................... 312 10,101
ALLTEL Corp. ................ 318 9,977
American Stores Company...... 244 9,974
Williams Companies, Inc. .... 262 9,844
+Kroger Co. ................. 211 9,811
Unicom Corp. ................ 361 9,792
Sysco Corp. ................. 300 9,787
Comcast Corp.--Special (Class
A)......................... 550 9,763
Morton International,
Inc. ...................... 239 9,739
Masco Corporation............ 269 9,684
Freeport-McMoRan Copper &
Gold Inc. (Class B)........ 324 9,680
Pioneer Hi-Bred
International, Inc......... 138 9,660
Cognizant Corporation........ 287 9,471
Dover Corp. ................. 188 9,447
Comerica Inc. ............... 180 9,428
+Digital Equipment
Corporation................ 259 9,421
Peco Energy Co. ............. 373 9,418
Browning Ferris Industries,
Inc. ...................... 356 9,345
Carolina Power & Light
Company.................... 254 9,271
Lincoln National Corp. ...... 175 9,187
Dresser Industries, Inc. .... 294 9,114
Becton, Dickinson and
Company.................... 209 9,065
Central and South West
Corp. ..................... 353 9,046
Amerada Hess Corporation..... 156 9,029
Eaton Corp. ................. 129 8,998
Genuine Parts Company........ 202 8,989
Inco Ltd. ................... 282 8,989
Houston Industries Inc. ..... 393 8,892
UNUM Corporation............. 123 8,887
Greentree Financial Corp. ... 230 8,884
Delta Air Lines, Inc. ....... 125 8,859
CINergy Corporation ......... 264 8,811
+Price/Costco, Inc. ......... 350 8,794
Consolidated Natural
Gas Co. ................... 159 8,785
Fluor Corporation............ 140 8,785
Transamerica Corporation..... 111 8,769
Rohm & Haas Co. ............. 107 8,734
Placer Dome Inc. ............ 401 8,722
+Cabletron Systems, Inc. .... 262 8,712
Union Carbide Corp. ......... 213 8,706
Quaker Oats Company.......... 228 8,692
Clorox Company............... 86 8,632
Salomon Inc. ................ 183 8,624
Coastal Corp. ............... 176 8,602
+Federal Express Corp. ...... 191 8,500
+ITT Corp. .................. 195 8,458
+K Mart Corp. ............... 811 8,414
Newell Co. .................. 266 8,379
<CAPTION>
Shares Value
Common Stocks Held (Note 1a)
-------------------------------------------------------
<S> <C> <C>
Baker Hughes, Inc. .......... 242 8,349
Limited, Inc. (The).......... 454 8,342
International Flavors &
Fragrances, Inc. .......... 185 8,325
Times Mirror Co. ............ 166 8,258
Rite Aid Corporation......... 205 8,149
St. Paul Companies, Inc. .... 139 8,149
Ingersoll-Rand Company....... 183 8,144
Tribune Co. ................. 103 8,124
Providian Corporation........ 157 8,066
Sherwin-Williams Company..... 144 8,064
Northrop Grumman Corp. ...... 97 8,027
Winn-Dixie Stores, Inc. ..... 253 8,001
+Tenet Healthcare Corp. ..... 364 7,962
Donnelley (R.R.) & Sons
Co. ....................... 252 7,907
DTE Energy Holdings
Company.................... 243 7,867
SAFECO Corporation........... 200 7,850
Grace (W.R.) & Co. .......... 149 7,711
McGraw-Hill, Inc. ........... 167 7,703
Cooper Industries, Inc. ..... 181 7,625
Republic New York
Corporation................ 93 7,591
MGIC Investment Corp. ....... 99 7,524
Nucor Corporation............ 147 7,497
General Dynamics
Corporation................ 106 7,473
Newmont Mining Corporation... 167 7,473
+Silicon Graphics, Inc. ..... 293 7,471
Sonat, Inc. ................. 145 7,467
Hercules Inc. ............... 171 7,396
Phelps Dodge Corporation..... 109 7,357
CVS Corporation.............. 177 7,323
MBIA, Inc. .................. 72 7,290
VF Corp. .................... 107 7,222
Eastman Chemical Co. ........ 130 7,183
Grainger (W.W.) Inc. ........ 89 7,142
Guidant Corp. ............... 124 7,068
Willamette Industries,
Inc. ...................... 100 6,962
Champion International
Corp. ..................... 160 6,920
+Autozone, Inc. ............. 250 6,875
General Public Utilities Corp.... 202 6,792
+Bay Networks Inc. .......... 325 6,784
Dun & Bradstreet Corp. ...... 285 6,769
Jefferson Pilot Corp. ....... 119 6,738
Allegheny Teledyne Inc. ..... 292 6,716
Case Corp. .................. 123 6,704
Great Western Financial
Corp. ..................... 231 6,699
Baltimore Gas &
Electric Company........... 247 6,607
Union Electric Company....... 171 6,583
Interpublic Group of
Companies, Inc. ........... 136 6,460
+Western Atlas, Inc. ........ 90 6,379
PP&L Resources Inc. ......... 272 6,256
Frontier Corp. .............. 273 6,177
TJX Companies Inc. .......... 130 6,159
New York Times Co. .......... 162 6,156
Avery Dennison Corp. ........ 174 6,155
Golden West Financial
Corporation................ 96 6,060
Laidlaw Inc. ................ 526 6,049
</TABLE>
-68-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Index 500 Fund
Schedule of Investments as of December 31, 1996 (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Value
Common Stocks Held (Note 1a)
-------------------------------------------------------
<S> <C> <C>
Reynolds Metals Co. ......... 107 6,032
Raychem Corp. ............... 75 6,009
Knight-Ridder, Inc. ......... 157 6,005
Torchmark Corp. ............. 118 5,959
+Advanced Micro Devices, Inc. ... 229 5,897
Dillard Department
Stores Inc. ............... 190 5,866
Columbia Gas System, Inc. ... 92 5,854
Kerr-McGee Corp. ............ 81 5,832
Whirlpool Corp. ............. 125 5,828
Ohio Edison Company.......... 256 5,824
+St. Jude Medical, Inc. ..... 136 5,797
+LSI Logic Corporation....... 216 5,778
Ahmanson (H.F) & Co. ........ 177 5,753
Johnson Controls, Inc. ...... 69 5,718
Rubbermaid Inc. ............. 251 5,710
Beneficial Corp. ............ 90 5,704
+National Semiconductor
Corp. ..................... 232 5,655
Hasbro, Inc. ................ 144 5,598
Union Camp Corp. ............ 117 5,587
Dana Corp. .................. 171 5,579
Tupperware Corporation....... 104 5,577
Harcourt General Inc. ....... 119 5,489
Dow Jones & Co. , Inc. ...... 162 5,488
Mallinckrodt Group Inc. ..... 124 5,471
+Novell, Inc. ............... 575 5,427
Southwest Airlines Co. ...... 243 5,376
Northern States Power Co. ... 116 5,321
Brown-Forman Corp. (Class
B)......................... 116 5,307
Nordstrom, Inc. ............. 150 5,306
+Andrew Corp. ............... 100 5,300
+Humana, Inc. ............... 272 5,202
Mead Corp. .................. 88 5,115
PACCAR Inc. ................. 75 5,081
Block (H & R), Inc. ......... 174 5,046
Temple-Inland Inc. .......... 93 5,034
Great Lakes Chemical
Corporation................ 106 4,956
+General Instrument Corp. ... 229 4,952
Circuit City Stores, Inc. ... 164 4,941
Pall Corp. .................. 193 4,921
Westvaco Corp. .............. 171 4,916
+Woolworth Corp. ............ 224 4,900
+Fruit of the Loom, Inc. .... 129 4,886
ITT Industries Inc. ......... 198 4,851
Parker Hannifin Corp. ....... 125 4,844
Armstrong World
Industries, Inc. .......... 69 4,796
James River Corp. of
Virginia................... 144 4,770
Ashland Oil Inc. ............ 108 4,739
+Ceridian Corp. ............. 116 4,698
Sigma-Aldrich Corp. ......... 75 4,678
Liz Claiborne, Inc. ......... 120 4,635
Engelhard Corporation........ 241 4,609
Deluxe Corporation........... 138 4,520
Harris Corp. ................ 65 4,461
Wendy's International,
Inc. ...................... 217 4,448
Black & Decker Corporation... 147 4,428
USX-US Steel Group, Inc...... 141 4,424
Pennzoil Co. ................ 78 4,407
<CAPTION>
Shares Value
Common Stocks Held (Note 1a)
-------------------------------------------------------
<S> <C> <C>
+Oryx Energy Co. ............ 176 4,356
+FMC Corporation............. 62 4,348
Pacific Enterprises.......... 142 4,313
Tandy Corp. ................. 98 4,312
Perkin-Elmer Corporation..... 72 4,239
+Apple Computer, Inc. ....... 200 4,150
United States Surgical
Corp. ..................... 105 4,134
Nalco Chemical Company....... 113 4,082
Ecolab Inc. ................. 108 4,064
USF&G Corp. ................. 194 4,050
Stanley Works................ 149 4,023
Whitman Corp. ............... 174 3,980
Brunswick Corp. ............. 165 3,960
Thomas & Betts Corp. ........ 89 3,949
Harnischfeger Industries,
Inc. ...................... 82 3,946
Allergan, Inc. .............. 110 3,919
Reebok International Ltd. ... 93 3,906
Ryder System, Inc. .......... 137 3,853
Louisiana-Pacific Corp. ..... 182 3,845
+ALZA Corp. ................. 142 3,674
Owens-Corning Fiberglass
Corp. ..................... 86 3,666
Cyprus Amax Minerals Co. .... 156 3,647
Goodrich (B.F.) Co. ......... 90 3,645
Snap-On, Inc. ............... 102 3,634
General Signal Corporation... 84 3,591
+DSC Communications Corp. ... 200 3,575
American Greetings Corp.
(Class A).................. 125 3,547
Noram Energy Corp. .......... 230 3,536
Homestake Mining Company..... 246 3,506
Giant Food, Inc. (Class A)... 100 3,450
+Harrah's Entertainment,
Inc. ...................... 172 3,419
Moore Corp. Ltd. ............ 167 3,403
Santa Fe Pacific Gold
Corp. ..................... 220 3,382
Maytag Corp. ................ 168 3,318
Polaroid Corp. .............. 76 3,306
Echlin Inc. ................. 104 3,289
Bausch & Lomb, Inc. ......... 93 3,255
Bemis Company, Inc. ......... 88 3,245
+Rowan Companies, Inc. ...... 143 3,235
Pep Boys--Manny, Moe &
Jack....................... 105 3,229
Super Valu, Inc. ............ 113 3,206
Mercantile Stores
Company, Inc. ............. 62 3,061
Louisiana Land &
Exploration Co. ........... 57 3,057
Cummins Engine
Company, Inc. ............. 66 3,036
Biomet, Inc. ................ 200 3,025
National Service
Industries, Inc. .......... 80 2,990
Millipore Corp. ............. 72 2,979
Sun Company, Inc. ........... 122 2,974
NICOR Inc. .................. 83 2,967
Manor Care, Inc. ............ 105 2,835
Tektronix, Inc. ............. 55 2,819
Cooper Tire & Rubber Co. .... 138 2,726
+Tandem Computers, Inc. ..... 198 2,722
Worthington Industries,
Inc. ...................... 150 2,719
ENSERCH Corporation.......... 117 2,691
</TABLE>
-69-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Index 500 Fund
Schedule of Investments as of December 31, 1996 (concluded)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Value
Common Stocks Held (Note 1a)
-------------------------------------------------------
<S> <C> <C>
Bard (C.R.), Inc. ........... 96 2,688
Battle Mountain Gold
Company.................... 376 2,585
Boise Cascade Corp. ......... 81 2,572
Foster Wheeler Corp. ........ 68 2,525
+USAir Group, Inc. .......... 108 2,524
Stone Container Corp. ....... 166 2,469
+Amdahl Corp. ............... 203 2,461
Shared Medical Systems
Corp. ..................... 50 2,456
+Niagara Mohawk Power
Corp. ..................... 242 2,390
Timken Co. .................. 52 2,385
Meredith Corp. .............. 45 2,374
+King World Productions,
Inc. ...................... 63 2,323
Darden Restaurants, Inc. .... 264 2,310
Alberto-Culver Company (Class
B)......................... 47 2,256
Crane Co. ................... 77 2,233
Helmerich & Payne, Inc. ..... 42 2,189
+Beverly Enterprises,
Inc. ...................... 166 2,117
Briggs & Stratton Corp. ..... 48 2,112
+Santa Fe Energy
Resources, Inc. ........... 152 2,109
Autodesk, Inc. .............. 75 2,100
Potlatch Corp. .............. 48 2,064
Great Atlantic & Pacific Tea
Co., Inc. ................. 64 2,040
Peoples Energy Corp. ........ 59 1,999
+Unisys Corp. ............... 293 1,978
Scientific-Atlanta, Inc. .... 130 1,950
USLIFE Corp. ................ 58 1,928
Russell Corp. ............... 64 1,904
Centex Acceptance Corp. ..... 48 1,806
ASARCO, Inc. ................ 72 1,791
Harland John H. Company...... 52 1,716
Trinova Corp. ............... 47 1,710
+Bethlehem Steel Corp. ...... 187 1,683
Fleetwood Enterprises,
Inc. ...................... 60 1,650
Inland Steel Co. ............ 82 1,640
Longs Drug Stores Corp. ..... 33 1,621
Safety-Kleen Corp. .......... 98 1,605
EG&G, Inc. .................. 79 1,590
Echo Bay Mines Ltd. ......... 233 1,544
<CAPTION>
Shares Value
Common Stocks Held (Note 1a)
-------------------------------------------------------
<S> <C> <C>
McDermott International,
Inc. ...................... 92 1,529
Cincinnati Milacron, Inc. ... 67 1,466
Springs Industries, Inc. .... 34 1,462
ONEOK, Inc. ................. 46 1,380
Jostens, Inc. ............... 65 1,373
Ball Corp. .................. 51 1,326
Alexander & Alexander
Services, Inc. ............ 76 1,321
Caliber Systems, Inc. ....... 66 1,271
Eastern Enterprises.......... 34 1,203
Pulte Corp. ................. 39 1,199
+Navistar International
Corp. ..................... 123 1,122
Fleming Companies, Inc. ..... 63 1,087
+Data General Corp. ......... 66 957
Coors (Adolph) Co. (Class
B)......................... 50 950
+Charming Shoppes, Inc. ..... 175 875
Kaufman and Broad Home
Corp. ..................... 65 837
Stride Rite Corp. ........... 83 830
Nacco Industries, Inc. (Class
A)......................... 15 802
+Intergraph Corp. ........... 75 769
+Armco, Inc. ................ 179 738
Giddings & Lewis, Inc. ...... 50 644
- -------------------------------------------------------
Total Common Stocks
(Cost--$9,340,272)--88.3%.... 9,488,361
- -------------------------------------------------------
Short-Term Obligations--
US Government Agency Face
Obligations* Amount
- -------------------------------------------------------
Federal Home Loan
Mortgage Corp., 6.50% due
1/02/1997.................. $1,356,000 1,355,755
- -------------------------------------------------------
Total Short-Term Obligations
(Cost--$1,355,755)--12.6%.... 1,355,755
- -------------------------------------------------------
Total Investments
(Cost--$10,696,027)--100.9%.. 10,844,116
Variation Margin on Stock
Index Futures
Contracts**--(0.3%)........ (29,200)
Liabilities in Excess of
Other Assets--(0.6%)....... (63,076)
-----------
Net Assets--100.0%........... $10,751,840
===========
- ------------------------------------------------------------------------------
</TABLE>
+ Non-income producing security.
++ Portion of holdings pledged as collateral for stock index futures
contracts.
* Certain US Government Agency Obligations are traded on a discount basis;
the interest rate shown is the discount rate paid at the time of purchase
by the Fund.
** Stock index futures contracts purchased as of December 31, 1996 were as
follows:
- ----------------------------------------------------------------
Number of Expiration Value
Contracts Issue Date (Note 1b)
- ----------------------------------------------------------------
4 S&P 500 Stock Index March 1997 $ 1,489,000
- ----------------------------------------------------------------
Total Stock Index Futures Contracts Purchased
(Contract Price--$1,483,955).................... $ 1,489,000
===========
- ------------------------------------------------------------
See Notes to Financial Statements.
-70-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--International Equity Focus Fund
Schedule of Investments as of December 31, 1996 (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Value Percent of
AFRICA Industry Held Investments Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
South Africa Banking 14,500 Nedcor Ltd. (ADR)(a)(d).. $ 210,250 $ 194,010 0.1%
102,858 Nedcor Ltd. (GDR)(b)(e).. 1,097,188 1,376,240 0.4
10,072 Nedcor Ltd. (Ordinary)... 148,818 137,855 0.0
----------- ------
1,456,256 1,708,105 0.5
-----------------------------------------------------------------------------------------------------
Beverages 138,736 South African Breweries,
Ltd.................... 3,702,680 3,515,872 1.0
-----------------------------------------------------------------------------------------------------
Entertainment 496,000 Sun International (South
Africa), Ltd........... 613,843 397,776 0.1
-----------------------------------------------------------------------------------------------------
Mining 5,150 Anglo American Corp. of
South Africa, Ltd...... 347,236 283,602 0.1
23,800 Anglo American Corp. of
South Africa, Ltd.
(ADR)(a)............... 1,522,851 1,291,150 0.4
47,300 Evander Gold Mines Ltd... 511,564 404,619 0.1
----------- ------
2,381,651 1,979,371 0.6
- ---------------------------------------------------------------------------------------------------------------------
Total Investments in
Africa 8,154,430 7,601,124 2.2
- ---------------------------------------------------------------------------------------------------------------------
LATIN AMERICA
---------------------------------------------------------------------------------------------------------------------
Argentina Banking 60,853 Banco Frances del Rio de
la Plata S.A.
(ADR)(a)............... 1,345,168 1,673,458 0.5
-----------------------------------------------------------------------------------------------------
Oil & Related 246,594 Companhia Naviera Perez
Companc
S.A.C.F.I.M.F.A. (Class
B)..................... 1,604,857 1,733,903 0.5
-----------------------------------------------------------------------------------------------------
Telecommunications 14,300 Telefonica de Argentina
S.A. (Class B)
(ADR)(a)............... 351,750 370,013 0.1
-----------------------------------------------------------------------------------------------------
Total Investments in
Argentina 3,301,775 3,777,374 1.1
- ---------------------------------------------------------------------------------------------------------------------
Brazil Banking 139,240,000 Banco Bradesco S.A. PN
(Preferred)............ 1,075,689 1,009,219 0.3
-----------------------------------------------------------------------------------------------------
Beverages 3,270,000 Companhia Cervejaria
Brahma S.A. PN
(Preferred)............ 1,637,606 1,787,814 0.5
-----------------------------------------------------------------------------------------------------
Telecommunications 75,755 Telecomunicacoes
Brasileiras S.A.-
Telebras (ADR)(a)...... 3,897,541 5,795,258 1.7
-----------------------------------------------------------------------------------------------------
Utilities 41,000 Companhia Energetica de
Minas Gerais S.A.
(CEMIG) (ADR)(a)....... 1,253,624 1,383,750 0.4
-----------------------------------------------------------------------------------------------------
Total Investments in
Brazil 7,864,460 9,976,041 2.9
- ---------------------------------------------------------------------------------------------------------------------
Chile Telecommunications 18,100 Compania de
Telecomunicaciones de
Chile S.A. (ADR)(a).... 1,410,403 1,830,363 0.5
-----------------------------------------------------------------------------------------------------
Utilities 20,480 Enersis S.A. (ADR)(a).... 530,086 568,320 0.2
-----------------------------------------------------------------------------------------------------
Total Investments in
Chile 1,940,489 2,398,683 0.7
- ---------------------------------------------------------------------------------------------------------------------
Mexico Beverages 35,970 Panamerican Beverages,
Inc. (Class A)......... 1,640,662 1,686,094 0.5
-----------------------------------------------------------------------------------------------------
Broadcast--Media 19,000 Grupo Televisa, S.A. de
C.V. (GDR)(b)(d)....... 530,765 486,875 0.1
-----------------------------------------------------------------------------------------------------
Building & 264,950 Apasco, S.A. de C.V.
Construction 'A'.................... 1,593,376 1,817,723 0.5
-----------------------------------------------------------------------------------------------------
Health & Personal 65,885 Kimberly-Clark de Mexico,
S.A. de C.V. (ADR)(a).. 2,460,495 2,520,101 0.7
-----------------------------------------------------------------------------------------------------
</TABLE>
-71-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series, Inc.--International Equity Focus Fund
Schedule of Investments as of December 31, 1996 (continued) (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
LATIN AMERICA Shares Value Percent of
(concluded) Industry Held Investments Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Mexico Multi-Industry 269,200 Grupo Carso, S.A. de C.V.
(concluded) 'A1'................... 2,259,825 1,419,362 0.4
-----------------------------------------------------------------------------------------------------
Telecommunications 269,200 Carso Global Telecom,
S.A. de C.V. 'A1'
(d).................... 709,354 625,887 0.2
-----------------------------------------------------------------------------------------------------
Total Investments in
Mexico 9,194,477 8,556,042 2.4
- ---------------------------------------------------------------------------------------------------------------------
Total Investments in
Latin America 22,301,201 24,708,140 7.1
- ---------------------------------------------------------------------------------------------------------------------
PACIFIC
BASIN
---------------------------------------------------------------------------------------------------------------------
Australia Food & Beverage 192,019 Coca-Cola Amatil, Ltd.
(Ordinary)............. 1,289,134 2,051,145 0.6
-----------------------------------------------------------------------------------------------------
Media 89,939 The News Corp., Ltd.
(Ordinary)............. 431,743 474,292 0.1
52,364 The News Corp., Ltd.
(Preferred)............ 222,611 232,890 0.1
----------- ------
654,354 707,182 0.2
-----------------------------------------------------------------------------------------------------
Merchandising 18,700 Amway Asia Pacific
Ltd.(ADR)(a)........... 725,368 792,413 0.2
-----------------------------------------------------------------------------------------------------
Natural Gas 37,943 Broken Hill Proprietary
Pipelines Co. ................... 452,087 540,007 0.1
-----------------------------------------------------------------------------------------------------
Property 371,927 Lend Lease Corp. ........ 4,978,452 7,207,380 2.1
-----------------------------------------------------------------------------------------------------
Total Investments in
Australia 8,099,395 11,298,127 3.2
- ---------------------------------------------------------------------------------------------------------------------
Hong Kong Banking 354,242 HSBC Holdings PLC........ 4,447,990 7,580,431 2.2
34,000 J.C.G. Holdings Ltd...... 32,167 33,191 0.0
----------- ------
4,480,157 7,613,622 2.2
-----------------------------------------------------------------------------------------------------
Diversified 854,140 Hutchison Whampoa Ltd. .. 4,945,751 6,709,207 1.9
-----------------------------------------------------------------------------------------------------
Foods 3,166,000 C.P. Pokphand Co.,
Ltd. .................. 1,084,557 1,238,318 0.4
4,224,000 Tingyi (Cayman Islands)
Holdings Co. (d)....... 1,113,725 1,105,974 0.3
----------- ------
2,198,282 2,344,292 0.7
-----------------------------------------------------------------------------------------------------
Insurance 176,000 National Mutual Asia
Ltd. .................. 184,973 167,261 0.0
-----------------------------------------------------------------------------------------------------
Multi-Industry 399,000 Swire Pacific Ltd. (Class
A)..................... 2,742,209 3,804,791 1.1
-----------------------------------------------------------------------------------------------------
Property 527,000 Cheung Kong (Holdings)
Ltd. .................. 3,684,755 4,684,672 1.4
4,192,000 China Overseas Land &
Investment............. 1,182,026 2,127,437 0.6
----------- ------
4,866,781 6,812,109 2.0
-----------------------------------------------------------------------------------------------------
Total Investments in Hong
Kong 19,418,153 27,451,282 7.9
- ---------------------------------------------------------------------------------------------------------------------
Japan Automobiles 440,000 Suzuki Motor Corp.
(Ordinary)............. 4,988,943 4,027,634 1.2
-----------------------------------------------------------------------------------------------------
Capital Goods 911,000 Mitsubishi Heavy
Industries, Ltd........ 7,221,146 7,237,651 2.1
-----------------------------------------------------------------------------------------------------
Chemicals 347,000 Shin-Etsu Chemical Co.,
Ltd. (Ordinary)........ 6,674,107 6,322,712 1.8
-----------------------------------------------------------------------------------------------------
Electrical 84,000 Chudenko Corp.
Construction (Ordinary)............. 2,961,934 2,422,798 0.7
61,000 Taihei Dengyo Kaisha,
Ltd. .................. 1,103,158 605,786 0.2
----------- ------
4,065,092 3,028,584 0.9
-----------------------------------------------------------------------------------------------------
Electrical 219,000 Murata Manufacturing Co.,
Equipment Ltd. .................. 8,117,559 7,281,088 2.1
515,000 NEC Corp. ............... 6,701,653 6,226,252 1.8
118,000 Rohm Co., Ltd. .......... 4,979,943 7,744,387 2.2
261,000 Sharp Corporation........ 4,076,502 3,718,912 1.0
----------- ------
23,875,657 24,970,639 7.1
-----------------------------------------------------------------------------------------------------
</TABLE>
-72-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series, Inc.--International Equity Focus Fund
Schedule of Investments as of December 31, 1996 (continued) (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PACIFIC
BASIN Shares Value Percent of
(continued) Industry Held Investments Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Japan Insurance 365,000 Dai-Tokyo Fire & Marine
(concluded) Insurance Co., Ltd. ... 2,575,006 1,938,472 0.5
187,000 Koa Fire & Marine
Insurance Co., Ltd. ... 1,281,743 907,548 0.3
166,000 Mitsui Fire & Marine
Insurance Co., Ltd. ... 1,353,118 893,074 0.2
118,000 Nichido Fire & Marine
Insurance Co., Ltd. ... 917,801 672,539 0.2
152,000 Nippon Fire & Marine
Insurance Co., Ltd. ... 1,069,498 689,119 0.2
498,000 Sumitomo Marine & Fire
Insurance Co., Ltd. ... 4,176,958 3,096,373 0.9
330,000 Tokio Marine & Fire
Insurance Co., Ltd.
(Ordinary)............. 3,890,208 3,106,218 0.9
268,000 Yasuda Marine & Fire
Insurance Co., Ltd. ... 2,004,769 1,393,230 0.4
------------ ------------ ----------
17,269,101 12,696,573 3.6
-----------------------------------------------------------------------------------------------------
Office Equipment 408,000 Canon, Inc. (Ordinary)... 7,392,805 9,019,689 2.6
-----------------------------------------------------------------------------------------------------
Packaging 194,000 Toyo Seikan Kaisha, Ltd.
(Ordinary)............. 6,036,561 4,674,093 1.3
-----------------------------------------------------------------------------------------------------
Pharmaceuticals 197,000 Sankyo Co., Ltd.
(Ordinary)............. 4,452,652 5,579,965 1.6
140,000 Taisho Pharmaceutical
Co., Ltd. (Ordinary)... 2,828,042 3,300,518 0.9
------------ ------------ ----------
7,280,694 8,880,483 2.5
-----------------------------------------------------------------------------------------------------
Retailing 127,000 Ito Yokado Co., Ltd.
(Ordinary)............. 7,163,905 5,527,461 1.6
-----------------------------------------------------------------------------------------------------
Tire & Rubber 197,000 Bridgestone Corp......... 3,447,899 3,742,660 1.1
-----------------------------------------------------------------------------------------------------
Total Investments in
Japan 95,415,910 90,128,179 25.8
- ---------------------------------------------------------------------------------------------------------------------
Malaysia Airlines 351,000 Malaysian Airline System
BHD.................... 895,065 910,515 0.3
-----------------------------------------------------------------------------------------------------
Banking 247,000 Arab-Malaysian Merchant
Bank Holding BHD....... 1,760,803 2,073,822 0.6
257,000 Malayan Banking BHD...... 2,320,535 2,849,901 0.8
598,666 Public Bank (Malaysia)
BHD 'Foreign'.......... 1,055,118 1,268,461 0.4
------------ ------------ ----------
5,136,456 6,192,184 1.8
-----------------------------------------------------------------------------------------------------
Building Products 300,500 Hume Industries
(Malaysia) BHD......... 1,773,006 1,892,257 0.5
-----------------------------------------------------------------------------------------------------
Diversified 690,000 Renong Berhad............ 1,129,538 1,224,238 0.3
Holdings
-----------------------------------------------------------------------------------------------------
Printing/Publishing 232,000 The New Straits Times
Press BHD (Malaysia)... 1,308,148 1,341,465 0.4
-----------------------------------------------------------------------------------------------------
Telecommunications 568,000 Technology Resources
Industries BHD (d)..... 1,803,275 1,120,253 0.3
8,000 Telekom Malaysia BHD
(d).................... 69,490 71,287 0.0
------------ ------------ ----------
1,872,765 1,191,540 0.3
-----------------------------------------------------------------------------------------------------
Utilities--Electric 114,000 Tenaga Nasional BHD...... 523,137 546,297 0.2
-----------------------------------------------------------------------------------------------------
Total Investments in
Malaysia 12,638,115 13,298,496 3.8
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-73-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series, Inc.--International Equity Focus Fund
Schedule of Investments as of December 31, 1996 (continued) (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PACIFIC
BASIN Shares Value Percent of
(concluded) Industry Held Investments Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
New Zealand Chemicals 10,000 Fernz Corporation
Ltd. .................. 27,213 34,319 0.0
-----------------------------------------------------------------------------------------------------
Electronics 17,000 PDL Holdings Ltd. ....... 82,587 92,023 0.0
-----------------------------------------------------------------------------------------------------
Foods 548,600 Wrightson Ltd. .......... 418,731 477,473 0.2
-----------------------------------------------------------------------------------------------------
Telecommunications 60,000 Telecom Corporation of
New Zealand............ 256,371 306,532 0.1
-----------------------------------------------------------------------------------------------------
Textiles 93,450 Lane Walker Rudkin
Industries, Ltd. ...... 109,531 112,413 0.0
-----------------------------------------------------------------------------------------------------
Total Investments in New
Zealand 894,433 1,022,760 0.3
- ---------------------------------------------------------------------------------------------------------------------
South Korea Telecommunications 79,207 Korea Mobile
Telecommunications
Corp. (ADR)(a)......... 986,349 1,019,790 0.3
-----------------------------------------------------------------------------------------------------
Utilities 17,580 Korea Electric Power
Corp. ................. 752,967 513,315 0.1
-----------------------------------------------------------------------------------------------------
Total Investments in
South Korea 1,739,316 1,533,105 0.4
- ---------------------------------------------------------------------------------------------------------------------
Thailand Banking 108,500 Finance One Public Co.,
Ltd 'Foreign'.......... 856,748 219,987 0.1
430,500 Krung Thai Bank Public
Co., Ltd. ............. 2,013,799 830,887 0.3
410,800 Phatra Thanakit Public
Co., Ltd. 'Foreign'.... 2,925,216 1,169,275 0.3
------------ ------------ ----------
5,795,763 2,220,149 0.7
-----------------------------------------------------------------------------------------------------
Utilities-- 518,000 TelecomAsia Corporation
Communications Public Company Ltd.
'Foreign' (d).......... 990,931 1,080,555 0.3
-----------------------------------------------------------------------------------------------------
Total Investments in
Thailand 6,786,694 3,300,704 1.0
- ---------------------------------------------------------------------------------------------------------------------
Total Investments in the
Pacific Basin 144,992,016 148,032,653 42.4
- ---------------------------------------------------------------------------------------------------------------------
SOUTHEAST ASIA
---------------------------------------------------------------------------------------------------------------------
India Automobiles 26,300 Ashok Leyland Ltd.
(GDR)(b)............... 302,506 243,933 0.1
20,000 Ashok Leyland Ltd.
(GDR)(b)(e)............ 255,800 185,500 0.0
------------ ------------ ----------
558,306 429,433 0.1
-----------------------------------------------------------------------------------------------------
Hotels 14,700 East India Hotels Ltd.
(GDR)(b)(d)(e)......... 404,100 345,450 0.1
13,300 Indian Hotels Co., Ltd.
(GDR)(b)(e)............ 299,250 339,150 0.1
------------ ------------ ----------
703,350 684,600 0.2
-----------------------------------------------------------------------------------------------------
Machinery & 49,500 Larsen & Toubro Ltd.
Engineering (GDR)(b)(e)............ 888,875 712,800 0.2
-----------------------------------------------------------------------------------------------------
Utilities 103,750 BSES Ltd.(GDR)(b)........ 2,025,897 2,126,875 0.6
-----------------------------------------------------------------------------------------------------
Total Investments in
India 4,176,428 3,953,708 1.1
- ---------------------------------------------------------------------------------------------------------------------
Indonesia Building Materials 305,000 PT Semen Gresik.......... 992,608 981,787 0.3
-----------------------------------------------------------------------------------------------------
Food & Household 614,000 PT Wicaksana Overseas
Products International.......... 574,396 702,160 0.2
-----------------------------------------------------------------------------------------------------
Telecommunications 50,000 P.T. Kabelmetal Indonesia
(Rights)++............. 0 0 0.0
24,100 P.T. Telekomunikasi
Indonesia (ADR)(a)..... 786,702 831,450 0.2
------------ ------------ ----------
786,702 831,450 0.2
-----------------------------------------------------------------------------------------------------
Total Investments in
Indonesia 2,353,706 2,515,397 0.7
- ---------------------------------------------------------------------------------------------------------------------
Total Investments in
Southeast Asia 6,530,134 6,469,105 1.8
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-74-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series, Inc.--International Equity Focus Fund
Schedule of Investments as of December 31, 1996 (continued) (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Value Percent of
WESTERN EUROPE Industry Held Investments Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Czech Republic Broadcast--Media 10,000 Central European Media
Enterprises Ltd. (Class
A) (d)................. 275,000 312,500 0.1
-----------------------------------------------------------------------------------------------------
Total Investments in the
Czech Republic 275,000 312,500 0.1
- ---------------------------------------------------------------------------------------------------------------------
Finland Diversified 24,500 Outokumpu OY............. 412,272 417,907 0.1
-----------------------------------------------------------------------------------------------------
Paper & Forest 154,100 Enso-Gutzeit OY (Class A)
Products (d).................... 1,154,546 1,248,980 0.4
149,200 Metsa Serla OY (Class
B)..................... 1,124,023 1,118,489 0.3
73,900 UPM-Kymmene OY (d)....... 1,409,376 1,525,499 0.4
------------ ------------ ----------
3,687,945 3,892,968 1.1
-----------------------------------------------------------------------------------------------------
Total Investments in
Finland 4,100,217 4,310,875 1.2
- ---------------------------------------------------------------------------------------------------------------------
France Automobiles 6,027 Peugeot S.A.............. 792,975 678,444 0.2
-----------------------------------------------------------------------------------------------------
Banking 15,900 Compagnie Financiere de
Paribas (Ordinary)..... 867,231 1,075,426 0.3
18,900 Compangie Financiere de
Suez (Ordinary)........ 743,625 803,651 0.2
6,050 Societe Generale de
Surveillance S.A.
(Class A) (Ordinary)... 634,340 654,212 0.2
------------ ------------ ----------
2,245,196 2,533,289 0.7
-----------------------------------------------------------------------------------------------------
Building & 8,777 Bouygues S.A............. 908,125 910,182 0.3
Construction
-----------------------------------------------------------------------------------------------------
Communication 10,027 Alcatel Alsthom Cie
Equipment Generale d'Electricite
S.A.................... 932,571 805,562 0.2
-----------------------------------------------------------------------------------------------------
Foods 4,300 Groupe Danone S.A........ 683,124 599,248 0.2
-----------------------------------------------------------------------------------------------------
Insurance 16,340 Assurances Generales de
France S.A. (AGF)...... 416,753 527,554 0.2
-----------------------------------------------------------------------------------------------------
Multi-Industry 2,969 EuraFrance S.A........... 918,349 1,283,057 0.4
-----------------------------------------------------------------------------------------------------
Oil & Related 13,220 Societe Nationale Elf
Aquitaine.............. 967,228 1,203,509 0.3
-----------------------------------------------------------------------------------------------------
Semiconductor 5,650 SGS-Thomson
Microelectronics N.V.
(d).................... 259,759 399,682 0.1
-----------------------------------------------------------------------------------------------------
Steel 75,498 Usinor-Sacilor S.A....... 1,116,040 1,098,708 0.3
-----------------------------------------------------------------------------------------------------
Total Investments in
France 9,240,120 10,039,235 2.9
- ---------------------------------------------------------------------------------------------------------------------
Germany Automobiles 3,418 Volkswagen AG............ 1,285,442 1,421,852 0.4
-----------------------------------------------------------------------------------------------------
Banking 29,610 Commerzbank AG........... 700,836 752,519 0.2
3,100 Deutsche Bank AG
(Ordinary)............. 151,032 144,875 0.0
19,800 Deutsche Bank AG
(Warrants)(c).......... 169,779 111,966 0.0
------------ ------------ ----------
1,021,647 1,009,360 0.2
-----------------------------------------------------------------------------------------------------
Chemicals 4,199 Henkel KGaA (d).......... 180,333 201,421 0.1
42,527 Henkel KGaA (Preferred).. 1,764,347 2,136,716 0.6
------------ ------------ ----------
1,944,680 2,338,137 0.7
-----------------------------------------------------------------------------------------------------
Engineering & 1,800 Philipp Holzmann AG (d).. 688,665 421,190 0.1
Construction
-----------------------------------------------------------------------------------------------------
Machinery 17,250 Kloeckner Werke AG (d)... 1,232,262 801,674 0.2
-----------------------------------------------------------------------------------------------------
Machinery & 3,511 Thyssen AG (Ordinary).... 652,027 623,011 0.2
Equipment
-----------------------------------------------------------------------------------------------------
Metals 1,290 Degussa AG............... 462,391 584,001 0.2
-----------------------------------------------------------------------------------------------------
</TABLE>
-75-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series, Inc.--International Equity Focus Fund
Schedule of Investments as of December 31, 1996 (continued) (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
WESTERN Shares
EUROPE Held/ Value Percent of
(continued) Industry Face Amount Investments Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Germany Retail 1,940 Karstadt AG.............. 757,073 655,704 0.2
(concluded) -----------------------------------------------------------------------------------------------------
Retail Specialty 5,500 Moebel Walther........... 306,369 296,718 0.1
-----------------------------------------------------------------------------------------------------
Total Investments in
Germany 8,350,556 8,151,647 2.3
- ---------------------------------------------------------------------------------------------------------------------
Greece Banking 10,850 Ergo Bank S.A.
(Registered)........... 471,469 550,512 0.2
-----------------------------------------------------------------------------------------------------
Beverages 44,109 Hellenic Bottling Co.
S.A.................... 1,176,157 1,414,760 0.4
-----------------------------------------------------------------------------------------------------
Total Investments in
Greece 1,647,626 1,965,272 0.6
- ---------------------------------------------------------------------------------------------------------------------
Hungary Telecommunications 5,500 Magyar TarKozlesi
Reszvenytarsasag
(Ordinary) (d)(e)...... 910,789 1,191,213 0.4
-----------------------------------------------------------------------------------------------------
Total Investments in
Hungary 910,789 1,191,213 0.4
- ---------------------------------------------------------------------------------------------------------------------
Ireland Insurance 157,000 Irish Life PLC........... 526,948 727,894 0.2
-----------------------------------------------------------------------------------------------------
Packaging & 297,800 Jefferson Smurfit Group
Containers PLC (Ordinary)......... 888,436 858,467 0.3
-----------------------------------------------------------------------------------------------------
Total Investments in
Ireland 1,415,384 1,586,361 0.5
- ---------------------------------------------------------------------------------------------------------------------
Italy Building Materials 109,418 Italcementi S.p.A........ 607,540 612,582 0.2
-----------------------------------------------------------------------------------------------------
Chemicals 2,243,560 Montedison S.p.A. (d).... 1,966,796 1,527,970 0.4
-----------------------------------------------------------------------------------------------------
Diversified 1,411,500 Compagnie Industrial
Riunite S.p.A. (CIR)
(d).................... 1,306,203 869,259 0.3
335,500 Compagnie Industrial
Riunite S.p.A. (CIR)
(NC Savings) (d)....... 157,313 109,163 0.0
------------ ------------ ----------
1,463,516 978,422 0.3
-----------------------------------------------------------------------------------------------------
Insurance 60,500 Assicurazioni Generali
S.p.A.................. 1,392,767 1,145,645 0.3
713,560 Istituto Nazionale della
Assicurazioni (INA)
S.p.A.................. 1,027,949 928,697 0.3
------------ ------------ ----------
2,420,716 2,074,342 0.6
-----------------------------------------------------------------------------------------------------
Oil & Related 264,000 Ente Nazionale
Idrocarburi S.p.A.
(ENI).................. 1,102,238 1,353,690 0.4
-----------------------------------------------------------------------------------------------------
Telecommunications 643,016 Stet Societa Finanziaria
Telefonica S.p.A....... 1,452,678 2,170,563 0.6
-----------------------------------------------------------------------------------------------------
Tire & Rubber Lit 967,974,800 Pirelli S.p.A. 5% due
12/31/1998............. 681,998 706,097 0.2
-----------------------------------------------------------------------------------------------------
Total Investments in
Italy 9,695,482 9,423,666 2.7
- ---------------------------------------------------------------------------------------------------------------------
Netherlands Chemicals 6,660 Akzo Nobel N.V........... 823,170 910,637 0.3
24,770 European Vinyls
Corporation
International N.V...... 1,064,893 786,440 0.2
------------ ------------ ----------
1,888,063 1,697,077 0.5
-----------------------------------------------------------------------------------------------------
Electrical 29,250 Philips Electronics
Equipment N.V.................... 1,055,864 1,186,269 0.3
-----------------------------------------------------------------------------------------------------
Engineering & 8,550 Kondor Wessels Groep NV.. 301,062 346,260 0.1
Construction
-----------------------------------------------------------------------------------------------------
Holding Company 13,600 Internatio-Muller NV..... 300,713 341,970 0.1
-----------------------------------------------------------------------------------------------------
Insurance 56,055 Internationale Nederlanden
Groep N.V.............. 1,629,332 2,020,059 0.6
-----------------------------------------------------------------------------------------------------
</TABLE>
-76-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series, Inc.--International Equity Focus Fund
Schedule of Investments as of December 31, 1996 (continued) (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
WESTERN
EUROPE Shares Value Percent of
(continued) Industry Held Investments Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Netherlands Telecommunications 25,700 Koninklijke PTT Nederland
(concluded) N.V.................... 600,608 561,350 0.1
-----------------------------------------------------------------------------------------------------
Transportation 22,350 KLM Royal Dutch Airlines
N.V.................... 655,652 629,322 0.2
-----------------------------------------------------------------------------------------------------
Total Investments in the
Netherlands 6,431,294 6,782,307 1.9
- ---------------------------------------------------------------------------------------------------------------------
Norway Consumer Goods 17,618 Orkla A.S. (Class A)..... 918,190 1,216,618 0.3
-----------------------------------------------------------------------------------------------------
Oil & Gas Producers 36,005 Saga Petroleum A.S.
(Class B).............. 396,180 558,728 0.2
-----------------------------------------------------------------------------------------------------
Total Investments in
Norway 1,314,370 1,775,346 0.5
- ---------------------------------------------------------------------------------------------------------------------
Poland Automotive & 19,000 T.C. Debica S.A. (d)..... 299,311 424,344 0.1
Equipment
-----------------------------------------------------------------------------------------------------
Banking 17,078 Wielkopolsky Bank
Kredytowy S.A.......... 108,118 115,617 0.1
-----------------------------------------------------------------------------------------------------
Engineering & 188,300 Mostostal-Export S.A..... 512,705 446,831 0.1
Construction
-----------------------------------------------------------------------------------------------------
Total Investments in
Poland 920,134 986,792 0.3
- ---------------------------------------------------------------------------------------------------------------------
Portugal Forest Products 38,273 Sonae Investimentos --
SGPS S.A............... 880,494 1,212,390 0.3
-----------------------------------------------------------------------------------------------------
Total Investments in
Portugal 880,494 1,212,390 0.3
- ---------------------------------------------------------------------------------------------------------------------
Russia Natural Gas 36,194 RAO Gazprom
(ADR)(a)(d)(e)......... 622,839 642,444 0.2
-----------------------------------------------------------------------------------------------------
Total Investments in
Russia 622,839 642,444 0.2
- ---------------------------------------------------------------------------------------------------------------------
Spain Engineering & 3,500 Fomento de Construciones Y
Construction Contratas S.A.......... 289,804 326,095 0.1
-----------------------------------------------------------------------------------------------------
Financial Services 16,500 Argentaria Corp. Bancaria
de Espana.............. 704,967 738,161 0.2
-----------------------------------------------------------------------------------------------------
Total Investments in
Spain 994,771 1,064,256 0.3
- ---------------------------------------------------------------------------------------------------------------------
Sweden Appliances 20,481 Electrolux AB............ 1,002,283 1,190,092 0.3
-----------------------------------------------------------------------------------------------------
Banking 7,549 Sparbanken Sverige AB
(Class A).............. 93,787 129,601 0.0
-----------------------------------------------------------------------------------------------------
Building Related 47,531 Svedala Industry AB...... 690,761 805,551 0.2
-----------------------------------------------------------------------------------------------------
Engineering 27,400 SKF AB 'A'............... 496,206 629,215 0.2
-----------------------------------------------------------------------------------------------------
Forest Products 37,800 Mo Och Domsjo AB-'B'
Free................... 962,403 1,064,945 0.3
432,300 Rottneros Bruks AB....... 666,730 548,701 0.2
91,500 Stora Kopparbergs
Bergslags AB........... 1,152,700 1,262,069 0.4
------------ ------------ ----------
2,781,833 2,875,715 0.9
-----------------------------------------------------------------------------------------------------
Insurance 50,335 Forsakrings AB Skandia... 1,198,333 1,425,481 0.4
-----------------------------------------------------------------------------------------------------
Metals & Mining 46,553 Avesta Sheffield AB...... 411,954 502,076 0.1
-----------------------------------------------------------------------------------------------------
Pharmaceutical-- 19,005 Astra 'A' Fria........... 833,308 939,792 0.3
Prescription
-----------------------------------------------------------------------------------------------------
Total Investments in
Sweden 7,508,465 8,497,523 2.4
- ---------------------------------------------------------------------------------------------------------------------
Switzerland Banking 10,360 CS Holding AG
(Registered)........... 1,060,531 1,064,013 0.3
-----------------------------------------------------------------------------------------------------
Chemicals 1,375 Clariant AG
(Registered)........... 449,723 588,493 0.2
-----------------------------------------------------------------------------------------------------
</TABLE>
-77-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series, Inc.--International Equity Focus Fund
Schedule of Investments as of December 31, 1996 (continued) (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
WESTERN
EUROPE Shares Value Percent of
(concluded) Industry Held Investments Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Switzerland Diversified 13,805 Oerlikon-Buehrle Holdings
(concluded) AG (d)................. 1,459,291 1,361,114 0.4
-----------------------------------------------------------------------------------------------------
Jewelry 4,738 SMH AG (Societe Suisse pour
la Microelectronique et
l'Horlogerie).......... 673,901 675,947 0.2
-----------------------------------------------------------------------------------------------------
Leisure 798 Fotolabo S.A............. 331,433 309,949 0.1
-----------------------------------------------------------------------------------------------------
Machinery 417 Saurer AG (d)............ 181,527 180,654 0.0
-----------------------------------------------------------------------------------------------------
Total Investments in
Switzerland 4,156,406 4,180,170 1.2
- ---------------------------------------------------------------------------------------------------------------------
Turkey Beverages 7,915,658 Erciyas Biracilik Ve Malt
Sanayii A.S............ 1,131,316 858,809 0.2
-----------------------------------------------------------------------------------------------------
Metal Fabricating 7,949,486 Eregli Demir Ve Celik
Fabrikalari T.A.S...... 941,635 954,232 0.3
-----------------------------------------------------------------------------------------------------
Retail Stores 1,398,387 Migros Turk A.S.......... 997,813 1,710,861 0.5
-----------------------------------------------------------------------------------------------------
Total Investments in
Turkey 3,070,764 3,523,902 1.0
- ---------------------------------------------------------------------------------------------------------------------
United Kingdom Beverages 151,140 Grand Metropolitan PLC
(Ordinary) (d)......... 958,951 1,189,423 0.3
42,433 Matthew Clark PLC........ 411,176 188,745 0.1
------------ ------------ ----------
1,370,127 1,378,168 0.4
-----------------------------------------------------------------------------------------------------
Chemicals 94,500 Inspec Group PLC......... 285,567 342,742 0.1
6,183 Millennium Chemicals Inc.
(d).................... 177,414 109,748 0.0
------------ ------------ ----------
462,981 452,490 0.1
-----------------------------------------------------------------------------------------------------
Computer Services 26,190 Misys PLC................ 323,536 497,793 0.1
-----------------------------------------------------------------------------------------------------
Congolomerates 432,825 Hanson PLC (Ordinary).... 734,719 607,191 0.2
-----------------------------------------------------------------------------------------------------
Diversified 100,000 Peninsular & Oriental
Steam Navigation Co.
(The).................. 802,965 1,009,372 0.3
-----------------------------------------------------------------------------------------------------
Food & Household 85,336 Cadbury Schweppes PLC.... 679,109 719,015 0.2
Products
-----------------------------------------------------------------------------------------------------
Food Manufacturing 62,660 Unilever PLC............. 1,180,687 1,518,470 0.4
-----------------------------------------------------------------------------------------------------
Industrial--Other 134,000 Tomkins PLC (d).......... 461,257 618,967 0.2
-----------------------------------------------------------------------------------------------------
Insurance 110,150 Prudential Corp. PLC..... 588,540 926,205 0.3
-----------------------------------------------------------------------------------------------------
Pharmaceuticals 51,700 Glaxo Holdings PLC....... 679,333 838,490 0.2
-----------------------------------------------------------------------------------------------------
Real Estate 60,000 Land Securities PLC...... 593,293 766,781 0.2
-----------------------------------------------------------------------------------------------------
Retail 196,500 Tesco PLC (Ordinary)..... 901,348 1,193,411 0.3
-----------------------------------------------------------------------------------------------------
Retail Trade 389,160 ASDA Group PLC........... 716,019 818,903 0.2
-----------------------------------------------------------------------------------------------------
Tobacco 43,282 Imperial Tobacco Group
PLC (d)................ 301,618 279,897 0.1
-----------------------------------------------------------------------------------------------------
Utilities 60,000 Anglian Water PLC........ 491,821 605,623 0.2
60,000 Severn Trent PLC......... 514,675 683,636 0.2
115,500 United Utilities PLC..... 1,024,248 1,227,080 0.4
50,000 Yorkshire Water PLC...... 482,984 603,057 0.2
------------ ------------ ----------
2,513,728 3,119,396 1.0
-----------------------------------------------------------------------------------------------------
Utilities-- 104,623 Cable & Wireless PLC..... 698,024 868,992 0.3
Communications
-----------------------------------------------------------------------------------------------------
Total Investments in the
United Kingdom 13,007,284 15,613,541 4.5
- ---------------------------------------------------------------------------------------------------------------------
Total Investments in
Western Europe 74,541,995 81,259,440 23.3
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-78-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series, Inc.--International Equity Focus Fund
Schedule of Investments as of December 31, 1996 (continued) (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHORT-TERM Face Value Percent of
SECURITIES Amount Short-Term Securities Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Commercial Paper* US$5,000,000 Alpine Securitization
Co., 5.33% due
1/16/1997.............. 4,988,156 4,988,156 1.4
7,000,000 Dean Witter, Discover &
Co., 5.45% due
1/15/1997.............. 6,984,104 6,984,104 2.0
16,682,000 General Motors Accept-
ance Corp., 7.50% due
1/02/1997.............. 16,675,049 16,675,049 4.8
------------ ------------ ----------
28,647,309 28,647,309 8.2
-----------------------------------------------------------------------------------------------------
Commercial A$10,660,744 Westpac Banking Corp.,
Paper -- Foreign* 6.17% due 5/15/1997.... 8,238,547 8,288,961 2.4
-----------------------------------------------------------------------------------------------------
Foreign Government L 4,250,000 UK Treasury Bill, 6.11%
Obligations* due 2/17/1997.......... 6,996,929 7,217,474 2.0
-----------------------------------------------------------------------------------------------------
US Government & Federal National
Agency Mortgage Association:
Obligations* US$5,000,000 5.23% due 1/07/1997.... 4,994,915 4,994,915 1.4
5,000,000 5.49% due 1/24/1997.... 4,981,700 4,981,700 1.4
United States Treasury
Bills+:
11,000,000 4.93% due 1/09/1997.... 10,986,443 10,989,660 3.2
12,000,000 4.98% due 1/09/1997.... 11,985,060 11,988,720 3.5
350,000 4.94% due 1/30/1997.... 348,559 348,681 0.1
1,600,000 4.99% due 1/30/1997.... 1,593,347 1,593,968 0.5
10,000 4.75% due 2/27/1997.... 9,923 9,923 0.0
30,000 4.81% due 2/27/1997.... 29,768 29,768 0.0
90,000 4.82% due 2/27/1997.... 89,301 89,305 0.0
150,000 5% due 2/27/1997....... 148,792 148,842 0.0
320,000 5.01% due 2/27/1997.... 317,417 317,530 0.1
------------ ------------ ----------
35,485,225 35,493,012 10.2
- ---------------------------------------------------------------------------------------------------------------------
Total Investments in
Short-Term Securities 79,368,010 79,646,756 22.8
- ---------------------------------------------------------------------------------------------------------------------
Nominal
Value/Number
of Contracts
OPTIONS Covered by Premiums
PURCHASED Options Issue Paid
---------------------------------------------------------------------------------------------------------------------
Call Options 348 Nikkei, expiring June
Purchased 1997 at 22,000......... 106,592 57,556 0.0
-----------------------------------------------------------------------------------------------------
Currency Put 5,600,000 German Deutschemark,
Options Purchased expiring July 1997 at
DM1.55................. 64,848 94,640 0.0
1,600,000 Japanese Yen, expiring
February 1997 at Y115... 9,040 22,997 0.0
17,000,000 Japanese Yen, expiring
July 1997 at Y115.5.... 237,575 306,000 0.1
4,600,000 Swiss Franc, expiring
July 1997 at
Chf1.285............... 62,100 194,120 0.1
------------ ------------ ----------
373,563 617,757 0.2
-----------------------------------------------------------------------------------------------------
Put Options 35 Bovespa, expiring Febru-
Purchased ary 1997 at 64,469..... 117,250 29,962 0.0
-----------------------------------------------------------------------------------------------------
Total Options Purchased 597,405 705,275 0.2
- ---------------------------------------------------------------------------------------------------------------------
Total Investments 336,485,191 348,422,493 99.8
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-79-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--International Equity Focus Fund
Schedule of Investments as of December 31, 1996 (concluded) (in US dollars)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Nominal
Value/Number
of Contracts
Covered by Premiums Value Percent of
OPTIONS WRITTEN Options Issue Received (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Call Options 35 Bovespa, expiring
Written February 1997 at
64,469................. (117,250) (154,869) 0.0
-----------------------------------------------------------------------------------------------------
Total Options Written (117,250) (154,869) 0.0
- ---------------------------------------------------------------------------------------------------------------------
Total Investments, Net of Options Written................... $336,367,941 348,267,624 99.8
=============
Variation Margin on Stock Index Futures Contracts**......... 51,556 0.0
Unrealized Depreciation on Forward Foreign Exchange
Contracts***................................................ (305) 0.0
Other Assets Less Liabilities............................... 760,954 0.2
------------ ----------
Net Assets.................................................. $349,079,829 100.0%
============= ===========
- ---------------------------------------------------------------------------------------------------------------------
(a) American Depositary Receipts (ADR).
(b) Global Depositary Receipts (GDR).
(c) Warrants entitle the Fund to purchase a predetermined number of shares of common stock. The purchase price and the
number of shares are subject to adjustment under certain conditions until the expiration date.
(d) Non-income producing security.
(e) Restricted security as to resale. The value of the Fund's investment in
restricted securities was approximately $4,793,000 representing 1.4% of
net assets.
</TABLE>
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Acquisition Value
Issue Date(s) Cost (Note 1a)
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Ashok Leyland Ltd. (GDR).................................................... 3/09/1995 $ 255,800 $ 185,500
East India Hotels Ltd. (GDR)................................................ 4/23/1996- 404,100 345,450
4/24/1996
Indian Hotels Co., Ltd. (GDR)............................................... 3/08/1996 299,250 339,150
Larsen & Toubro (GDR)....................................................... 3/06/1996- 888,875 712,800
4/23/1996
Magyar Tar Kozlesi Reszvenytarsasag (Ordinary).............................. 2/15/1995- 910,789 1,191,213
12/01/1995
Nedcor Ltd. (GDR)........................................................... 5/23/1995- 1,097,188 1,376,240
5/22/1996
RAO Gazprom (ADR)........................................................... 10/21/1996- 622,839 642,444
12/06/1996
- ---------------------------------------------------------------------------------------------------------------------
Total $4,478,841 $4,792,797
========== ==========
- ---------------------------------------------------------------------------------------------------------------------
* Commercial Paper, Commercial Paper -- Foreign and certain Foreign and US Government & Agency Obligations are traded on a
discount basis; the interest rates shown are the rates paid at the time of purchase by the Fund.
</TABLE>
** Stock index futures contracts purchased as of December 31, 1996 were as
follows:
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Number of Expiration Value
Contracts Issue Exchange Date (Note 1a & 1b)
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
250 All Ordinaries..............................................
SFE March 1997 $12,156,224
36 Nikkei 225..................................................
SIMEX March 1997 3,006,995
61 TOPIX.......................................................
TSE March 1997 7,754,059
---------------------------------------------------------------------------------------------------------------------
Total Stock Index Futures Contracts Purchased (Total Contract Price--$22,724,370) $22,917,278
---------------------------------------------------------------------------------------------------------------------
Stock index futures contracts sold as of December 31, 1996 were as follows:
---------------------------------------------------------------------------------------------------------------------
Number of Expiration Value
Contracts Issue Exchange Date (Note 1a & 1b)
---------------------------------------------------------------------------------------------------------------------
42 FTSE 100....................................................
LIFFE March 1997 $ 7,408,106
17 Hang Seng...................................................
HKFE January 1997 1,479,312
---------------------------------------------------------------------------------------------------------------------
Total Stock Index Futures Contracts Sold (Total Contract Price--$8,607,499) $ 8,887,418
---------------------------------------------------------------------------------------------------------------------
***Forward foreign exchange contracts as of December 31, 1996 were as follows:
---------------------------------------------------------------------------------------------------------------------
Unrealized
Expiration Depreciation
Foreign Currency Purchased Date (Note 1b)
---------------------------------------------------------------------------------------------------------------------
DM15,978,060 ......................................................................
January 1997 $ (305)
---------------------------------------------------------------------------------------------------------------------
Total (US$ Commitment--10,400,000) $ (305)
---------------------------------------------------------------------------------------------------------------------
</TABLE>
++ The rights may be exercised until February 18, 1997.
+ Securities held as collateral in connection with open futures contracts.
See Notes to Financial Statements.
-80-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Natural Resources Focus Fund
Schedule of Investments as of December 31, 1996
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Value Percent of
Industry Held Common Stocks Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Aluminum 15,000 Alcan Aluminium, Ltd. ........ $ 314,175 $ 504,375 1.1%
7,600 +Alumax, Inc. ................ 250,293 253,650 0.6
4,300 Aluminum Co. of America....... 224,399 274,125 0.6
------------ ------------ ------
788,867 1,032,150 2.3
- ---------------------------------------------------------------------------------------------------------------------
Chemicals 4,300 Air Products & Chemicals,
Inc. ....................... 245,939 297,238 0.7
72,000 Asahi Chemical Industry Co.,
Ltd. ....................... 530,650 407,876 0.9
17,000 BASF AG....................... 407,600 655,028 1.4
10,400 Dow Chemical Co. ............. 646,664 815,100 1.8
6,700 duPont (E.I.) de Nemours &
Co. ........................ 323,847 632,313 1.4
------------ ------------ ------
2,154,700 2,807,555 6.2
- ---------------------------------------------------------------------------------------------------------------------
Diversified Resources 20,000 Asahi Glass Co., Ltd. ........ 240,000 188,256 0.4
Companies 12,800 Canadian Pacific, Ltd. ....... 197,224 339,200 0.7
5,100 Coastal Corp. ................ 137,570 249,263 0.6
33,000 Cyprus Amax Minerals Co. ..... 921,470 771,375 1.7
25,500 Norcen Energy Resources
Ltd. ....................... 378,524 565,839 1.3
20,000 Occidental Petroleum Corp. ... 391,200 467,500 1.0
52,300 RGC Ltd. ..................... 206,473 232,190 0.5
------------ ------------ ------
2,472,461 2,813,623 6.2
- ---------------------------------------------------------------------------------------------------------------------
Gold 122,000 +Acacia Resources Ltd. ....... 250,570 237,386 0.5
43,700 +Amax Gold, Inc. ............. 259,987 278,588 0.6
17,500 Ashanti Goldfields Co. Ltd.
(GDR)***.................... 434,367 216,563 0.5
23,500 Cambior Inc. ................. 315,479 346,496 0.8
173,300 +Delta Gold N.L. ............. 333,170 324,818 0.7
30,600 Driefontein Consolidated
Ltd. ....................... 477,914 322,295 0.7
133,000 Great Central Mines N.L. ..... 411,933 378,150 0.8
51,600 +Miramar Mining Corporation... 268,637 225,985 0.5
45,000 Newcrest Mining Ltd. ......... 192,990 178,695 0.4
20,864 Newmont Mining Corp. ......... 828,080 933,664 2.1
45,000 Placer Dome Inc. ............. 1,018,177 978,750 2.2
24,800 Prime Resources Group,
Inc. ....................... 242,631 175,591 0.4
42,900 Santa Fe Pacific Gold
Corp. ...................... 535,350 659,588 1.5
22,000 +TVX Gold, Inc. .............. 179,135 170,500 0.4
------------ ------------ ------
5,748,420 5,427,069 12.1
- ---------------------------------------------------------------------------------------------------------------------
Integrated Oil 12,300 Amerada Hess Corp. ........... 646,044 711,863 1.6
Companies 10,500 Amoco Corp. .................. 554,378 845,250 1.9
5,200 British Petroleum, Co. PLC
(ADR)*...................... 396,812 735,150 1.6
14,000 ENI Societa per Azioni
(ADR)*...................... 654,500 722,750 1.6
2,000 OMV AG........................ 214,068 225,547 0.5
25,000 Petro-Canada (Installment
Receipts)(c)................ 195,677 271,875 0.6
7,300 Repsol, S.A. ................. 210,174 279,926 0.6
3,000 Repsol, S.A. (ADR)* .......... 86,490 114,375 0.2
17,800 Societe Nationale Elf
Aquitaine (ADR)* ........... 645,343 805,450 1.8
12,000 Total, S.A. (Class B)......... 728,842 976,099 2.2
19,700 Yacimientos Petroliferos
Fiscales, S.A. (ADR)*....... 427,078 497,425 1.1
------------ ------------ ------
4,759,406 6,185,710 13.7
- ---------------------------------------------------------------------------------------------------------------------
Metals & Mining 10,800 ASARCO Inc. .................. 305,116 268,650 0.6
259,000 +Centaur Mining & Exploration
Ltd. ....................... 390,350 401,111 0.9
25,600 Falconbridge Ltd. (Installment
Receipts) (a)............... 384,069 366,248 0.8
7,400 Inco Ltd...................... 244,911 235,875 0.5
51,300 Industrias Penoles, S.A. de
C.V. ....................... 230,560 181,841 0.4
465,000 M.I.M. Holdings Ltd. ......... 867,286 649,973 1.4
34,370 Minsur S.A. (T Shares)........ 111,555 119,542 0.3
</TABLE>
-81-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Natural Resources Focus Fund
Schedule of Investments as of December 31, 1996 (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Value Percent of
Industry Held Common Stocks Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Metals & Mining 91,000 Mitsubishi Materials Corp. ... 461,572 367,772 0.8
(concluded) 32,400 Noranda Inc. ................. 600,505 722,496 1.6
25,500 Outokumpu OY.................. 455,626 434,964 1.0
9,400 ++P.T. Tambang Timah
(GDR)***.................... 115,742 169,905 0.4
144,400 Pasminco Ltd. ................ 195,275 227,071 0.5
6,700 Phelps Dodge Corp. ........... 382,311 452,250 1.0
108,000 QNI Ltd. ..................... 216,381 217,007 0.5
52,400 (The) RTZ Corp. PLC .......... 680,570 840,879 1.9
28,000 Resolute Ltd. ................ 60,351 58,263 0.1
6,000 Rio Algom Ltd. ............... 116,616 134,015 0.3
410,000 Savage Resources Ltd. ........ 313,412 449,358 1.0
41,000 Savage Resources Ltd.
(Warrants) (b).............. 5,506 10,420 0.0
46,000 Sumitomo Metal Mining Co.
Ltd. ....................... 383,546 310,242 0.7
34,000 Trelleborg 'B' Fria........... 454,495 451,504 1.0
23,000 +Westmin Resources, Inc. ..... 120,329 111,642 0.2
164,900 WMC Ltd. ..................... 964,809 1,038,541 2.3
------------ ------------ ------
8,060,893 8,219,569 18.2
- ---------------------------------------------------------------------------------------------------------------------
Oil & Gas Producers 21,400 Apache Corp. ................. 573,935 757,025 1.7
37,000 +Chauvco Resources Ltd. ...... 437,096 380,803 0.8
10,200 +Chieftain International, Inc.
(f) ........................ 227,716 265,200 0.6
23,100 Enserch Exploration Inc. ..... 230,541 271,425 0.6
68,300 Enterprise Oil PLC............ 449,045 753,667 1.7
37,300 +Gulf Canada Resources,
Ltd. ....................... 264,784 272,263 0.6
7,300 Louisiana Land and Exploration
Co. (The)................... 283,067 391,463 0.9
21,400 Mitchell Energy & Development
Corp. (Class B)............. 374,226 473,475 1.0
28,600 +Northrock Resources Ltd. .... 227,905 256,774 0.6
13,000 +Oryx Energy Co. ............. 216,739 321,750 0.7
4,000 PanCanadian Petroleum Ltd. ... 152,305 157,956 0.4
93,000 Ranger Oil Ltd. .............. 625,617 918,375 2.0
8,200 Sonat, Inc. .................. 269,737 422,300 0.9
9,800 Vastar Resources, Inc. ....... 268,604 372,400 0.8
------------ ------------ ------
4,601,317 6,014,876 13.3
- ---------------------------------------------------------------------------------------------------------------------
Oil Services 12,500 +Coflexip Stena Offshore, Inc.
(ADR)*...................... 259,460 326,562 0.7
9,800 IHC Caland N.V. .............. 214,018 560,406 1.3
10,600 +Petroleum Geo-Services ASA
(ADR)*...................... 309,952 412,075 0.9
6,400 Schlumberger Ltd. ............ 382,287 639,200 1.4
10,300 +Smedvig ASA (ADR)*........... 218,875 207,288 0.5
7,200 Transocean Offshore Inc.
(d)......................... 440,451 450,900 1.0
------------ ------------ ------
1,825,043 2,596,431 5.8
- ---------------------------------------------------------------------------------------------------------------------
Paper & Forest Products 24,533 Aracruz Celulose S.A.
(ADR)*...................... 196,788 202,397 0.5
31,400 Avenor Inc. .................. 611,175 465,270 1.0
15,800 Empresa Nacional de Celulosas,
S.A. ....................... 233,184 189,181 0.4
8,700 Georgia-Pacific Corp. ........ 615,783 626,400 1.4
14,800 International Paper Co. ...... 497,368 597,550 1.3
57,500 Metsa Serla OY 'B'............ 499,397 431,053 1.0
16,800 Mo Och Domsjo AB 'B' Co. ..... 373,697 473,309 1.0
52,000 Slocan Forest Products
Ltd. ....................... 523,964 588,321 1.3
9,520 +UPM-Kymmene OY (e)........... 169,172 196,519 0.4
17,200 Weyerhaeuser Co. ............. 687,415 814,850 1.8
9,000 Willamette Industries,
Inc. ....................... 376,875 626,625 1.4
------------ ------------ ------
4,784,818 5,211,475 11.5
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-82-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Natural Resources Focus Fund
Schedule of Investments as of December 31, 1996 (concluded)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Value Percent of
Industry Held Common Stocks Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Plantations 136,000 Golden Hope Plantations BHD... 240,608 231,604 0.5
90,000 Kuala Lumpur Kepong BHD....... 120,553 228,119 0.5
------------ ------------ ------
361,161 459,723 1.0
- ---------------------------------------------------------------------------------------------------------------------
Refining 45,300 Total Petroleum (North
America), Ltd. (ADR)*....... 579,947 469,987 1.0
- ---------------------------------------------------------------------------------------------------------------------
Steel 83,000 British Steel PLC............. 218,182 228,614 0.5
135,000 +Kobe Steel, Ltd. ............ 390,945 284,456 0.6
12,800 Koninklijke Nederlandsche
Hoogovens en Staalfabrienken
N.V. ....................... 529,034 533,951 1.2
148,000 Nippon Steel Corp. ........... 501,972 437,098 1.0
244,000 Sumitomo Metal Industries,
Ltd. ....................... 773,176 600,518 1.3
------------ ------------ ------
2,413,309 2,084,637 4.6
- ---------------------------------------------------------------------------------------------------------------------
Wood Products 18,400 Louisiana-Pacific Corp. ...... 467,929 388,700 0.8
26,800 Riverside Forest Products
Ltd......................... 352,710 348,204 0.8
------------ ------------ ------
820,639 736,904 1.6
- ---------------------------------------------------------------------------------------------------------------------
Total Common Stocks 39,370,981 44,059,709 97.5
- ---------------------------------------------------------------------------------------------------------------------
Face
Amount Short-Term Investments
---------------------------------------------------------------------------------------------------------------------
Commercial Paper** $1,352,000 General Electric Capital
Corp., 7.10% due
1/02/1997................... 1,351,467 1,351,467 3.0
- ---------------------------------------------------------------------------------------------------------------------
Total Short-Term Investments 1,351,467 1,351,467 3.0
- ---------------------------------------------------------------------------------------------------------------------
Total Investments............. $ 40,722,448 45,411,176 100.5
============
Liabilities in Excess of Other
Assets...................... (214,181) (0.5)
------------ ------
Net Assets.................... $ 45,196,995 100.0%
============ ======
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Receipts evidence payment by the Fund of 67% of the purchase price common
stock of Falconbridge Ltd. The Fund is obligated to pay the remaining 33%,
approximately $360,000, over the next year.
(b) Warrants entitle the Fund to purchase a predetermined number of shares of
common stock. The purchase price and the number of shares are subject to
adjustment under certain conditions until the expiration date.
(c) Receipts evidence payment by the Fund of 71% of the purchase price common
stock of Petro-Canada. The Fund is obligated to pay the remaining 29%,
approximately $189,000, over the next year.
(d) Created as a result of the merger of Sonat Offshore and Transocean.
(e) Created as a result of the merger of Kymmene Corporation and Repola Ltd.
(f) Investment in companies 5% or more of whose outstanding securities are
held by the Fund (such companies are defined as "Affiliated Companies" in
Section 2(a)(3) of the Investment Company Act of 1940) were as follows:
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Net Share Net Dividend
Industry Affiliate Activity Cost Income
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Oil & Gas Producers Chieftain International, Inc. ..................... 10,200 $227,716 --
- ---------------------------------------------------------------------------------------------------------------------
Total $227,716
=======
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* American Depositary Receipts (ADR).
** Commercial Paper is traded on a discount basis; the interest rates shown
are the discount rates paid at the time of purchase by the Fund.
*** Global Depositary Receipts (GDR).
+ Non-income producing security.
++ Restricted security as to resale. The value of the Fund's investment in
restricted securities was approximately $170,000, representing 0.4% of net
assets.
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Acquisition Value
Issue Date Cost (Note 1a)
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
P.T. Tambang Timah (GDR)......................................................... 10/06/1995 $115,742 $169,905
- ---------------------------------------------------------------------------------------------------------------------
Total $115,742 $169,905
======== ========
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
-83-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Prime Bond Fund
Schedule of Investments as of December 31, 1996
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P Moody's Face Value
Industry Ratings Ratings Amount Corporate Bonds & Notes Cost (Note 1a)
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Asset-Backed AAA Aaa $ 9,000,000 Banc One Credit Card Master
Securities++--3.3% Trust (Series B),
7.55% due 12/15/1999............. $ 9,171,523 $ 9,129,330
AAA Aaa 4,000,000 Citibank, Credit Card Master Trust
I, 5.62% due 12/10/2008.......... 3,998,440 3,996,240
AAA Aaa 4,462,458 Fifth Third Auto Grantor Trust,
6.45% due 3/15/2002.............. 4,460,715 4,480,575
------------ ------------
17,630,678 17,606,145
- ---------------------------------------------------------------------------------------------------------------------
Banks & Thrifts--12.0% Bank of New York Co., Inc.:
A- A2 4,000,000 7.625% due 7/15/2002............. 4,306,000 4,159,160
A- A2 2,000,000 7.875% due 11/15/2002............ 2,213,400 2,106,200
BankAmerica Corp.:
A A2 7,000,000 8.375% due 3/15/2002............. 7,361,550 7,499,310
A+ A1 1,000,000 7.125% due 5/12/2005............. 985,500 1,007,540
BBB+ A2 2,000,000 First Interestate Bancorp, 11.25%
due 3/27/2001.................... 2,354,060 2,303,520
BBB+ A1 5,000,000 +First Union Capital Corp., 7.85%
due 1/01/2027.................... 4,991,300 4,991,300
A- A2 1,500,000 First Union Corp., 7.50% due
7/15/2006........................ 1,500,690 1,539,720
A- A3 2,000,000 Golden West Financial Corp., 9.15%
due 5/23/1998.................... 2,271,480 2,075,860
BBB+ A3 1,000,000 +HSBC Americas Inc., 7.808% due
12/15/2026....................... 988,460 966,100
AA- Aa2 3,000,000 JPM Capital Trust, 7.54% due
1/15/2027........................ 3,000,000 2,931,870
NationsBank Corp.:
A A2 2,000,000 7.50% due 2/15/1997.............. 1,998,280 2,003,740
A- A3 5,000,000 6.50% due 8/15/2003.............. 4,755,150 4,887,850
Norwest Corp.:
AA- Aa3 5,000,000 6.25% due 4/15/1999.............. 4,983,600 5,004,000
AA- Aa3 2,500,000 6.75% due 5/12/2000.............. 2,529,975 2,528,250
A A2 12,950,000 US Bancorp, 6.95% due 11/28/1997... 13,048,032 13,082,738
AA+ Aa2 3,000,000 Wachovia Corp., 6.55% due
6/09/1997........................ 2,997,810 3,012,780
BBB A1 4,500,000 Wells Fargo Capital I, 7.96% due
12/15/2026....................... 4,421,515 4,498,065
------------ ------------
64,706,802 64,598,003
- ---------------------------------------------------------------------------------------------------------------------
Canadian Province of Quebec (Canada) (2):
Province*--2.4% A+ A2 3,500,000 8.80% due 4/15/2003.............. 3,944,780 3,852,135
A+ A2 9,500,000 7.125% due 2/09/2024............. 7,990,800 9,123,230
------------ ------------
11,935,580 12,975,365
- ---------------------------------------------------------------------------------------------------------------------
Federal AAA Aaa 3,000,000 Federal Home Loan Banks, 6.65%
Agencies--1.9% due 11/13/2001................... 2,997,656 2,992,020
AAA Aaa 7,000,000 Federal National Mortgage
Association, 7.85% due
9/10/2004........................ 6,925,569 7,164,080
------------ ------------
9,923,225 10,156,100
- ---------------------------------------------------------------------------------------------------------------------
Finance--4.5% Associates Corp. of North America:
AA- Aa3 5,000,000 8.375% due 1/15/1998............. 5,016,100 5,115,700
AA- Aa3 1,500,000 5.25% due 9/01/1998.............. 1,454,385 1,478,085
AA- Aa3 1,000,000 7.25% due 9/01/1999.............. 987,620 1,021,960
A+ Aa3 5,500,000 CIT Group Holdings, Inc., 7% due
9/30/1997........................ 5,547,490 5,545,705
Commercial Credit Co.:
A+ A1 3,250,000 10.00% due 5/01/1999............. 3,626,350 3,506,393
A+ A1 3,000,000 6.70% due 8/01/1999.............. 3,022,580 3,018,030
AAA Aaa 3,245,000 General Electric Capital Corp.,
8.125% due 5/15/2012............. 3,449,052 3,587,347
A+ A2 1,000,000 Transamerica Financial Corp., 6.80%
due 3/15/1999.................... 999,730 1,010,520
------------ ------------
24,103,307 24,283,740
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-84-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Prime Bond Fund
Schedule of Investments as of December 31, 1996 (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P Moody's Face Value
Industry Ratings Ratings Amount Corporate Bonds & Notes Cost (Note 1a)
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Finance-- Bear Stearns Companies
Other--14.4% Inc.(The):
A A2 10,000,000 6.75% due 8/15/2000.............. 9,936,500 10,059,900
A A2 1,000,000 6.70% due 8/01/2003.............. 1,002,800 983,990
Dean Witter, Discover & Co.:
A A2 3,500,000 6.75% due 8/15/2000.............. 3,486,805 3,525,375
A A2 4,000,000 6.30% due 1/15/2006.............. 3,982,400 3,778,688
A A2 3,500,000 6.75% due 1/01/2016.............. 3,500,000 3,222,170
A+ A2 4,000,000 Equitable Cos. Inc., 9% due
12/15/2004....................... 4,416,200 4,478,800
Equitable Life Assurance Society:
A A2 4,355,000 +6.95% due 12/01/2005............. 4,110,249 4,272,168
A A2 3,500,000 +7.70% due 12/01/2015............. 3,476,060 3,498,530
A Baa1 10,000,000 Lehman Brothers Holdings, Inc.,
7.375% due 8/15/1997............. 9,987,000 10,065,300
BBB+ A3 5,000,000 MBNA Corporation, 5.681% due
9/14/1998........................ 5,000,000 5,001,980
AA- A2 6,100,000 +Pacific Mutual Life Insurance
Company, 7.90% due 12/30/2023.... 5,999,655 6,242,496
PaineWebber Group, Inc.:
BBB+ Baa1 3,000,000 9.25% due 12/15/2001............. 3,501,570 3,288,240
BBB+ Baa1 2,000,000 8.875% due 3/15/2005............. 2,012,540 2,169,240
Smith Barney Holdings, Inc.:
A- A2 2,000,000 5.875% due 2/01/2001............. 1,993,680 1,943,496
A- A2 4,000,000 6.50% due 10/15/2002............. 3,980,560 3,933,680
A- A2 2,000,000 6.625% due 11/15/2003............ 1,988,320 1,969,380
A A1 2,000,000 Travelers Capital II, 7.75% due
12/01/2036....................... 2,003,400 1,923,120
Travelers Corp. (The):
A+ A1 1,000,000 9.50% due 3/01/2002.............. 1,084,200 1,119,190
A+ A1 6,000,000 7.875% due 5/15/2025............. 6,053,840 6,266,940
------------ ------------
77,515,779 77,742,683
- ---------------------------------------------------------------------------------------------------------------------
Industrial-- Anheuser-Busch Cos., Inc.:
Consumer AA- A1 2,500,000 8.75% due 12/01/1999............. 2,839,090 2,656,250
Goods--3.8% AA- A1 5,000,000 7.375% due 7/01/2023............. 5,127,300 4,947,100
A- A3 7,000,000 IBP, Inc., 6.125% due 2/01/2006.... 6,431,460 6,600,510
AA Aa2 2,000,000 Kimberly-Clark Corporation, 7.875%
due 2/01/2023.................... 2,033,960 2,082,080
A A2 4,000,000 Philip Morris Companies, Inc., 9%
due 1/01/2001.................... 4,071,540 4,303,480
------------ ------------
20,503,350 20,589,420
- ---------------------------------------------------------------------------------------------------------------------
Industrial-- AA Aa3 2,000,000 BP America Inc., 9.375% due
Energy--2.6% 11/01/2000....................... 2,204,960 2,200,980
AA- A1 7,000,000 Consolidated Natural Gas Co., 8.75%
due 6/01/1999.................... 7,448,861 7,361,900
A- A1 3,000,000 Dresser Industries, Inc., 7.60% due
8/15/2096........................ 2,991,270 3,062,790
A+ A1 1,500,000 Texaco Capital Inc., 9% due
12/15/1999....................... 1,731,670 1,606,110
------------ ------------
14,376,761 14,231,780
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-85-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Prime Bond Fund
Schedule of Investments as of December 31, 1996 (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P Moody's Face Value
Industry Ratings Ratings Amount Corporate Bonds & Notes Cost (Note 1a)
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Industrial-- A- A3 6,500,000 Chrysler Finance Corporation
Manufacturing--8.2% 10.95% due 8/01/2017............. 7,380,520 7,007,260
AA- Aa3 2,950,000 du Pont (E.I.) de Nemours & Co.,
8.25% due 1/15/2022.............. 3,066,304 3,102,751
Ford Motor Credit Company:
A+ A1 3,000,000 7% due 9/25/2001................. 2,988,060 3,044,730
A+ A1 5,000,000 7.50% due 6/15/2004.............. 5,140,200 5,147,300
A+ A1 2,500,000 7.75% due 3/15/2005.............. 2,497,725 2,603,625
General Motors Acceptance Corp.:
A- A3 3,000,000 7.125% due 5/11/1998............. 3,033,840 3,045,660
A- A3 4,000,000 7.70% due 4/15/2016.............. 3,967,000 4,136,920
A- A3 3,500,000 7.40% due 9/01/2025.............. 3,471,790 3,461,290
Lockheed Martin Corp.:
BBB+ A3 7,000,000 6.625% due 6/15/1998............. 6,999,090 7,053,970
BBB+ A3 2,500,000 6.55% due 5/15/1999.............. 2,498,800 2,511,675
A- Baa2 3,000,000 McDonnell Douglas Corporation,
8.625% due 4/01/1997............. 3,050,010 3,019,710
------------ ------------
44,093,339 44,134,891
- ---------------------------------------------------------------------------------------------------------------------
Industrial-- A+ A1 2,500,000 Bass America, Inc., 8.125% due
Services--11.1% 3/31/2002........................ 2,668,930 2,656,825
A A2 4,000,000 Carnival Cruise Lines, Inc., 7.70%
due 7/15/2004.................... 4,208,480 4,159,680
Columbia/HCA Healthcare Corp.:
A- A2 5,000,000 6.41% due 6/15/2000.............. 4,997,000 4,987,400
A- A2 1,845,000 7.05% due 12/01/2027............. 1,729,946 1,756,643
A- A2 3,000,000 7.75% due 7/15/2036.............. 2,976,840 3,058,500
Dillard Department Stores, Inc.:
A+ A2 5,000,000 7.375% due 6/15/1999............. 5,305,840 5,089,200
A+ A2 3,000,000 9.125% due 8/01/2011............. 3,240,150 3,465,210
A A2 2,000,000 +Disney Enterprises Inc., 6.85% due
1/10/2007........................ 1,998,660 1,998,580
A+ A1 7,000,000 +Electronic Data Systems Corp.,
6.85% due 5/15/2000.............. 6,994,470 7,085,547
A A3 5,000,000 Hertz Corp., 6% due 1/15/2003...... 4,823,600 4,804,800
AAA Aaa 3,000,000 Johnson & Johnson Co., 8.72% due
11/01/2024....................... 3,000,000 3,338,040
A A2 2,000,000 May Department Stores Company,
10.625% due 11/01/2010........... 2,419,800 2,588,400
A- A2 7,000,000 Sears, Roebuck & Co., 6.82% due
10/17/2002....................... 7,014,280 7,009,520
AA A2 7,000,000 Wal-Mart Stores, Inc., 8.50% due
9/15/2024........................ 7,036,810 7,490,350
------------ ------------
58,414,806 59,488,695
- ---------------------------------------------------------------------------------------------------------------------
Industrial AA A1 9,500,000 Boeing Co., 6.35% due 6/15/2003.... 8,549,905 9,348,760
Transportation-- Southwest Airlines, Inc.:
3.4% A- A3 3,500,000 9.40% due 7/01/2001.............. 4,021,990 3,804,500
A- A3 4,000,000 8% due 3/01/2005................. 3,980,450 4,231,480
A- A3 1,000,000 7.875% due 9/01/2007............. 992,600 1,032,790
------------ ------------
17,544,945 18,417,530
- ---------------------------------------------------------------------------------------------------------------------
Supranational--
0.6% AAA Aaa 1,000,000 Asian Development Bank, 10.75%
due 6/01/1997...................... 1,084,890 1,019,170
AAA Aaa 2,000,000 Inter-American Development Bank
Co., 8.875% due 6/01/2009........ 2,481,700 2,330,520
------------ ------------
3,566,590 3,349,690
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-86-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Prime Bond Fund
Schedule of Investments as of December 31, 1996 (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P Moody's Face Value
Industry Ratings Ratings Amount Corporate Bonds & Notes Cost (Note 1a)
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Utilities-- GTE Corp.:
Communications-- BBB+ A3 1,000,000 8.85% due 3/01/1998.............. 1,143,360 1,031,020
2.5% BBB+ A3 1,500,000 9.375% due 12/01/2000............ 1,647,090 1,648,305
BBB+ A3 3,500,000 9.10% due 6/01/2003.............. 3,965,330 3,904,215
BBB+ A3 2,000,000 10.30% due 11/15/2017............ 2,187,020 2,164,900
AAA Aaa 2,500,000 Indiana Bell Telephone Co. Inc.,
7.30% due 8/15/2026.............. 2,495,725 2,537,100
Southwestern Bell Telcommunications
Corp.:
AA Aa3 1,000,000 6.125% due 3/01/2000............. 1,005,000 993,580
AA Aa3 1,000,000 6.625% due 4/01/2005............. 958,450 989,450
------------ ------------
13,401,975 13,268,570
- ---------------------------------------------------------------------------------------------------------------------
Utilities-- AA- Aa2 7,000,000 Duke Power Co., 8% due
Electric--3.8% 11/01/1999....................... 6,966,520 7,288,190
A+ A1 3,000,000 Georgia Power Co., 6.125% due
9/01/1999........................ 2,892,720 2,983,140
AA- A1 2,000,000 Northern States Power Company,
7.125% due 7/01/2025............. 2,122,360 1,960,120
A A2 7,500,000 Virginia Electric & Power Co.,
8.625% due 10/01/2024............ 7,416,540 8,114,235
------------ ------------
19,398,140 20,345,685
- ---------------------------------------------------------------------------------------------------------------------
Yankee ABN AMRO Bank (1):
Corporates*-- AA- Aa2 1,500,000 7.55% due 6/28/2006.............. 1,499,790 1,553,055
10.9% AA- Aa2 1,000,000 7.30% due 12/01/2026............. 977,900 950,800
A+ A1 6,000,000 Australia & New Zealand Banking
Group Ltd., 7.55% due 9/15/2006
(1).............................. 5,990,880 6,176,640
AA- Aa3 6,500,000 CRA Finance Ltd., 6.50% due
12/01/2003 (1)................... 6,509,920 6,333,535
A A3 2,000,000 China Light & Power Co., Ltd.,
7.50% due 4/15/2006 (5).......... 1,987,260 2,016,640
AA+ Aa1 1,000,000 Deutsche Bank Financial Inc., 6.70%
due 12/13/2006 (1)............... 996,910 981,360
Enersis S.A.(4):
A- Baa1 8,000,000 6.90% due 12/01/2006............. 7,979,360 7,807,920
A- Baa1 2,000,000 7.40% due 12/01/2016............. 1,989,440 1,940,480
A+ A1 2,000,000 Ford Capital, B.V., 9.50% due
6/01/2010 (1).................... 2,217,880 2,375,320
Grand Metropolitan Investment Corp.
(1):
A+ A2 5,500,000 6.50% due 9/15/1999.............. 5,615,810 5,503,190
A+ A2 1,000,000 8.625% due 8/15/2001............. 1,049,910 1,079,190
BBB+ A3 3,000,000 HSBC Americas Inc., 7% due
11/01/2006 (1)................... 2,974,800 2,961,600
AA- A1 6,000,000 Korea Electric Power Corporation,
8% due 7/01/2002 (5)............. 6,312,060 6,330,780
A+ A1 1,000,000 +Petronas Corp., 6.875% due
7/01/2003 (4).................... 986,480 1,001,430
BBB+ A3 3,000,000 Philips Electronics N.V., 7.20% due
6/01/2026 (4).................... 2,993,220 3,041,250
Pohang Iron & Steel Co., Ltd. (3):
A+ A2 4,500,000 7.375% due 5/15/2005............. 4,581,720 4,561,695
A+ A2 4,000,000 7.125% due 11/01/2006............ 3,995,480 3,989,080
------------ ------------
58,658,820 58,603,965
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-87-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Prime Bond Fund
Schedule of Investments as of December 31, 1996 (concluded)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P Moody's Face Value
Ratings Ratings Amount Corporate Bonds & Notes Cost (Note 1a)
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Yankee AAA Aaa 2,000,000 Export-Import Bank of Japan, 8.35%
Sovereign*--2.7% due 12/01/1999 (1)............... 2,113,320 2,107,060
AA- A1 3,000,000 Korea Development Bank, 6.625% due
11/21/2003 (2)................... 3,011,060 2,970,000
Metropolis of Tokyo (Japan) (2):
AAA Aaa 3,000,000 8.70% due 10/05/1999............. 3,469,410 3,184,290
AAA Aaa 250,000 9.25% due 11/08/2000............. 268,427 273,657
BBB A3 6,000,000 People's Republic of China, 6.625%
due 1/15/2003 (2)................ 5,970,960 5,839,254
------------ ------------
14,833,177 14,374,261
- ---------------------------------------------------------------------------------------------------------------------
Total Corporate Bonds &
Notes--88.1%....................... 470,607,274 474,166,523
- ---------------------------------------------------------------------------------------------------------------------
US Government Obligations
---------------------------------------------------------------------------------------------------------------------
US Treasury Notes
AAA Aaa 2,500,000 5.875% due 6/30/2000............. 2,502,025 2,481,250
AAA Aaa 2,500,000 8.75% due 8/15/2000.............. 2,976,172 2,709,375
AAA Aaa 1,000,000 6.25% due 2/15/2003.............. 982,500 998,750
AAA Aaa 5,500,000 5.75% due 8/15/2003.............. 5,371,953 5,335,000
AAA Aaa 11,000,000 6.50% due 5/15/2005.............. 10,668,276 11,073,920
AAA Aaa 3,000,000 6.50% due 10/15/2006............. 2,985,469 3,016,410
- ---------------------------------------------------------------------------------------------------------------------
Total US Government
Obligations--4.7% 25,486,395 25,614,705
- ---------------------------------------------------------------------------------------------------------------------
Short-Term Securities
---------------------------------------------------------------------------------------------------------------------
Commercial Paper**--0.9% 5,000,000 General Electric Capital Corp., 6%
due 1/03/1997.................... 4,997,500 4,997,500
- ---------------------------------------------------------------------------------------------------------------------
Repurchase 24,932,000 Lehman Brothers Inc., purchased on
Agreements***--4.7% 12/31/96 to yield 7.10% to
1/02/97.......................... 24,932,000 24,932,000
- ---------------------------------------------------------------------------------------------------------------------
Total Short-Term Securities--5.6% 29,929,500 29,929,500
- ---------------------------------------------------------------------------------------------------------------------
Total Investments--98.4%........... $526,023,169 529,710,728
============
Other Assets Less
Liabilities--1.6%.................. 8,683,000
------------
Net Assets--100.0%................. $538,393,728
============
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* Corresponding industry groups for foreign securities, which are
denominated in US dollars.
(1) Financial Institution (4) Industrial
(2) Government Entity (5) Utility
(3) Industrial Mining and Metals
** Commercial Paper is traded on a discount basis; the interest rate shown is
the discount rate paid at the time of purchase by the Fund.
*** Repurchase Agreements are fully collateralized by US Government and Agency
Obligations.
+ Restricted security as to resale. The value of the Fund's investment in
restricted securities was approximately $30,056,000, representing 5.6% of
net assets.
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Acquisition Value
Issue Date Cost (Note 1a)
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Disney Enterprises Inc., 6.85% due 1/10/2007.................................. 12/18/1996 $ 1,998,660 $ 1,998,580
Electronic Data Systems, Corp., 6.85% due 5/15/2000 .......................... 5/26/1995 6,994,470 7,085,547
Equitable Life Assurance Society, 6.95% due 12/01/2005........................ 6/11/1996 4,110,249 4,272,168
Equitable Life Assurance Society, 7.70% due 12/01/2015........................ 10/17/1996 3,476,060 3,498,530
First Union Capital Corp., 7.85% due 1/01/2027................................ 12/27/1996 4,991,300 4,991,300
HSBC Americas Inc., 7.808% due 12/15/2026..................................... 12/04/1996 988,460 966,100
Pacific Mutual Life Insurance Company, 7.90% due 12/30/2023................... 9/24/1996 5,999,655 6,242,496
Petronas Corp., 6.875% due 7/01/2003.......................................... 8/10/1995 986,480 1,001,430
- ---------------------------------------------------------------------------------------------------------------------
Total $29,545,334 $30,056,151
=========== ===========
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
++ Subject to principal paydowns.
Ratings of issues shown have not been audited by Deloitte & Touche LLP.
See Notes to Financial Statements.
-88-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Quality Equity Fund
Schedule of Investments as of December 31, 1996
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Value Percent of
Industry Held Stocks & Warrants Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Aerospace 176,000 Northrop Grumman Corp. ..... $ 11,530,816 $ 14,564,000 1.8%
190,000 United Technologies
Corp. .................... 7,831,355 12,540,000 1.6
------------ ------------ ------
19,362,171 27,104,000 3.4
- ---------------------------------------------------------------------------------------------------------------------
Automobile 205,000 General Motors Corp. ....... 10,846,146 11,428,750 1.4
- ---------------------------------------------------------------------------------------------------------------------
Automobile Parts 338,000 +Lear Corporation........... 11,323,000 11,534,250 1.5
- ---------------------------------------------------------------------------------------------------------------------
Banking 320,000 Bank of New York Co.,
Inc....................... 6,531,925 10,800,000 1.3
60,000 Bank of New York Co., Inc.
(Warrants) (c)............ 433,750 4,447,500 0.6
67,100 BankAmerica Corporation .... 6,865,310 6,693,225 0.8
121,000 Citicorp.................... 8,956,427 12,463,000 1.6
------------ ------------ ------
22,787,412 34,403,725 4.3
- ---------------------------------------------------------------------------------------------------------------------
Building & Construction 277,800 Oakwood Homes Corp.......... 6,329,367 6,354,675 0.8
- ---------------------------------------------------------------------------------------------------------------------
Chemicals 163,000 +FMC Corporation............ 11,552,704 11,430,375 1.4
240,000 PPG Industries Inc. ........ 11,911,956 13,470,000 1.7
------------ ------------ ------
23,464,660 24,900,375 3.1
- ---------------------------------------------------------------------------------------------------------------------
Communications 96,834 TCI Pacific Communications
(Convertible Preferred)... 9,353,653 8,787,686 1.1
- ---------------------------------------------------------------------------------------------------------------------
Computer Services 215,000 cisco Systems, Inc. ........ 10,373,567 13,679,375 1.7
255,000 Electronic Data Systems
Corp. .................... 11,193,379 11,028,750 1.4
86,000 International Business
Machines Corp. ........... 9,370,635 12,986,000 1.6
------------ ------------ ------
30,937,581 37,694,125 4.7
- ---------------------------------------------------------------------------------------------------------------------
Computer Technology 295,500 +Gulfstream Aerospace
Corp...................... 7,274,816 7,165,875 0.9
- ---------------------------------------------------------------------------------------------------------------------
Computers 203,000 +Compaq Computer Corp. ..... 15,028,761 15,072,750 1.9
- ---------------------------------------------------------------------------------------------------------------------
Congolomerates 100,200 AlliedSignal Inc. .......... 7,365,309 6,713,400 0.9
- ---------------------------------------------------------------------------------------------------------------------
Electrical Equipment 114,000 General Electric Co. ....... 8,855,064 11,271,750 1.4
80,300 Linear Technology
Corporation............... 3,295,002 3,513,125 0.5
------------ ------------ ------
12,150,066 14,784,875 1.9
- ---------------------------------------------------------------------------------------------------------------------
Electronics/Instruments 387,500 Corning Inc. ............... 11,485,244 17,921,875 2.3
- ---------------------------------------------------------------------------------------------------------------------
Energy & Related 690,300 Edison International........ 13,122,844 13,719,712 1.7
- ---------------------------------------------------------------------------------------------------------------------
Engineering & Construction 274,400 Foster Wheeler
Corporation............... 11,706,877 10,187,100 1.3
- ---------------------------------------------------------------------------------------------------------------------
Entertainment 245,351 Viacom, Inc. (Class B)...... 9,184,077 8,556,616 1.1
- ---------------------------------------------------------------------------------------------------------------------
Financial Services 307,000 American Express Company.... 14,499,680 17,345,500 2.2
302,800 First Data Corp............. 10,714,914.. 11,052,200 1.4
------------ ------------ ------
25,214,594 28,397,700 3.6
- ---------------------------------------------------------------------------------------------------------------------
Foods 362,000 Heinz (H.J.) Company........ 11,901,557 12,941,500 1.6
- ---------------------------------------------------------------------------------------------------------------------
Foreign--Argentina* 255,000 Yacimientos Petroliferos
Fiscales S.A. (ADR)
(a)(1).................... 5,330,905 6,438,750 0.8
- ---------------------------------------------------------------------------------------------------------------------
Foreign--Canada* 240,000 Canadian Pacific, Ltd.(2)... 4,915,307 6,360,000 0.8
118,400 Magna International, Inc.
(Class A)(3).............. 5,437,021 6,600,800 0.8
73,900 Potash Corp. of Saskatchewan
Inc.(4) .................. 5,014,349 6,281,500 0.8
------------ ------------ ------
15,366,677 19,242,300 2.4
- ---------------------------------------------------------------------------------------------------------------------
Foreign--France* 130,000 Scor SA (ADR) (a)(5)........ 4,959,500 4,468,750 0.5
111,100 +SGS-Thompson
Microelectronics N.V. (NY
Registered Shares)(6)..... 4,089,372 7,777,000 1.0
------------ ------------ ------
9,048,872 12,245,750 1.5
- ---------------------------------------------------------------------------------------------------------------------
Foreign--Mexico* 140,000 Panamerican Beverages, Inc.
(Class A) (7)............. 5,529,885 6,562,500 0.8
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-89-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Quality Equity Fund
Schedule of Investments as of December 31, 1996 (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Value Percent of
Industry Held Stocks & Warrants Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Foreign--South Korea* 175,700 Hyundai Engineering &
Construction Co., Ltd.
(GDR) (b)(8)++............ 2,289,371 1,098,125 0.1
- ---------------------------------------------------------------------------------------------------------------------
Foreign--Switzerland* 113,000 +Novartis AG (ADR) (a)(9)... 4,932,475 6,313,875 0.8
- ---------------------------------------------------------------------------------------------------------------------
Foreign--United Kingdom* 208,000 British Steel PLC (ADR)
(a)(10)................... 5,476,712 5,720,000 0.7
205,000 Glaxo Wellcome PLC (ADR)
(a)(9).................... 5,547,641 6,508,750 0.8
197,000 Grand Metropolitan PLC (ADR)
(a)(7).................... 5,337,393 6,230,125 0.8
47,000 Imperial Chemical Industries
PLC (ADR) (a)(11)......... 2,416,395 2,444,000 0.3
88,600 National Westminster Bank
PLC (ADR) (a)(12)......... 5,587,192 6,157,700 0.8
147,000 Vodafone Group PLC (ADR)
(a)(13)................... 5,117,125 6,082,125 0.8
------------ ------------ ------
29,482,458 33,142,700 4.2
- ---------------------------------------------------------------------------------------------------------------------
Hospital Management 417,000 +Health Management
Associates, Inc. (Class
A)........................ 9,396,499 9,382,500 1.2
- ---------------------------------------------------------------------------------------------------------------------
Hospital Supplies 305,000 Abbott Laboratories......... 12,470,021 15,478,750 2.0
- ---------------------------------------------------------------------------------------------------------------------
Insurance 103,000 Aetna Inc. ................. 6,648,424 8,240,000 1.0
285,000 Allstate Corp. ............. 9,378,920 16,494,375 2.1
196,000 UNUM Corporation............ 12,508,249 14,161,000 1.8
------------ ------------ ------
28,535,593 38,895,375 4.9
- ---------------------------------------------------------------------------------------------------------------------
Leisure 426,000 Brunswick Corporation....... 10,541,056 10,224,000 1.3
- ---------------------------------------------------------------------------------------------------------------------
Machinery 206,000 +American Standard
Companies, Inc. .......... 6,825,765 7,879,500 1.0
300,000 Deere & Co. ................ 12,310,813 12,187,500 1.5
------------ ------------ ------
19,136,578 20,067,000 2.5
- ---------------------------------------------------------------------------------------------------------------------
Manufacturing 200,000 Fisher Scientific
International, Inc. ...... 6,606,669 9,425,000 1.2
- ---------------------------------------------------------------------------------------------------------------------
Natural Gas 330,000 Enron Corp. ................ 12,657,402 14,231,250 1.8
- ---------------------------------------------------------------------------------------------------------------------
Natural Gas Pipelines 170,000 IMC Global, Inc. ........... 6,589,268 6,651,250 0.8
- ---------------------------------------------------------------------------------------------------------------------
Oil Service 350,000 Dresser Industries, Inc. ... 8,202,968 10,850,000 1.4
78,000 Schlumberger Ltd. .......... 6,580,141 7,790,250 1.0
------------ ------------ ------
14,783,109 18,640,250 2.4
- ---------------------------------------------------------------------------------------------------------------------
Paper 146,000 Kimberly-Clark
Corporation .............. 11,227,298 13,906,500 1.8
- ---------------------------------------------------------------------------------------------------------------------
Petroleum 261,600 Pennzoil Co. ............... 10,752,129 14,780,400 1.9
357,000 Unocal Corp. ............... 12,002,947 14,503,125 1.8
------------ ------------ ------
22,755,076 29,283,525 3.7
- ---------------------------------------------------------------------------------------------------------------------
Pharmaceuticals 195,000 Merck & Co., Inc. .......... 11,792,491 15,453,750 1.9
- ---------------------------------------------------------------------------------------------------------------------
Railroads 154,000 Burlington Northern Santa Fe
Inc. ..................... 12,636,886 13,301,750 1.7
- ---------------------------------------------------------------------------------------------------------------------
Real Estate 279,000 Prentiss Properties Trust... 5,708,700 6,975,000 0.8
Investment Trusts 137,700 Starwood Lodging Trust...... 5,396,590 7,590,712 1.0
------------ ------------ ------
11,105,290 14,565,712 1.8
- ---------------------------------------------------------------------------------------------------------------------
Retail 591,400 Limited, Inc. (The)......... 12,739,046 10,866,975 1.4
260,000 Sears, Roebuck & Co. ....... 10,339,207 11,992,500 1.5
------------ ------------ ------
23,078,253 22,859,475 2.9
- ---------------------------------------------------------------------------------------------------------------------
Retail Specialty 347,100 Rite Aid Corporation........ 11,147,442 13,797,225 1.7
426,000 +Toys 'R' Us, Inc. ......... 13,238,973 12,780,000 1.6
------------ ------------ ------
24,386,415 26,577,225 3.3
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-90-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Quality Equity Fund
Schedule of Investments as of December 31, 1996 (concluded)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Value Percent of
Industry Held Stocks & Warrants Cost (Note 1a) Net Assets
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Software--Computer 311,600 BMC Software, Inc. ......... $ 11,552,980 $ 12,892,450 1.6%
302,750 Oracle Corp. ............... 10,052,946 12,601,969 1.6
------------ ------------ ------
21,605,926 25,494,419 3.2
- ---------------------------------------------------------------------------------------------------------------------
Steel 267,000 AK Steel Holding Corp. ..... 11,024,039 10,579,875 1.3
- ---------------------------------------------------------------------------------------------------------------------
Telecommunications 478,000 +Airtouch Communications,
Inc. ..................... 13,584,871 12,069,500 1.5
220,000 Bell Atlantic Corp.......... 13,554,148 14,245,000 1.8
------------ ------------ ------
27,139,019 26,314,500 3.3
- ---------------------------------------------------------------------------------------------------------------------
Tobacco 71,000 Philip Morris Companies,
Inc. ..................... 6,752,180 7,996,375 1.0
- ---------------------------------------------------------------------------------------------------------------------
Travel & Lodging 453,300 Carnival Corp. (Class A).... 13,364,651 14,958,900 1.9
- ---------------------------------------------------------------------------------------------------------------------
Utilities--Gas 140,000 El Paso Natural Gas
Company .................. 6,860,804 7,070,000 0.9
- ---------------------------------------------------------------------------------------------------------------------
Total Stocks & Warrants 655,263,301 754,070,370 94.9
- ---------------------------------------------------------------------------------------------------------------------
Face
Amount Short-Term Securities
---------------------------------------------------------------------------------------------------------------------
Commercial Paper** $ 5,000,000 Clipper Receivables Corp.,
5.42% due 1/09/1997....... 4,993,225 4,993,225 0.6
8,511,000 General Motors Acceptance
Corp., 7.50% due
1/02/1997................. 8,507,454 8,507,454 1.1
10,000,000 Goldman Sachs Group, L.P.,
5.42% due 1/06/1997....... 9,990,966 9,990,966 1.2
7,000,000 International Securitization
Corp., 5.75% due
1/21/1997................. 6,976,521 6,976,521 0.9
------------ ------------ ------
30,468,166 30,468,166 3.8
- ---------------------------------------------------------------------------------------------------------------------
US Government Agency 10,000,000 Federal Home Loan Mortgage
Obligations** Corp., 5.40% due
1/03/1997................. 9,995,500 9,995,500 1.3
- ---------------------------------------------------------------------------------------------------------------------
Total Short-Term Securities 40,463,666 40,463,666 5.1
- ---------------------------------------------------------------------------------------------------------------------
Total Investments........... $695,726,967 794,534,036 100.0
============
Liabilities In Excess of
Other Assets.............. (258,808) 0.0
------------ ------
Net Assets.................. $794,275,228 100.0%
============ ======
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) American Depositary Receipts (ADR).
(b) Global Depositary Receipts (GDR).
(c) Warrants entitle the Fund to purchase a predetermined number of shares of
common stock. The purchase price and number of shares are subject to
adjustment under certain conditions until the expiration date.
* Corresponding industry groups for foreign securities:
<TABLE>
<S> <C> <C>
(1) Petroleum (6) Semiconductors (11) Chemicals
(2) Natural Resources (7) Beverages (12) Banking
(3) Automobile Parts (8) Engineering & Construction (13) Communications
(4) Natural Gas Pipelines (9) Pharmaceuticals
(5) Insurance (10) Steel
</TABLE>
** Commercial Paper and certain US Government Agency Obligations are traded
on a discount basis; the interest rates shown are the discount rates paid
at the time of purchase by the Fund.
+ Non-income producing security.
++ Restricted security as to resale, the value of the Fund's investment in
restricted securities was approximately $1,098,000, representing 0.1% of
net assets.
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------
Acquisition Value
Issue Date Cost (Note 1a)
-----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Hyundai Engineering & Construction Co., Ltd. (GDR).................. 3/19/1996 $2,289,371 $1,098,125
-----------------------------------------------------------------------------------------------------------------
Total $2,289,371 $1,098,125
========== ===========
-----------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
-91-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Reserve Assets Fund
Schedule of Investments as of December 31, 1996
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Face Interest Maturity Value
Amount Issue Rate* Date (Note 1a)
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Bank Notes--1.3% $ 300,000 Bank of America, Illinois...................... 5.63% 12/30/97 $ 299,850
- ---------------------------------------------------------------------------------------------------------------------
Total Bank Notes (Cost--$299,971) 299,850
- ---------------------------------------------------------------------------------------------------------------------
Certificates of 500,000 Chase Manhattan Bank USA, Delaware............. 5.60 4/01/97 500,100
Deposit--2.2%
- ---------------------------------------------------------------------------------------------------------------------
Total Certificates of Deposit (Cost--$500,000) 500,100
- ---------------------------------------------------------------------------------------------------------------------
Commercial 282,000 Allomon Funding Corp........................... 5.35 1/17/97 281,377
Paper--43.5% 587,000 Allomon Funding Corp........................... 5.33 1/21/97 585,358
364,000 Bear Stearns Companies, Inc. (The)............. 5.35 1/31/97 362,424
800,000 Beta Finance Inc............................... 5.35 4/07/97 788,558
750,000 Caisse des Depots et Consignations............. 5.30 2/03/97 746,417
500,000 Finova Capital Corp............................ 5.48 3/20/97 494,204
500,000 General Electric Capital Corp.................. 5.50 3/03/97 495,483
333,000 General Electric Capital Corp.................. 5.64 3/05/97 329,892
300,000 General Electric Capital Corp.................. 5.45 3/25/97 296,296
720,000 General Motors Acceptance Corp................. 5.34 1/23/97 717,774
400,000 General Motors Acceptance Corp................. 5.33 6/02/97 390,940
502,000 Greenwich Funding Corporation.................. 5.33 1/28/97 500,078
526,000 Korea Development Bank......................... 5.32 1/23/97 524,374
87,000 Korea Development Bank......................... 5.35 1/23/97 86,731
1,000,000 National Fleet Funding Corp.................... 5.34 1/15/97 998,072
500,000 New Center Asset Trust......................... 5.43 1/29/97 497,984
600,000 New Center Asset Trust......................... 5.50 2/25/97 595,131
500,000 Toshiba International Finance (UK) PLC......... 5.35 1/17/97 498,896
58,000 Toshiba International Finance (UK) PLC......... 5.37 1/27/97 57,787
712,000 Windmill Funding Corp.......................... 5.35 1/24/97 709,694
- ---------------------------------------------------------------------------------------------------------------------
Total Commercial Paper (Cost--$9,957,326) 9,957,470
- ---------------------------------------------------------------------------------------------------------------------
Corporate Notes--8.7% 1,000,000 LABS Trust Series 1996-C Senior Notes+......... 5.625 12/29/97 1,000,000
1,000,000 Short-Term Card Account Trust (1995-1)+........ 5.615 1/15/97 1,000,000
- ---------------------------------------------------------------------------------------------------------------------
Total Corporate Notes (Cost--$1,999,996) 2,000,000
- ---------------------------------------------------------------------------------------------------------------------
Funding 1,000,000 Jackson National Life Insurance Co.+........... 5.41 4/08/97 1,000,000
Agreements--4.4%
- ---------------------------------------------------------------------------------------------------------------------
Total Funding Agreements (Cost--$1,000,000) 1,000,000
- ---------------------------------------------------------------------------------------------------------------------
Master Notes--4.4% 1,000,000 Goldman Sachs Group, L.P.+..................... 5.88 8/01/97 1,000,000
- ---------------------------------------------------------------------------------------------------------------------
Total Master Notes (Cost--$1,000,000) 1,000,000
- ---------------------------------------------------------------------------------------------------------------------
US Government, Agency 70,000 Federal Farm Credit Bank....................... 5.52 1/21/97 69,796
& Instrumentality 90,000 Federal Farm Credit Bank....................... 5.50 2/13/97 89,451
Obligations-- 120,000 Federal Home Loan Bank......................... 5.62 5/05/97 117,823
Discount--5.6% 40,000 Federal National Mortgage Association.......... 5.35 3/13/97 39,582
110,000 Federal National Mortgage Association.......... 5.41 3/13/97 108,851
165,000 Federal National Mortgage Association.......... 5.38 3/14/97 163,253
300,000 Federal National Mortgage Association.......... 5.30 3/17/97 296,689
110,000 Federal National Mortgage Association.......... 5.34 3/18/97 108,769
50,000 Federal National Mortgage Association.......... 5.40 3/24/97 49,396
20,000 Federal National Mortgage Association.......... 5.28 4/03/97 19,731
15,000 Federal National Mortgage Association.......... 5.26 4/10/97 14,782
210,000 International Bank for Reconstruction and
Development.................................... 5.54 2/20/97 208,482
- ---------------------------------------------------------------------------------------------------------------------
Total US Government, Agency & Instrumentality
Obligations--Discount (Cost--$1,286,426) 1,286,605
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
-92-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.--Reserve Assets Fund
Schedule of Investments as of December 31, 1996 (concluded)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Face Interest Maturity Value
Amount Issue Rate* Date (Note 1a)
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
US Government, Agency 105,000 Federal Home Loan Bank......................... 6.12% 4/15/98 104,967
& Instrumentality 1,000,000 Federal National Mortgage Association+......... 5.85 2/14/97 1,000,494
Obligations-- 1,000,000 Federal National Mortgage Association+......... 5.70 5/19/97 1,000,000
Non-Discount--30.7% 500,000 Federal National Mortgage Association+......... 5.521 5/22/97 499,870
300,000 Federal National Mortgage Association.......... 5.47 12/30/97 299,541
500,000 Federal National Mortgage Association+......... 5.46 4/24/98 499,750
1,000,000 Federal National Mortgage Association+......... 5.75 5/14/98 1,000,000
365,000 Student Loan Marketing Association+............ 5.62 1/23/97 365,018
200,000 US Treasury Notes.............................. 6.125 5/31/97 200,500
400,000 US Treasury Notes.............................. 8.50 7/15/97 406,437
200,000 US Treasury Notes.............................. 6.00 8/31/97 200,562
250,000 US Treasury Notes.............................. 5.75 9/30/97 250,449
650,000 US Treasury Notes.............................. 5.625 10/31/97 650,406
200,000 US Treasury Notes.............................. 5.375 11/30/97 199,594
150,000 US Treasury Notes.............................. 5.25 12/31/97 149,519
200,000 US Treasury Notes.............................. 5.625 11/30/98 199,156
- ---------------------------------------------------------------------------------------------------------------------
Total US Government, Agency &
Instrumentality Obligations--
Non-Discount (Cost--$7,026,821) 7,026,263
- ---------------------------------------------------------------------------------------------------------------------
Total Investments
(Cost--$23,070,540)--100.8%.................... 23,070,288
Liabilities in Excess of Other
Assets--(0.8%)................................. (184,917)
-----------
Net Assets--100.0%............................. $22,885,371
===========
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* Commercial Paper and certain US Government, Agency & Instrumentality
Obligations are traded on a discount basis; the interest rates shown are the
discount rates paid at the time of purchase by the Fund. Other securities
bear interest rates at the rates shown, payable at fixed dates or upon
maturity. The interest rates on variable rate securities are adjusted
periodically based upon appropriate indexes; the interest rates shown are
the rates in effect at December 31, 1996.
+ Variable Rate Notes.
See Notes to Financial Statements.
-93-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Statements of Assets and Liabilities as of December 31, 1996
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Basic Developing Domestic
American Value Capital Money
Balanced Focus Markets Market
Fund Fund Focus Fund Fund
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Assets:
Investments, at value* (Note 1a)........................... $210,545,210 $522,663,382 $ 96,192,191 $ 278,860,287
Cash....................................................... 993 -- 71 10,370
Foreign cash (Note 1c)..................................... -- -- 724,487 --
Receivable for securities sold............................. -- 3,242,613 435,288 --
Interest receivable........................................ 1,786,475 -- 40,392 1,069,959
Receivable for capital shares sold......................... -- 936,960 971,206 --
Dividends receivable....................................... 151,604 519,497 68,281 --
Deferred organization expenses (Note 1f)................... -- 1,440 -- --
Prepaid registration fees and other assets (Note 1f)....... 3,441 1,794 27,135 2,392
------------ ------------ ----------- ------------
Total assets............................................. 212,487,723 527,365,686 98,459,051 279,943,008
------------ ------------ ----------- ------------
- ---------------------------------------------------------------------------------------------------------------------
Liabilities:
Payable for securities purchased........................... 166,848 1,672,743 2,753,565 3,197,475
Payable for capital shares redeemed........................ 135,085 322,896 26 1,832,621
Payable to investment adviser (Note 2)..................... 103,518 273,971 27,327 114,211
Accrued expenses and other liabilities..................... 35,258 165,912 79,231 42,687
------------ ------------ ----------- ------------
Total liabilities........................................ 440,709 2,435,522 2,860,149 5,186,994
------------ ------------ ----------- ------------
- ---------------------------------------------------------------------------------------------------------------------
Net Assets................................................. $212,047,014 $524,930,164 $ 95,598,902 $ 274,756,014
============ ============ =========== ============
- ---------------------------------------------------------------------------------------------------------------------
Net Assets Consist of:
Common Stock, $0.10 par value+............................. $ 1,324,286 $ 3,562,243 $ 950,806 $ 27,477,548
Paid-in capital in excess of par........................... 174,548,138 422,337,791 92,662,419 247,297,930
Undistributed investment income--net....................... 3,604,288 3,224,622 1,752,408 --
Undistributed (accumulated) realized capital gains (losses)
on investments and foreign currency transactions--net
(Note 5)................................................. 20,595,249 52,901,365 (4,054,029) --
Unrealized appreciation (depreciation) on investments and
foreign currency transactions--net....................... 11,975,053 42,904,143 4,287,298 (19,464)
------------ ------------ ----------- ------------
Net Assets................................................. $212,047,014 $524,930,164 $ 95,598,902 $ 274,756,014
============ ============ =========== ============
- ---------------------------------------------------------------------------------------------------------------------
Capital Shares Outstanding................................. 13,242,862 35,622,430 9,508,063 274,775,478
============ ============ =========== ============
Net Asset Value, Offering and Redemption Price Per Share... $ 16.01 $ 14.74 $ 10.05 $ 1.00
============ ============ =========== ============
- ---------------------------------------------------------------------------------------------------------------------
* Identified cost.......................................... $198,570,157 $479,759,239 $ 91,897,323 $ 278,879,751
============ ============ =========== ============
+ Authorized shares........................................ 100,000,000 100,000,000 100,000,000 1,300,000,000
============ ============ =========== ============
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
-94-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Statements of Assets and Liabilities as of December 31, 1996 (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Global Global Global
Equity Bond Strategy Utility
Growth Focus Focus Focus
Fund Fund++ Fund Fund
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Assets:
Investments, at value* (Note 1a)............................ $451,805,311 $100,348,183 $867,228,567 $142,177,130
Cash........................................................ 608 10,072 194,752 25,262
Foreign cash (Note 1c)...................................... -- 60,267 15,583,973 340
Interest receivable......................................... 58,494 2,094,950 3,816,480 33,360
Receivable for forward foreign exchange contracts (Note
1b)....................................................... -- 141,607 3,709,150 --
Receivable for securities sold.............................. 1,151,250 2,666,378 -- --
Dividends receivable........................................ 312,385 -- 1,082,249 430,750
Receivable for capital shares sold.......................... 703,607 779 414 78,173
Deferred organization expenses (Note 1f).................... -- 2,367 -- 2,414
Prepaid registration fees and other assets (Note 1f)........ 2,555 642 3,600 918
------------ ------------ ------------ ------------
Total assets.............................................. 454,034,210 105,325,245 891,619,185 142,748,347
------------ ------------ ------------ ------------
- ---------------------------------------------------------------------------------------------------------------------
Liabilities:
Unrealized depreciation on forward foreign exchange
contracts (Note 1b)....................................... -- 78,492 2,598,413 --
Payable for securities purchased............................ 561,675 11,126,689 16,114,249 --
Payable for capital shares redeemed......................... 48,793 104,824 691,642 177,446
Payable to investment adviser (Note 2)...................... 293,221 43,076 496,049 74,269
Accrued expenses and other liabilities...................... 101,256 164,790 1,434,257 58,831
Payable for forward foreign exchange contracts (Note 1b).... -- -- 81,757 --
Variation margin on stock index futures contracts (Note
1b)....................................................... -- 17,464 -- --
------------ ------------ ------------ ------------
Total liabilities......................................... 1,004,945 11,535,335 21,416,367 310,546
------------ ------------ ------------ ------------
- ---------------------------------------------------------------------------------------------------------------------
Net Assets.................................................. $453,029,265 $ 93,789,910 $870,202,818 $142,437,801
============ ============ ============ ============
- ---------------------------------------------------------------------------------------------------------------------
Net Assets Consist of:
Common Stock, $0.10 par value+.............................. $ 1,727,480 $ 960,915 $ 6,272,330 $ 1,168,693
Paid-in capital in excess of par............................ 374,280,783 94,976,976 746,052,734 117,927,335
Undistributed investment income--net........................ 1,422,632 118,851 20,579,673 1,132,021
Undistributed (accumulated) realized capital gains (losses) on
investments and foreign currency transactions--net (Note
5)........................................................ 22,041,727 (1,230,690) 26,215,075 (2,628,376)
Unrealized appreciation (depreciation) on investments and
foreign currency transactions--net........................ 53,556,643 (1,036,142) 71,083,006 24,838,128
------------ ------------ ------------ ------------
Net Assets.................................................. $453,029,265 $ 93,789,910 $870,202,818 $142,437,801
============ ============ ============ ============
- ---------------------------------------------------------------------------------------------------------------------
Capital Shares Outstanding.................................. 17,274,795 9,609,151 62,723,303 11,686,930
============ ============ ============ ============
Net Asset Value, Offering and Redemption Price Per Share.... $ 26.22 $ 9.76 $ 13.87 $ 12.19
============ ============ ============ ============
- ---------------------------------------------------------------------------------------------------------------------
* Identified cost........................................... $398,248,668 $101,153,795 $793,370,058 $117,339,737
============ ============ ============ ============
+ Authorized shares......................................... 100,000,000 100,000,000 200,000,000 100,000,000
============ ============ ============ ============
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
++ International Bond Fund was acquired by World Income Focus Fund. Subsequent
to the acquisition, World Income Focus Fund changed its name to Global Bond
Focus Fund.
See Notes to Financial Statements.
-95-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Statements of Assets and Liabilities as of December 31, 1996 (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
High
Government Current International
Bond Income Index 500 Equity Focus
Fund++ Fund Fund++++ Fund
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Assets:
Investments, at value* (Note 1a)............................ $ 87,831,280 $410,867,543 $ 10,844,116 $ 347,717,218
Options purchased, at value (premiums paid-$597,405) (Notes
1a & 1b).................................................. -- -- -- 705,275
Variation margin on stock index futures contracts (Note
1b)....................................................... -- -- -- 51,556
Cash........................................................ 776 -- -- 11,007
Foreign cash (Note 1c)...................................... -- -- -- 814,905
Receivable for options written.............................. -- -- -- 26,960
Interest receivable......................................... 1,419,180 6,689,392 -- 210
Receivable for capital shares sold.......................... 365,988 2,353 -- 287,014
Dividends receivable........................................ -- -- 7,216 306,875
Receivable for securities sold.............................. -- -- 1,881 294,641
Receivable for forward foreign exchange contracts (Note
1b)....................................................... -- -- -- 217,542
Receivable from investment adviser (Note 2)................. -- -- 1,651 --
Receivable for loaned securities (Note 6)................... 83 -- -- --
Deferred organization expenses (Note 1f).................... -- -- 14,852 --
Prepaid registration fees and other assets (Note 1f)........ 717 5,893 -- 3,416
------------ ------------ ------------ ------------
Total assets.............................................. 89,618,024 417,565,181 10,869,716 350,436,619
------------ ------------ ------------ ------------
- ---------------------------------------------------------------------------------------------------------------------
Liabilities:
Options written, at value (premiums received-$117,250)
(Notes 1a & 1b)........................................... -- -- -- 154,869
Unrealized depreciation on forward foreign exchange
contracts (Note 1b)....................................... -- -- -- 305
Payable for custodian bank (Note 1h)........................ -- 2,604,491 -- --
Payable for securities purchased............................ -- -- 63,798 604,180
Payable to investment adviser (Note 2)...................... 12,244 172,193 -- 225,798
Payable for capital shares redeemed......................... -- 83,294 22 8,823
Variation margin on stock index futures contracts (Note
1b)....................................................... -- -- 29,200 --
Accrued expenses and other liabilities...................... 24,988 90,285 24,856 362,815
------------ ------------ ------------ ------------
Total liabilities......................................... 37,232 2,950,263 117,876 1,356,790
------------ ------------ ------------ ------------
- ---------------------------------------------------------------------------------------------------------------------
Net Assets.................................................. $ 89,580,792 $414,614,918 $ 10,751,840 $ 349,079,829
============ ============ ============ ============
- ---------------------------------------------------------------------------------------------------------------------
Net Assets Consist of:
Common Stock, $0.10 par value+.............................. $ 861,700 $ 3,638,978 $ 105,735 $ 3,002,760
Paid-in capital in excess of par............................ 87,437,337 412,111,475 10,476,301 329,573,888
Undistributed investment income--net........................ 484,603 3,786,391 16,863 4,510,300
Undistributed (accumulated) realized capital gains (losses)
on investments and foreign currency
transactions--net (Note 5)................................ (154,414) (5,478,242) (193) 192,008
Unrealized appreciation on investments and foreign currency
transactions--net......................................... 951,566 556,316 153,134 11,800,873
------------ ------------ ------------ ------------
Net Assets.................................................. $ 89,580,792 $414,614,918 $ 10,751,840 $ 349,079,829
============ ============ ============ ============
- ---------------------------------------------------------------------------------------------------------------------
Capital Shares Outstanding.................................. 8,617,002 36,389,781 1,057,347 30,027,594
============ ============ ============ ============
Net Asset Value, Offering and Redemption Price Per Share.... $ 10.40 $ 11.39 $ 10.17 $ 11.63
============ ============ ============ ============
- ---------------------------------------------------------------------------------------------------------------------
* Identified cost........................................... $ 86,879,714 $410,311,227 $ 10,696,027 $ 335,887,786
============ ============ ============ ============
+ Authorized shares......................................... 100,000,000 100,000,000 100,000,000 100,000,000
============ ============ ============ ============
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
++ Formerly known as Intermediate Government Bond Fund.
++++ The Fund commenced operations on December 13, 1996.
See Notes to Financial Statements.
-96-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Statements of Assets and Liabilities as of December 31, 1996 (concluded)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Natural
Resources Prime Quality Reserve
Focus Bond Equity Assets
Fund Fund Fund Fund
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Assets:
Investments, at value* (Note 1a)............................ $ 45,411,176 $529,710,728 $794,534,036 $ 23,070,288
Cash........................................................ 507 654 85 6,098
Interest receivable......................................... -- 8,433,549 -- 88,796
Receivable for securities sold.............................. 39,532 5,093,200 -- --
Dividends receivable........................................ 59,829 -- 1,227,381 --
Receivable for capital shares sold.......................... -- 498,018 365,270 39,787
Receivable for loaned securities (Note 6)................... -- 610 -- --
Prepaid registration fees and other assets (Note 1f)........ 403 7,494 5,695 2,561
------------ ------------ ------------ ------------
Total assets.............................................. 45,511,447 543,744,253 796,132,467 23,207,530
------------ ------------ ------------ ------------
- ---------------------------------------------------------------------------------------------------------------------
Liabilities:
Payable for securities purchased............................ 220,652 4,996,751 1,289,280 299,763
Payable to investment adviser (Note 2)...................... 25,855 201,657 304,791 9,534
Payable for capital shares redeemed......................... 50,989 54,060 110,758 820
Accrued expenses and other liabilities...................... 16,956 98,057 152,410 12,042
------------ ------------ ------------ ------------
Total liabilities......................................... 314,452 5,350,525 1,857,239 322,159
------------ ------------ ------------ ------------
- ---------------------------------------------------------------------------------------------------------------------
Net Assets.................................................. $ 45,196,995 $538,393,728 $794,275,228 $ 22,885,371
============ ============ ============ ============
- ---------------------------------------------------------------------------------------------------------------------
Net Assets Consist of:
Common Stock, $0.10 par value+.............................. $ 344,378 $ 4,521,158 $ 2,419,424 $ 2,288,562
Paid-in capital in excess of par............................ 36,969,567 542,786,415 651,091,058 20,597,061
Undistributed investment income--net........................ 221,415 3,129,844 5,217,038 --
Undistributed (accumulated) realized capital gains (losses) on
investments and foreign currency transactions--net (Note
5)........................................................ 2,970,842 (15,731,248) 36,740,639 --
Unrealized appreciation (depreciation) on investments and
foreign currency transactions--net........................ 4,690,793 3,687,559 98,807,069 (252)
------------ ------------ ------------ ------------
Net Assets.................................................. $ 45,196,995 $538,393,728 $794,275,228 $ 22,885,371
============ ============ ============ ============
- ---------------------------------------------------------------------------------------------------------------------
Capital Shares Outstanding.................................. 3,443,783 45,211,583 24,194,244 22,885,622
============ ============ ============ ============
Net Asset Value, Offering and Redemption Price Per Share.... $ 13.12 $ 11.91 $ 32.83 $ 1.00
============ ============ ============ ============
- ---------------------------------------------------------------------------------------------------------------------
* Identified cost........................................... $ 40,722,448 $526,023,169 $695,726,967 $ 23,070,540
============ ============ ============ ============
+ Authorized shares......................................... 100,000,000 100,000,000 100,000,000 500,000,000
============ ============ ============ ============
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
-97-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Statements of Operations for the Year Ended December 31, 1996
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Basic Developing Domestic
American Value Capital Money
Balanced Focus Markets Market
Fund Fund Focus Fund Fund
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Investment Income (Notes 1d & 1e):
Interest and discount earned...................................... $ 6,807,063 $ 2,321,975 $ 557,486 $15,317,537
Dividends*........................................................ 1,833,183 5,869,178 2,257,621 --
----------- ----------- ---------- -----------
Total income...................................................... 8,640,246 8,191,153 2,815,107 15,317,537
----------- ----------- ---------- -----------
- ---------------------------------------------------------------------------------------------------------------------
Expenses:
Investment advisory fees (Note 2)................................. 1,186,936 2,414,605 765,718 1,386,726
Custodian fees.................................................... 27,739 39,578 192,342 17,641
Accounting services (Note 2)...................................... 47,193 94,151 17,633 49,358
Professional fees................................................. 20,794 27,988 8,370 29,810
Registration fees (Note 1f)....................................... 2,869 62,939 10,191 24
Directors' fees and expenses...................................... 5,004 7,451 1,383 6,723
Transfer agent fees (Note 2)...................................... 5,006 4,958 5,007 5,020
Pricing services.................................................. 685 232 6,224 --
Amortization of organization expenses (Note 1f)................... -- 720 2,667 1,340
Other............................................................. 4,250 5,250 -- 10,742
----------- ----------- ---------- -----------
Total expenses before reimbursement............................... 1,300,476 2,657,872 1,009,535 1,507,384
Reimbursement of expenses (Note 2)................................ -- -- (52,388) --
----------- ----------- ---------- -----------
Total expenses after reimbursement................................ 1,300,476 2,657,872 957,147 1,507,384
----------- ----------- ---------- -----------
Investment income--net............................................ 7,339,770 5,533,281 1,857,960 13,810,153
----------- ----------- ---------- -----------
- ---------------------------------------------------------------------------------------------------------------------
Realized & Unrealized Gain (Loss) on Investments & Foreign
Currency Transactions--Net (Notes 1b, 1c, 1e & 3):
Realized gain (loss) on investments--net.......................... 21,869,723 56,406,548 (51,709) 12,359
Realized loss on foreign currency transactions--net............... -- -- (105,274) --
Change in unrealized appreciation/depreciation on
investments--net................................................ (9,430,963) 13,550,612 4,837,024 (157,747)
Change in unrealized appreciation/depreciation on foreign currency
transactions.................................................... -- -- (7,883) --
----------- ----------- ---------- -----------
Total realized and unrealized gain (loss) on investments and
foreign currency transactions--net.............................. 12,438,760 69,957,160 4,672,158 (145,388)
----------- ----------- ---------- -----------
Net Increase in Net Assets Resulting from Operations.............. $19,778,530 $75,490,441 $6,530,118 $13,664,765
=========== =========== ========== ===========
- ---------------------------------------------------------------------------------------------------------------------
* Net of withholding tax on dividends............................. $ 873 $ 159,174 $ 103,221 --
=========== =========== ========== ===========
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
-98-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Statements of Operations for the Year Ended December 31, 1996 (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Global Global Global
Equity Bond Strategy Utility
Growth Focus Focus Focus
Fund Fund Fund Fund
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Investment Income (Notes 1d & 1e):
Interest and discount earned*.................................. $ 2,906,699 $7,362,977 $ 11,236,222 $ 659,024
Dividends**.................................................... 2,359,527 68,036 8,177,095 6,059,957
Other income................................................... -- 42,863 4,675 --
----------- ---------- ------------ -----------
Total income................................................... 5,266,226 7,473,876 19,417,992 6,718,981
----------- ---------- ------------ -----------
- ---------------------------------------------------------------------------------------------------------------------
Expenses:
Investment advisory fees (Note 2).............................. 3,010,613 518,022 3,715,122 880,959
Custodian fees................................................. 42,130 30,154 165,186 29,004
Accounting services (Note 2)................................... 90,851 18,069 107,351 31,814
Professional fees.............................................. 29,504 11,372 50,835 15,356
Registration fees (Note 1f).................................... 49,227 562 -- 19
Directors' fees and expenses................................... 8,142 1,898 12,226 3,283
Transfer agent fees (Note 2)................................... 5,002 5,002 5,006 5,007
Pricing services............................................... -- 5,093 3,930 --
Amortization of organization expenses (Note 1f)................ -- 1,578 -- 863
Other.......................................................... 5,389 2,016 17,599 4,391
----------- ---------- ------------ -----------
Total expenses................................................. 3,240,858 593,766 4,077,255 970,696
----------- ---------- ------------ -----------
Investment income--net......................................... 2,025,368 6,880,110 15,340,737 5,748,285
----------- ---------- ------------ -----------
- ---------------------------------------------------------------------------------------------------------------------
Realized & Unrealized Gain (Loss) on Investments & Foreign
Currency Transactions--Net (Notes 1b, 1c, 1e & 3):
Realized gain on investments--net.............................. 22,199,518 905,735 45,320,331 1,243,231
Realized gain (loss) on foreign currency transactions--net..... -- (75,020 ) 15,637,082 (46,439)
Change in unrealized appreciation/depreciation on
investments--net............................................. 5,970,999 (531,602 ) 37,056,845 10,440,233
Change in unrealized appreciation/depreciation on foreign
currency transactions........................................ -- (174,496 ) (12,458,193) (9,723)
----------- ---------- ------------ -----------
Total realized and unrealized gain on investments and foreign
currency transactions--net................................... 28,170,517 124,617 85,556,065 11,627,302
----------- ---------- ------------ -----------
Net Increase in Net Assets Resulting from Operations........... $30,195,885 $7,004,727 $100,896,802 $17,375,587
=========== ========== ============ ===========
- ---------------------------------------------------------------------------------------------------------------------
* Net of withholding tax on interest.......................... $ -- $ 32,711 $ 80,349 $ --
=========== ========== ============ ===========
** Net of withholding tax on dividends......................... $ 3,500 $ -- $ 462,853 $ 350,006
=========== ========== ============ ===========
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
-99-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Statements of Operations for the Year Ended December 31, 1996 (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
High International
Government Current Equity
Bond Income Index 500 Focus
Fund Fund Fund+ Fund
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Investment Income (Notes 1d & 1e):
Interest and discount earned*..................................... $3,898,013 $37,867,841 $ 9,587 $ 3,616,175
Dividends**....................................................... -- 883,127 7,276 5,353,531
Other income...................................................... 7,464 254,493 -- --
----------- ----------- -------- -----------
Total income...................................................... 3,905,477 39,005,461 16,863 8,969,706
----------- ----------- -------- -----------
- ---------------------------------------------------------------------------------------------------------------------
Expenses:
Investment advisory fees (Note 2)................................. 297,926 1,881,541 1,638 2,358,140
Custodian fees.................................................... 12,035 38,264 500 278,327
Accounting services (Note 2)...................................... 13,454 85,714 120 68,951
Professional fees................................................. 7,193 35,064 -- 26,860
Registration fees (Note 1f)....................................... 14,717 26,617 441 27,017
Pricing services.................................................. 1,264 9,274 25 22,351
Directors' fees and expenses...................................... 1,009 8,229 -- 6,266
Transfer agent fees (Note 2)...................................... 4,991 4,960 417 4,589
Amortization of organization expenses (Note 1f)................... -- -- 148 1,383
Other............................................................. 1,191 6,439 -- 9,054
----------- ----------- -------- -----------
Total expenses before reimbursement............................... 353,780 2,096,102 3,289 2,802,938
Reimbursement of expenses (Note 2)................................ (264,214 ) -- (3,289 ) --
----------- ----------- -------- -----------
Expenses after reimbursement...................................... 89,566 2,096,102 -- 2,802,938
----------- ----------- -------- -----------
Investment income--net............................................ 3,815,911 36,909,359 16,863 6,166,768
----------- ----------- -------- -----------
- ---------------------------------------------------------------------------------------------------------------------
Realized & Unrealized Gain (Loss) on Investments & Foreign
Currency Transactions--Net (Notes 1b, 1c, 1e & 3):
Realized gain (loss) on investments--net.......................... (154,413 ) (3,777,610) (193 ) 9,049,271
Realized gain on foreign currency transactions--net............... -- -- -- 889,867
Change in unrealized appreciation/depreciation on
investments--net................................................ (1,012,273 ) 8,565,962 153,134 3,256,180
Change in unrealized appreciation/depreciation on foreign currency
transactions.................................................... -- -- -- (745,643)
----------- ----------- -------- -----------
Total realized and unrealized gain (loss) on investments and
foreign currency transactions--net.............................. (1,166,686 ) 4,788,352 152,941 12,449,675
----------- ----------- -------- -----------
Net Increase in Net Assets Resulting from Operations.............. $2,649,225 $41,697,711 $169,804 $18,616,443
=========== =========== ======== ===========
- ---------------------------------------------------------------------------------------------------------------------
* Net of withholding tax on interest............................. $ -- $ -- $ -- $ 977
=========== =========== ======== ===========
** Net of withholding tax on dividends............................ $ -- $ -- $ -- $ 555,297
=========== =========== ======== ===========
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
+The Fund commenced operations on December 13, 1996.
See Notes to Financial Statements.
-100-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Statements of Operations for the Year Ended December 31, 1996 (concluded)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Natural
Resources Prime Quality Reserve
Focus Bond Equity Assets
Fund Fund Fund Fund
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Investment Income (Notes 1d & 1e):
Interest and discount earned................................ $ 75,317 $ 35,506,054 $ 5,883,776 $ 1,323,908
Dividends*.................................................. 939,896 -- 11,052,176 --
Other income................................................ -- 58,223 3,074 --
---------- ----------- ------------ ----------
Total income................................................ 1,015,213 35,564,277 16,939,026 1,323,908
---------- ----------- ------------ ----------
- ---------------------------------------------------------------------------------------------------------------------
Expenses:
Investment advisory fees (Note 2)........................... 297,742 2,160,063 3,136,852 118,827
Accounting services (Note 2)................................ 10,026 107,314 158,146 3,830
Custodian fees.............................................. 31,761 45,793 60,419 10,988
Professional fees........................................... 7,148 42,418 56,245 6,043
Registration fees (Note 1f)................................. 16 29,647 52,190 --
Directors' fees and expenses................................ 1,018 10,976 14,937 --
Transfer agent fees (Note 2)................................ 5,002 5,005 4,982 4,997
Pricing services............................................ 4,735 8,819 214 --
Other....................................................... 1,434 8,811 11,246 --
---------- ----------- ------------ ----------
Total expenses.............................................. 358,882 2,418,846 3,495,231 144,685
---------- ----------- ------------ ----------
Investment income--net...................................... 656,331 33,145,431 13,443,795 1,179,223
---------- ----------- ------------ ----------
- ---------------------------------------------------------------------------------------------------------------------
Realized & Unrealized Gain (Loss) on Investments & Foreign
Currency Transactions--Net (Notes 1b, 1c, 1e & 3):
Realized gain on investments--net........................... 2,970,830 215,210 36,740,673 3,049
Realized gain (loss) on foreign currency
transactions--net......................................... (13,371) -- 147 --
Change in unrealized appreciation/depreciation on
investments--net.......................................... 2,055,840 (21,044,224) 67,969,744 (14,201)
Change in unrealized appreciation/depreciation on foreign
currency transactions..................................... 2,033 -- -- --
---------- ----------- ------------ ----------
Total realized and unrealized gain (loss) on investments and
foreign currency transactions--net........................ 5,015,332 (20,829,014) 104,710,564 (11,152)
---------- ----------- ------------ ----------
Net Increase in Net Assets Resulting from Operations........ $ 5,671,663 $ 12,316,417 $118,154,359 $ 1,168,071
========== =========== ============ ==========
- ---------------------------------------------------------------------------------------------------------------------
* Net of withholding tax on dividends....................... $ 75,184 $ -- $ 262,454 $ --
========== =========== ============ ==========
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
-101-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Statements of Changes in Net Assets
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
American Balanced Fund
----------------------------------
For the Year Ended December 31,
----------------------------------
Increase (Decrease) in Net Assets: 1996 1995
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Operations:
Investment income--net......................................................... $ 7,339,770 $ 8,022,508
Realized gain (loss) on investments--net....................................... 21,869,723 (311,392)
Change in unrealized appreciation/depreciation on investments--net............. (9,430,963) 27,587,655
------------ ------------
Net increase in net assets resulting from operations........................... 19,778,530 35,298,771
------------ ------------
- ---------------------------------------------------------------------------------------------------------------------
Dividends & Distributions to Shareholders (Note 1g):
Investment income--net......................................................... (7,882,096) (7,173,644)
Realized gain on investments--net.............................................. (328,715) --
------------ ------------
Net decrease in net assets resulting from dividends and distributions to
shareholders................................................................... (8,210,811) (7,173,644)
------------ ------------
- ---------------------------------------------------------------------------------------------------------------------
Capital Share Transactions (Note 4):
Net increase (decrease) in net assets derived from capital share
transactions................................................................. (12,432,919) 25,836,347
------------ ------------
- ---------------------------------------------------------------------------------------------------------------------
Net Assets:
Total increase (decrease) in net assets........................................ (865,200) 53,961,474
Beginning of year.............................................................. 212,912,214 158,950,740
------------ ------------
End of year*................................................................... $212,047,014 $212,912,214
============ ============
- ---------------------------------------------------------------------------------------------------------------------
*Undistributed investment income--net.......................................... $ 3,604,288 $ 4,146,614
============ ============
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
-102-
<PAGE>
==============================================================================
Basic Value Focus Fund
- ----------------------------------
For the Year Ended December 31,
----------------------------------
1996 1995
- ----------------------------------
$ 5,533,281 $ 3,967,636
56,406,548 13,595,994
13,550,612 34,077,480
- ------------ ------------
75,490,441 51,641,110
- ------------ ------------
- ----------------------------------
(4,571,085) (3,296,595)
(16,947,347) (7,106,929)
- ------------ ------------
(21,518,432) (10,403,524)
- ------------ ------------
- ----------------------------------
164,495,262 100,918,588
- ------------ ------------
- ----------------------------------
218,467,271 142,156,174
306,462,893 164,306,719
- ------------ ------------
$524,930,164 $306,462,893
============ ============
- ----------------------------------
$ 3,224,622 $ 2,262,426
============ ============
- ----------------------------------
-103-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Statements of Changes in Net Assets (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Developing Capital
Markets Focus Fund
--------------------------------
For the Year Ended December 31,
--------------------------------
Increase (Decrease) in Net Assets: 1996 1995
-------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Operations:
Investment income--net.......................................................... $ 1,857,960 $ 1,186,414
Realized gain (loss) on investments and foreign currency transactions--net...... (156,983) (3,129,641)
Change in unrealized appreciation/depreciation on investments and foreign
currency transactions--net...................................................... 4,829,141 1,803,333
----------- -----------
Net increase (decrease) in net assets resulting from operations................. 6,530,118 (139,894)
----------- -----------
- ---------------------------------------------------------------------------------------------------------------------
Dividends & Distributions to Shareholders (Note 1g):
Investment income--net.......................................................... (1,385,673) (332,002)
Realized gain on investments--net............................................... -- --
----------- -----------
Net decrease in net assets resulting from dividends and distributions to
shareholders.................................................................... (1,385,673) (332,002)
----------- -----------
- ---------------------------------------------------------------------------------------------------------------------
Capital Share Transactions (Note 4):
Net increase (decrease) in net assets derived from capital share transactions... 35,245,827 19,004,774
----------- -----------
- ---------------------------------------------------------------------------------------------------------------------
Net Assets:
Total increase (decrease) in net assets......................................... 40,390,272 18,532,878
Beginning of year............................................................... 55,208,630 36,675,752
----------- -----------
End of year*.................................................................... $95,598,902 $55,208,630
=========== ===========
- ---------------------------------------------------------------------------------------------------------------------
*Undistributed investment income--net (Note 1i)................................. $ 1,752,408 $ 1,184,973
=========== ===========
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
-104-
<PAGE>
==============================================================================
Domestic Money
Market Fund
- ----------------------------------
For the Year Ended December 31,
----------------------------------
1996 1995
- ----------------------------------
$ 13,810,153 $ 17,526,423
12,359 44,778
(157,747) 334,598
------------
13,664,765 17,905,799
------------
- ----------------------------------
(13,810,153) (17,526,423)
(12,359) (44,778)
------------
)
(13,822,512 (17,571,201)
------------
- ----------------------------------
(28,998,068) (59,621,869)
------------
- ----------------------------------
(29,155,815) (59,287,271)
303,911,829 363,199,100
------------
$274,756,014 $303,911,829
============
- ----------------------------------
$ -- $ --
============
- ----------------------------------
-105-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Statements of Changes in Net Assets (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Equity Growth Fund
----------------------------------
For the Year Ended December 31,
----------------------------------
Increase (Decrease) in Net Assets: 1996 1995
-------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Operations:
Investment income--net......................................................... $ 2,025,368 $ 1,785,602
Realized gain on investments and foreign currency transactions--net............ 22,199,518 45,385,878
Change in unrealized appreciation/depreciation on investments and foreign
currency transactions--net..................................................... 5,970,999 44,941,516
------------ ------------
Net increase in net assets resulting from operations........................... 30,195,885 92,112,996
------------ ------------
- ---------------------------------------------------------------------------------------------------------------------
Dividends & Distributions to Shareholders (Note 1g):
Investment income--net......................................................... (1,882,603) (889,063)
Realized gain on investments--net.............................................. (43,561,906) --
------------ ------------
Net decrease in net assets resulting from dividends and distributions to
shareholders................................................................... (45,444,509) (889,063)
------------ ------------
- ---------------------------------------------------------------------------------------------------------------------
Capital Share Transactions (Note 4):
Net proceeds from issuance of capital shares................................... 128,356,735 78,653,598
Net proceeds from issuance of capital shares resulting from reorganization..... -- --
------------ ------------
Net increase in net assets derived from capital share transactions............. 128,356,735 78,653,598
------------ ------------
- ---------------------------------------------------------------------------------------------------------------------
Net Assets:
Total increase in net assets................................................... 113,108,111 169,877,531
Beginning of year.............................................................. 339,921,154 170,043,623
------------ ------------
End of year*................................................................... $453,029,265 $339,921,154
============ ============
- ---------------------------------------------------------------------------------------------------------------------
*Undistributed investment income--net (Note 1i)................................ $ 1,422,632 $ 1,279,867
============ ============
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
-106-
<PAGE>
==============================================================================
Global Bond Focus Fund
--------------------------------
For the Year Ended December 31,
--------------------------------
1996 1995
--------------------------------
$ 6,880,110 $ 6,952,991
830,715 510,287
(706,098) 4,502,738
------------
7,004,727 11,966,016
------------
- --------------------------------
(6,810,949) (6,851,555)
-- --
------------
)
(6,810,949 (6,851,555)
------------
- --------------------------------
(6,069,072) 1,580,255
17,820,572 --
------------
11,751,500 1,580,255
------------
- --------------------------------
11,945,278 6,694,716
81,844,632 75,149,916
------------
$93,789,910 $81,844,632
============
- --------------------------------
$ 118,851 $ 765,308
============
- --------------------------------
-107-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Statements of Changes in Net Assets (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Global Strategy Focus Fund
----------------------------------
For the Year Ended December 31,
----------------------------------
Increase (Decrease) in Net Assets: 1996 1995
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Operations:
Investment income--net......................................................... $ 15,340,737 $ 17,146,054
Realized gain (loss) on investments and foreign currency transactions--net..... 60,957,413 (23,380,052)
Change in unrealized appreciation/depreciation on investments and foreign
currency transactions--net..................................................... 24,598,652 58,162,628
------------ ------------
Net increase in net assets resulting from operations........................... 100,896,802 51,928,630
------------ ------------
- ---------------------------------------------------------------------------------------------------------------------
Dividends & Distributions to Shareholders (Note 1g):
Investment income--net......................................................... (12,699,527) (16,913,134)
In excess of realized gains on investments--net................................ -- (199,509)
------------ ------------
Net decrease in net assets resulting from dividends and distributions to
shareholders................................................................... (12,699,527) (17,112,643)
------------ ------------
- ---------------------------------------------------------------------------------------------------------------------
Capital Share Transactions (Note 4):
Net redemptions from capital shares............................................ (52,564,882) (9,981,690)
Net proceeds from issuance of capital shares resulting from reorganization..... 294,328,812 --
------------ ------------
Net increase (decrease) in net assets derived from capital share
transactions................................................................. 241,763,930 (9,981,690)
------------ ------------
- ---------------------------------------------------------------------------------------------------------------------
Net Assets:
Total increase (decrease) in net assets........................................ 329,961,205 24,834,297
Beginning of year.............................................................. 540,241,613 515,407,316
------------ ------------
End of year*................................................................... $870,202,818 $540,241,613
============ ============
- ---------------------------------------------------------------------------------------------------------------------
*Undistributed investment income--net (Note 1i)................................ $ 20,579,673 $ 7,489,615
============ ============
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
-108-
<PAGE>
==============================================================================
Global Utility Focus Fund
- ----------------------------------
For the Year Ended December 31,
----------------------------------
1996 1995
- ----------------------------------
$ 5,748,285 $ 5,942,408
1,196,792 (2,380,178)
10,430,510 26,090,740
------------
17,375,587 29,652,970
------------
- ----------------------------------
(6,739,387) (5,144,108)
-- --
------------
(6,739,387) (5,144,108)
------------
- ----------------------------------
16,423,676 2,526,392
-- --
------------
(16,423,676) (2,526,392)
------------
- ----------------------------------
(5,787,476) 21,982,470
148,225,277 126,242,807
------------
$142,437,801 $148,225,277
============
- ----------------------------------
$ 1,132,021 $ 2,159,534
============
- ----------------------------------
-109-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Statements of Changes in Net Assets (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Government
Bond Fund
--------------------------------
For the Year Ended December 31,
--------------------------------
Increase (Decrease) in Net Assets: 1996 1995
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Operations:
Investment income--net.......................................................... $ 3,815,911 $ 1,796,464
Realized gain (loss) on investments--net........................................ (154,413) 192,982
Change in unrealized appreciation/depreciation on investments--net.............. (1,012,273) 2,024,581
----------- -----------
Net increase in net assets resulting from operations............................ 2,649,225 4,014,027
----------- -----------
- ---------------------------------------------------------------------------------------------------------------------
Dividends & Distributions to Shareholders (Note 1g):
Investment income--net.......................................................... (3,530,361) (1,670,786)
Realized gain on investments--net............................................... (137,668) --
----------- -----------
Net decrease in net assets resulting from dividends and distributions to
shareholders.................................................................... (3,668,029) (1,670,786)
----------- -----------
- ---------------------------------------------------------------------------------------------------------------------
Capital Share Transactions (Note 4):
Net increase in net assets derived from capital share transactions.............. 49,603,169 20,842,535
----------- -----------
- ---------------------------------------------------------------------------------------------------------------------
Net Assets:
Total increase in net assets.................................................... 48,584,365 23,185,776
Beginning of year............................................................... 40,996,427 17,810,651
----------- -----------
End of year*.................................................................... $89,580,792 $40,996,427
=========== ===========
- ---------------------------------------------------------------------------------------------------------------------
*Undistributed investment income--net (Note 1i)................................. $ 484,603 $ 199,053
=========== ===========
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
-110-
<PAGE>
==============================================================================
High Current
Income Fund
- ----------------------------------
For the Year Ended December 31,
----------------------------------
1996 1995
- ----------------------------------
$ 36,909,359 $ 30,889,361
(3,777,610) 589,358
8,565,962 16,336,511
------------
41,697,711 47,815,230
------------
- ----------------------------------
(36,130,450) (30,645,264)
-- --
------------
(36,130,450) (30,645,264)
------------
- ----------------------------------
52,695,717 83,463,234
------------
- ----------------------------------
58,262,978 100,633,200
356,351,940 255,718,740
------------
$414,614,918 $356,351,940
============
- ----------------------------------
$ 3,786,391 $ 2,822,298
============
- ----------------------------------
-111-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Statements of Changes in Net Assets (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Index 500
Fund
---------------
For the Period
Dec. 13, 1996+
Increase (Decrease) in Net Assets: to Dec. 31, 1996
---------------------------------------------------------------------------------------------------------------------
<S> <C>
Operations:
Investment income--net........................................................................... $ 16,863
Realized gain (loss) on investments and foreign currency transactions--net....................... (193)
Change in unrealized appreciation/depreciation on investments and foreign currency
transactions--net................................................................................ 153,134
-----------
Net increase in net assets resulting from operations............................................. 169,804
-----------
- ---------------------------------------------------------------------------------------------------------------------
Dividends & Distributions to Shareholders (Note 1g):
Investment income--net........................................................................... --
Realized gain on investments--net................................................................ --
In excess of realized gain on investments--net................................................... --
-----------
Net decrease in net assets resulting from dividends and distributions to shareholders............ --
-----------
- ---------------------------------------------------------------------------------------------------------------------
Capital Share Transactions (Note 4):
Net increase in net assets derived from capital share transactions............................... 582,036
-----------
- ---------------------------------------------------------------------------------------------------------------------
Net Assets:
Total increase in net assets..................................................................... 751,840
Beginning of period.............................................................................. 10,000,000
-----------
End of period*................................................................................... $ 10,751,840
===========
- ---------------------------------------------------------------------------------------------------------------------
*Undistributed investment income--net (Note 1i).................................................. $ 16,863
===========
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
+ Commencement of Operations.
See Notes to Financial Statements.
-112-
<PAGE>
==============================================================================
International Equity
Focus Fund
- ----------------------------------
For the Year Ended December 31,
----------------------------------
1996 1995
- ----------------------------------
$ 6,166,768 $ 4,728,612
9,939,138 (7,417,463)
2,510,537 15,585,541
------------
18,616,443 12,896,690
------------
- ----------------------------------
(3,669,329) (151,930)
-- (3,904,078)
-- (5,275,618)
------------
(3,669,329) (9,331,626)
------------
- ----------------------------------
68,530,474 14,153,402
------------
- ----------------------------------
83,477,588 17,718,466
265,602,241 247,883,775
------------
$349,079,829 $265,602,241
============
- ----------------------------------
$ 4,510,300 $ 4,974,839
============
- ----------------------------------
-113-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Statements of Changes in Net Assets (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Natural Resources
Focus Fund
--------------------------------
For the Year Ended December 31,
--------------------------------
Increase (Decrease) in Net Assets: 1996 1995
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Operations:
Investment income--net.......................................................... $ 656,331 $ 745,572
Realized gain on investments and foreign currency transactions--net............. 2,957,459 789,560
Change in unrealized appreciation/depreciation on investments and foreign
currency transactions--net...................................................... 2,057,873 3,506,951
----------- -----------
Net increase in net assets resulting from operations............................ 5,671,663 5,042,083
----------- -----------
- ---------------------------------------------------------------------------------------------------------------------
Dividends & Distributions to Shareholders (Note 1g):
Investment income--net.......................................................... (722,544) (719,125)
Realized gain on investments--net............................................... (740,711) (116,046)
----------- -----------
Net decrease in net assets resulting from dividends and distributions to
shareholders.................................................................... (1,463,255) (835,171)
----------- -----------
- ---------------------------------------------------------------------------------------------------------------------
Capital Share Transactions (Note 4):
Net increase (decrease) in net assets derived from capital share transactions... (2,113,764) (819,422)
----------- -----------
- ---------------------------------------------------------------------------------------------------------------------
Net Assets:
Total increase in net assets.................................................... 2,094,644 3,387,490
Beginning of year............................................................... 43,102,351 39,714,861
----------- -----------
End of year*.................................................................... $45,196,995 $43,102,351
=========== ===========
- ---------------------------------------------------------------------------------------------------------------------
*Undistributed investment income-net (Note 1i).................................. $ 221,415 $ 315,714
=========== ===========
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
-114-
<PAGE>
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
Prime Bond Fund
- ----------------------------------
For the Year Ended December 31,
----------------------------------
1996 1995
- ----------------------------------
$ 33,145,431 $ 30,681,580
215,210 2,850,926
(21,044,224) 46,631,310
------------
12,316,417 80,163,816
------------
- ----------------------------------
(32,511,472) (30,585,478)
-- --
------------
(32,511,472) (30,585,478)
------------
- ----------------------------------
68,750,815 49,025,455
------------
- ----------------------------------
48,555,760 98,603,793
489,837,968 391,234,175
------------
$538,393,728 $489,837,968
============
- ----------------------------------
$ 3,129,844 $ 2,495,885
============
- ----------------------------------
-115-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Statements of Changes in Net Assets (concluded)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Quality Equity Fund
----------------------------------------
For the Year Ended December 31,
----------------------------------------
Increase (Decrease) in Net Assets: 1996 1995
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Operations:
Investment income--net.................................................... $ 13,443,795 $ 10,721,106
Realized gain on investments and foreign currency transactions--net....... 36,740,820 84,589,225
Change in unrealized appreciation/depreciation on investments and foreign
currency transactions--net................................................ 67,969,744 17,627,851
------------ ------------
Net increase in net assets resulting from operations...................... 118,154,359 112,938,182
------------ ------------
- ---------------------------------------------------------------------------------------------------------------------
Dividends & Distributions to Shareholders (Note 1g):
Investment income--net.................................................... (14,235,069) (8,042,730)
Realized gain on investments--net......................................... (84,325,410) (9,959,874)
------------ ------------
Net decrease in net assets resulting from dividends and distributions to
shareholders.............................................................. (98,560,479) (18,002,604)
------------ ------------
- ---------------------------------------------------------------------------------------------------------------------
Capital Share Transactions (Note 4):
Net increase (decrease) in net assets derived from capital share
transactions............................................................ 130,130,747 85,255,141
------------ ------------
- ---------------------------------------------------------------------------------------------------------------------
Net Assets:
Total increase (decrease) in net assets................................... 149,724,627 180,190,719
Beginning of year......................................................... 644,550,601 464,359,882
------------ ------------
End of year*.............................................................. $ 794,275,228 $ 644,550,601
============ ============
- ---------------------------------------------------------------------------------------------------------------------
*Undistributed investment income--net (Note 1i)........................... $ 5,217,038 $ 6,008,129
============ ============
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
-116-
<PAGE>
==============================================================================
Reserve Assets Fund
- ------------------------------------
For the Year Ended December 31,
- ------------------------------------
1996 1995
- ------------------------------------
$ 1,179,223 $ 1,572,494
3,049 10,309
(14,201) 41,873
------------
1,168,071 1,624,676
------------
- ------------------------------------
(1,179,223) (1,572,494)
(3,049) (10,309)
------------
(1,182,272) (1,582,803)
------------
- ------------------------------------
(2,650,297) (6,688,035)
------------
- ------------------------------------
(2,664,498) (6,646,162)
25,549,869 32,196,031
------------
$ 22,885,371 $ 25,549,869
============
- ------------------------------------
$ -- $ --
============
- ------------------------------------
-117-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Financial Highlights
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
American Balanced Fund
The following per share data and ratios have been -----------------------------------------------------------
derived from information provided in the financial For the Year Ended December 31,
statements. -----------------------------------------------------------
Increase (Decrease) in Net Asset Value: 1996 1995 1994 1993 1992
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Per Share Operating Performance:
Net asset value, beginning of year...................... $ 15.17 $ 13.08 $ 14.08 $ 12.85 $ 12.82
-------- -------- -------- -------- -------
Investment income--net.................................. .53 .59 .48 .32 .31
Realized and unrealized gain (loss) on
investments--net...................................... .89 2.06 (1.06) 1.37 .37
-------- -------- -------- -------- -------
Total from investment operations........................ 1.42 2.65 (.58) 1.69 .68
-------- -------- -------- -------- -------
Less dividends and distributions:
Investment income--net................................ (.56) (.56) (.37) (.34) (.37)
Realized gain on investments--net..................... (.02) -- -- (.12) (.28)
In excess of realized gain on investments--net........ -- -- (.05) -- --
-------- -------- -------- -------- -------
Total dividends and distributions....................... (.58) (.56) (.42) (.46) (.65)
-------- -------- -------- -------- -------
Net asset value, end of year............................ $ 16.01 $ 15.17 $ 13.08 $ 14.08 $ 12.85
======== ======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
Total Investment Return:*
Based on net asset value per share...................... 9.73% 20.81% (4.19%) 13.49% 5.72%
======== ======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses................................................ .60% .61% .63% .70% .97%
======== ======== ======== ======== =======
Investment income--net.................................. 3.39% 4.22% 3.95% 3.20% 3.71%
======== ======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
Supplemental Data:
Net assets, end of year (in thousands).................. $212,047 $212,912 $158,951 $115,420 $24,918
======== ======== ======== ======== =======
Portfolio turnover...................................... 236.50% 38.40% 35.36% 12.55% 36.34%
======== ======== ======== ======== =======
Average commission rate paid**.......................... $ .0610 -- -- -- --
======== ======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns exclude insurance-related fees and expenses.
** For the fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases
and sales of equity securities.
See Notes to Financial Statements.
-118-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Financial Highlights (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Basic Value Focus Fund
------------------------------------------------------
For the Year Ended
December 31, For the Period
The following per share data and ratios have been derived from ---------------------------------- July 1, 1993+ to
information provided in the financial statements. Increase December 31,
(Decrease) in Net Asset Value: 1996 1995 1994 1993
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Per Share Operating Performance:
Net asset value, beginning of period.......................... $ 13.10 $ 11.10 $ 10.95 $ 10.00
-------- -------- -------- -------
Investment income--net........................................ .17 .18 .17 .04
Realized and unrealized gain on investments--net.............. 2.37 2.49 .08 .91
-------- -------- -------- -------
Total from investment operations.............................. 2.54 2.67 .25 .95
-------- -------- -------- -------
Less dividends and distributions:
Investment income--net...................................... (.18) (.19) (.10) --
Realized gain on investments--net........................... (.72) (.48) -- --
-------- -------- -------- -------
Total dividends and distributions............................. (.90) (.67) (.10) --
-------- -------- -------- -------
Net asset value, end of period................................ $ 14.74 $ 13.10 $ 11.10 $ 10.95
======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
Total Investment Return:**
Based on net asset value per share............................ 20.69% 25.49% 2.36% 9.50%++
======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses...................................................... .66% .66% .72% .86%*
======== ======== ======== =======
Investment income--net........................................ 1.37% 1.68% 2.08% 1.69%*
======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
Supplemental Data:
Net assets, end of period (in thousands)...................... $524,930 $306,463 $164,307 $ 47,207
======== ======== ======== =======
Portfolio turnover............................................ 68.41% 74.10% 60.55% 30.86%
======== ======== ======== =======
Average commission rate paid++++.............................. $ .0549 -- -- --
======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of Operations.
++ Aggregate total investment return.
++++ For the fiscal years beginning on or after September 1, 1995, the Fund
is required to disclose its average commission rate per share for
purchases and sales of equity securities.
See Notes to Financial Statements.
-119-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Financial Highlights (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Developing Capital
Markets Focus Fund
--------------------------------------------
For the Year Ended
December 31, For the Period
The following per share data and ratios have been derived from ------------------------ May 2, 1994+ to
information provided in the financial statements. Increase (Decrease) December 31,
in Net Asset Value: 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Share Operating Performance:
Net asset value, beginning of period................................. $ 9.32 $ 9.51 $ 10.00
-------- -------- --------
Investment income--net............................................... .20 .20 .09
Realized and unrealized gain (loss) on investments and foreign
currency transactions--net......................................... .76 (.30) (.58)
-------- -------- --------
Total from investment operations..................................... .96 (.10) (.49)
-------- -------- --------
Less dividends from investment income--net........................... (.23) (.09) --
-------- -------- --------
Net asset value, end of period....................................... $ 10.05 $ 9.32 $ 9.51
======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------
Total Investment Return:**
Based on net asset value per share................................... 10.59% (1.08%) (4.90%)++
======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses, net of reimbursement....................................... 1.25% 1.25% 1.29%*
======== ======== ========
Expenses............................................................. 1.31% 1.36% 1.35%*
======== ======== ========
Investment income--net............................................... 2.42% 2.73% 2.18%*
======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------
Supplemental Data:
Net assets, end of period (in thousands)............................. $ 95,599 $55,209 $ 36,676
======== ======== ========
Portfolio turnover................................................... 87.33% 62.53% 29.79%
======== ======== ========
Average commission rate paid++....................................... $ 0.0003 $ -- $ --
======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of Operations.
++ For the fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases
and sales of equity securities. The "Average Commission Rate Paid"
includes commissions paid in foreign currencies, which have been converted
into US dollars using the prevailing exchange rate on the date of the
transaction. Such conversions may significantly affect the rate shown.
++ Aggregate total investment return.
See Notes to Financial Statements.
-120-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Financial Highlights (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Domestic Money Market Fund
----------------------------------------------------------
For the Year Ended
The following per share data and ratios have been derived December 31, For the Period
from information provided in the financial statements. ----------------------------------------- Feb. 20, 1992+
to Dec. 31,
Increase (Decrease) in Net Asset Value: 1996 1995 1994 1993 1992
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Per Share Operating Performance:
Net asset value, beginning of period...................... $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
-------- -------- -------- -------- --------
Investment income--net.................................... .0504 .0547 .0386 .0302 .0302
Realized and unrealized gain (loss) on investments--net... (.0005) .0012 (.0007) .0005 .0013
-------- -------- -------- -------- --------
Total from investment operations.......................... .0499 .0559 .0379 .0307 .0315
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net.................................. (.0504) (.0547) (.0386) (.0302) (.0302)
Realized gain on investments--net....................... (.0001) (.0002) -- (.0005) (.0010)
-------- -------- -------- -------- --------
Total dividends and distributions......................... (.0505) (.0549) (.0386) (.0307) (.0312)
-------- -------- -------- -------- --------
Net asset value, end of period............................ $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
======== ======== ======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------
Total Investment Return:**
Based on net asset value per share........................ 5.13% 5.64% 3.93% 3.10% 3.65%*
======== ======== ======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses, net of reimbursement............................ .54% .55% .50% .36% .32%*
======== ======== ======== ======== ========
Expenses.................................................. .54% .55% .57% .63% .88%*
======== ======== ======== ======== ========
Investment income--net, and realized gain on
investments--net........................................ 4.97% 5.50% 4.02% 3.03% 3.48%*
======== ======== ======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------
Supplemental Data:
Net assets, end of period (in thousands).................. $274,756 $303,912 $363,199 $170,531 $ 41,128
======== ======== ======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of Operations.
See Notes to Financial Statements.
-121-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Financial Highlights (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Equity Growth Fund+
--------------------------------------------------------
The following per share data and ratios have been derived For the Year Ended
from information provided in the financial statements. December 31,
--------------------------------------------------------
Increase (Decrease) in Net Asset Value: 1996 1995 1994 1993 1992
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Per Share Operating Performance:
Net asset value, beginning of year......................... $ 27.98 $ 19.26 $ 20.96 $ 17.80 $ 17.96
-------- -------- -------- -------- -------
Investment income (loss)--net.............................. .13 .17 .05 (.01) .01
Realized and unrealized gain (loss) on investments--net.... 1.84 8.64 (1.56) 3.17 (.10)
-------- -------- -------- -------- -------
Total from investment operations........................... 1.97 8.81 (1.51) 3.16 (.09)
-------- -------- -------- -------- -------
Less dividends and distributions:
Investment income--net................................... (.14) (.09) -- --++ (.07)
Realized gain on investments--net........................ (3.59) -- (.19) -- --
-------- -------- -------- -------- -------
Total dividends and distributions.......................... (3.73) (.09) (.19) -- (.07)
-------- -------- -------- -------- -------
Net asset value, end of year............................... $ 26.22 $ 27.98 $ 19.26 $ 20.96 $ 17.80
======== ======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
Total Investment Return:*
Based on net asset value per share......................... 8.11% 45.90% (7.27%) 17.78% (.53%)
======== ======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses................................................... .81% .81% .83% .96% 1.18%
======== ======== ======== ======== =======
Investment income (loss)--net.............................. .50% .72% .27% (.05%) .04%
======== ======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
Supplemental Data:
Net assets, end of year (in thousands)..................... $453,029 $339,921 $170,044 $ 98,976 $23,167
======== ======== ======== ======== =======
Portfolio turnover......................................... 80.84% 96.79% 88.48% 131.75% 98.64%
======== ======== ======== ======== =======
Average commission rate paid++............................. $ .0598 $ -- $ -- $ -- $ --
======== ======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns exclude insurance-related fees and expenses.
+ Based on average shares outstanding during the year.
++ Amount is less than $.01 per share.
++ For the fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases
and sales of equity securities.
See Notes to Financial Statements.
-122-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Financial Highlights (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Global Bond Focus Fund
----------------------------------------------------
For the Year Ended
The following per share data and ratios have been derived December 31, For the Period
from information provided in the financial statements. ---------------------------------- July 1, 1993+ to
December 31,
Increase (Decrease) in Net Asset Value: 1996++ 1995++ 1994 1993
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Per Share Operating Performance:
Net asset value, beginning of period........................ $ 9.79 $ 9.17 $ 10.38 $ 10.00
-------- -------- -------- -------
Investment income--net...................................... .78 .85 .76 .25
Realized and unrealized gain (loss) on investments and
foreign currency transactions--net........................ (.03) .61 (1.19) .33
-------- -------- -------- -------
Total from investment operations............................ .75 1.46 (.43) .58
-------- -------- -------- -------
Less dividends and distributions:
Investment income--net.................................... (.78) (.84) (.76) (.20)
In excess of realized gain on investments--net............ -- -- (.02) --
-------- -------- -------- -------
Total dividends and distributions........................... (.78) (.84) (.78) (.20)
-------- -------- -------- -------
Net asset value, end of period.............................. $ 9.76 $ 9.79 $ 9.17 $ 10.38
======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
Total Investment Return:**
Based on net asset value per share.......................... 8.02% 16.69% (4.21%) 5.90%++
======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses.................................................... .69% .68% .75% .94%*
======== ======== ======== =======
Investment income--net...................................... 7.95% 8.99% 8.01% 6.20%*
======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
Supplemental Data:
Net assets, end of period (in thousands).................... $ 93,790 $ 81,845 $ 75,150 $ 50,737
======== ======== ======== =======
Portfolio turnover.......................................... 267.13% 132.57% 117.58% 54.80%
======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of Operations.
++ Based on average shares outstanding during the year.
++ Aggregate total investment return.
See Notes to Financial Statements.
-123-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Financial Highlights (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Global Strategy Focus Fund
--------------------------------------------------------------
For the Year Ended
The following per share data and ratios have been December 31, For the Period
derived from information provided in the financial --------------------------------------------- Feb. 28, 1992+ to
statements. December 31,
Increase (Decrease) in Net Asset Value: 1996 1995 1994 1993 1992
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Per Share Operating Performance:
Net asset value, beginning of period............... $ 12.55 $ 11.73 $ 12.17 $ 10.22 $ 10.00
------- ------- ------- -------
Investment income--net............................. .28 .39 .30 .16 .13
Realized and unrealized gain (loss) on investments
and foreign currency transactions--net........... 1.33 .82 (.48) 1.96 .13
------- ------- ------- -------
Total from investment operations................... 1.61 1.21 (.18) 2.12 .26
------- ------- ------- -------
Less dividends and distributions:
Investment income--net........................... (.29) (.39) (.21) (.17) (.04)
Realized gain on investments--net................ -- --++ (.04) -- --
In excess of realized gain on investments--net... -- -- (.01)
------- ------- ------- -------
Total dividends and distributions.................. (.29) (.39) (.26) (.17) (.04)
------- ------- ------- -------
Net asset value, end of period..................... $ 13.87 $ 12.55 $ 11.73 $ 12.17 $ 10.22
======= ======= ======= =======
- ---------------------------------------------------------------------------------------------------------------------
Total Investment Return:**
Based on net asset value per share................. 13.17% 10.60% (1.46%) 21.03% 2.62%++
======= ======= ======= =======
- ---------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses, net of reimbursement..................... .71% .72% .77% .88% 1.25%*
======= ======= ======= =======
Expenses........................................... .71% .72% .77% .88% 1.35%*
======= ======= ======= =======
Investment income--net............................. 2.68% 3.33% 2.85% 2.41% 2.66%*
======= ======= ======= =======
- ---------------------------------------------------------------------------------------------------------------------
Supplemental Data:
Net assets, end of period (in thousands)........... $870,203 $540,242 $515,407 $269,627 $15,527
======= ======= ======= =======
Portfolio turnover................................. 173.44% 27.23% 21.03% 17.07% 14.47%
======= ======= ======= =======
Average commission rate paid+++.................... $ .0143 $ -- $ -- $ -- $ --
======= ======= ======= =======
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of Operations.
++ Amount is less than $.01 per share.
+++ For the fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases
and sales of equity securities. The "Average Commission Rate Paid"
includes commissions paid in foreign currencies, which have been
converted into US dollars using the prevailing exchange rate on the date
of the transaction. Such conversions may significantly affect the rate
shown.
++ Aggregate total investment return.
See Notes to Financial Statements.
-124-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Financial Highlights (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Global Utility Focus Fund
-----------------------------------------------------
For the Year Ended
December 31, For the Period
The following per share data and ratios have been derived ---------------------------------- July 1, 1993+ to
from information provided in the financial statements. December 31,
Increase (Decrease) in Net Asset Value: 1996 1995 1994 1993
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Per Share Operating Performance:
Net asset value, beginning of period........................ $ 11.30 $ 9.45 $ 10.66 $ 10.00
-------- -------- -------- --------
Investment income--net...................................... .46 .45 .35 .04
Realized and unrealized gain (loss) on investments and
foreign currency transactions--net........................ .95 1.79 (1.25) .64
-------- -------- -------- --------
Total from investment operations............................ 1.41 2.24 (.90) .68
-------- -------- -------- --------
Less dividends and distributions:
Investment income--net.................................... (.52) (.39) (.29) (.02)
In excess of realized gain on investments--net............ -- -- (.02) --
-------- -------- -------- --------
Total dividends and distributions........................... (.52) (.39) (.31) (.02)
-------- -------- -------- --------
Net asset value, end of period.............................. $ 12.19 $ 11.30 $ 9.45 $ 10.66
======== ======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------
Total Investment Return:**
Based on net asset value per share.......................... 12.96% 24.33% (8.51%) 6.85%++
======== ======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses.................................................... .66% .66% .73% .89%*
======== ======== ======== ========
Investment income--net...................................... 3.90% 4.44% 3.68% 2.84%*
======== ======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------
Supplemental Data:
Net assets, end of period (in thousands).................... $142,438 $148,225 $126,243 $104,517
======== ======== ======== ========
Portfolio turnover.......................................... 11.39% 11.05% 9.52% 1.72%
======== ======== ======== ========
Average commission rate paid++.............................. $ .0522 $ -- $ -- $ --
======== ======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of Operations.
++ For the fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases
and sales of equity securities. The "Average Commission Rate Paid"
includes commissions paid in foreign currencies, which have been converted
into US dollars using the prevailing exchange rate on the date of the
transaction. Such conversions may significantly affect the rate shown.
++ Aggregate total investment return.
See Notes to Financial Statements.
-125-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Financial Highlights (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Government Bond Fund
---------------------------------------------
For the Year Ended
December 31, For the Period
The following per share data and ratios have been derived from ------------------------- May 2, 1994+ to
information provided in the financial statements. December 31,
Increase (Decrease) in Net Asset Value: 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Share Operating Performance:
Net asset value, beginning of period................................ $ 10.79 $ 9.97 $ 10.00
-------- -------- --------
Investment income--net.............................................. .65 .62 .25
Realized and unrealized gain (loss) on investments--net............. (.36) .81 (.07)
-------- -------- --------
Total from investment operations.................................... .29 1.43 .18
-------- -------- --------
Less dividends and distributions:
Investment income--net............................................ (.64) (.61) (.21)
Realized gain on investments--net................................. (.04) -- --
-------- -------- --------
Total dividends and distributions................................... (.68) (.61) (.21)
-------- -------- --------
Net asset value, end of period...................................... $ 10.40 $ 10.79 $ 9.97
======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------
Total Investment Return:**
Based on net asset value per share.................................. 2.86% 14.83% 1.79%++
======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses, net of reimbursement...................................... .15% .00% .00%*
======== ======== ========
Expenses............................................................ .59% .66% .80%*
======== ======== ========
Investment income--net.............................................. 6.39% 6.28% 4.66%*
======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------
Supplemental Data:
Net assets, end of period (in thousands)............................ $ 89,581 $ 40,996 $ 17,811
======== ======== ========
Portfolio turnover.................................................. 21.23% 45.39% 103.03%
======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of Operations.
++ Aggregate total investment return.
See Notes to Financial Statements.
-126-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Financial Highlights (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
High Current Income Fund
The following per share data and ratios have been -----------------------------------------------------------
derived from information provided in the financial For the Year Ended December 31,
statements. -----------------------------------------------------------
Increase (Decrease) in Net Asset Value: 1996+ 1995 1994 1993 1992
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Per Share Operating Performance:
Net asset value, beginning of year...................... $ 11.25 $ 10.61 $ 12.06 $ 11.13 $ 10.23
-------- -------- -------- -------- -------
Investment income--net.................................. 1.08 1.09 1.05 .95 1.07
Realized and unrealized gain (loss) on
investments--net...................................... .12 .65 (1.47) .95 .90
-------- -------- -------- -------- -------
Total from investment operations........................ 1.20 1.74 (.42) 1.90 1.97
-------- -------- -------- -------- -------
Less dividends from investment income--net.............. (1.06) (1.10) (1.03) (.97) (1.07)
-------- -------- -------- -------- -------
Net asset value, end of year............................ $ 11.39 $ 11.25 $ 10.61 $ 12.06 $ 11.13
======== ======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
Total Investment Return:*
Based on net asset value per share...................... 11.27% 17.21% (3.59%) 17.84% 20.05%
======== ======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses................................................ .54% .55% .61% .72% .89%
======== ======== ======== ======== =======
Investment income--net.................................. 9.50% 9.92% 9.73% 8.62% 10.06%
======== ======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
Supplemental Data:
Net assets, end of year (in thousands).................. $414,615 $356,352 $255,719 $163,428 $26,343
======== ======== ======== ======== =======
Portfolio turnover...................................... 48.92% 41.60% 51.88% 35.67% 28.21%
======== ======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns exclude insurance-related fees and expenses.
+ Based on average shares outstanding during the year.
See Notes to Financial Statements.
-127-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Financial Highlights (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Index 500
Fund
-----------------
For the Period
The following per share data and ratios have been derived from information provided in the Dec. 13, 1996+ to
financial statements. Increase (Decrease) in Net Asset Value: Dec. 31, 1996
- ---------------------------------------------------------------------------------------------------------------------
<S> <C>
Per Share Operating Performance:
Net asset value, beginning of period........................................................... $ 10.00
--------
Investment income--net......................................................................... .02
Realized and unrealized gain on investments--net............................................... .15
--------
Total from investment operations............................................................... .17
--------
Net asset value, end of period................................................................. $ 10.17
========
- ---------------------------------------------------------------------------------------------------------------------
Total Investment Return:**
Based on net asset value per share............................................................. 1.70%++
========
- ---------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses, net of reimbursement................................................................. .00%*
========
Expenses....................................................................................... .60%*
========
Investment income--net......................................................................... 3.08%*
========
- ---------------------------------------------------------------------------------------------------------------------
Supplemental Data:
Net assets, end of period (in thousands)....................................................... $ 10,752
========
Portfolio turnover............................................................................. .04%
========
Average commission rate paid................................................................... $ .0120
========
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* Annualized
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of Operations.
++ Aggregate total investment return.
See Notes to Financial Statements.
-128-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Financial Highlights (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
International Equity Focus Fund
----------------------------------------------------
For the Year Ended
December 31, For the Period
The following per share data and ratios have been derived from -------------------------------- July 1, 1993+ to
information provided in the financial statements. Increase December 31,
(Decrease) in Net Asset Value: 1996++ 1995 1994 1993
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Per Share Operating Performance:
Net asset value, beginning of period............................ $ 11.06 $ 10.90 $ 11.03 $ 10.00
-------- -------- -------- -------
Investment income--net.......................................... .23 .20 .19 .01
Realized and unrealized gain (loss) on investments and foreign
currency transactions--net.................................... .49 .37 (.13) 1.02
-------- -------- -------- -------
Total from investment operations................................ .72 .57 .06 1.03
-------- -------- -------- -------
Less dividends and distributions:
Investment income--net........................................ (.15) (.01) (.18) --
Realized gain on investments--net............................. -- (.17) (.01) --
In excess of realized gain on investments--net................ -- (.23) -- --
-------- -------- -------- -------
Total dividends and distributions............................... (.15) (.41) (.19) --
-------- -------- -------- -------
Net asset value, end of period.................................. $ 11.63 $ 11.06 $ 10.90 $ 11.03
======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
Total Investment Return:**
Based on net asset value per share.............................. 6.62% 5.48% .55% 10.30%++
======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses........................................................ .89% .89% .97% 1.14%*
======== ======== ======== =======
Investment income--net.......................................... 1.96% 1.95% 1.09% .30%*
======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
Supplemental Data:
Net assets, end of period (in thousands)........................ $349,080 $265,602 $247,884 $76,906
======== ======== ======== =======
Portfolio turnover.............................................. 49.87% 100.02% 58.84% 17.39%
======== ======== ======== =======
Average commission rate paid***................................. $ .0004 $ -- $ -- $ --
======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
*** For the fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases
and sales of equity securities. The "Average Commission Rate Paid"
includes commissions paid in foreign currencies, which have been converted
into US dollars using the prevailing exchange rate on the date of the
transaction. Such conversions may significantly affect the rate shown.
+ Commencement of Operations.
++ Based on average shares outstanding during the period.
++ Aggregate total investment return.
See Notes to Financial Statements.
-129-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Financial Highlights (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Natural Resources Focus Fund
-------------------------------------------------------
The following per share data and ratios have been derived For the Year Ended December 31,
from information provided in the financial statements. -------------------------------------------------------
Increase (Decrease) in Net Asset Value: 1996 1995 1994 1993 1992
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Per Share Operating Performance:
Net asset value, beginning of year........................ $ 11.95 $ 10.82 $ 10.82 $ 9.84 $ 10.06
------- ------- ------- ------- -------
Investment income--net.................................... .18 .20 .17 .11 .18
Realized and unrealized gain (loss) on investments and
foreign currency transactions--net...................... 1.40 1.15 (.02) .92 (.05)
------- ------- ------- ------- -------
Total from investment operations.......................... 1.58 1.35 .15 1.03 .13
------- ------- ------- ------- -------
Less dividends and distributions:
Investment income--net.................................. (.20) (.19) (.15) (.05) (.29)
Realized gain on investments--net....................... (.21) (.03) -- -- (.06)
------- ------- ------- ------- -------
Total dividends and distributions......................... (.41) (.22) (.15) (.05) (.35)
------- ------- ------- ------- -------
Net asset value, end of year.............................. $ 13.12 $ 11.95 $ 10.82 $ 10.82 $ 9.84
======= ======= ======= ======= =======
- ---------------------------------------------------------------------------------------------------------------------
Total Investment Return:*
Based on net asset value per share........................ 13.52% 12.65% 1.44% 10.47% 1.36%
======= ======= ======= ======= =======
- ---------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses, net of reimbursement............................ .78% .78% .87% 1.13% 1.25%
======= ======= ======= ======= =======
Expenses.................................................. .78% .78% .87% 1.13% 1.27%
======= ======= ======= ======= =======
Investment income--net.................................... 1.43% 1.75% 1.91% 1.34% 2.00%
======= ======= ======= ======= =======
- ---------------------------------------------------------------------------------------------------------------------
Supplemental Data:
Net assets, end of year (in thousands).................... $45,197 $43,102 $39,715 $14,778 $ 4,144
======= ======= ======= ======= =======
Portfolio turnover........................................ 31.11% 30.15% 10.94% 58.44% 22.88%
======= ======= ======= ======= =======
Average commission rate paid**............................ $ .0225 -- -- -- --
======= ======= ======= ======= =======
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns exclude insurance-related fees and expenses.
**For fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases and
sales of equity securities. The "Average Commission Rate Paid" includes
commissions paid in foreign currencies, which have been converted into US
dollars using the prevailing exchange rate on the date of the transaction.
Such conversions may significantly affect the rate shown.
See Notes to Financial Statements.
-130-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Financial Highlights (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Prime Bond Fund
The following per share data and ratios have been -----------------------------------------------------------
derived from information provided in the financial For the Year Ended December 31,
statements. -----------------------------------------------------------
Increase (Decrease) in Net Asset Value: 1996 1995 1994 1993 1992
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Per Share Operating Performance:
Net asset value, beginning of year...................... $ 12.45 $ 11.12 $ 12.64 $ 12.04 $ 12.02
-------- -------- -------- -------- -------
Investment income--net.................................. .80 .82 .77 .70 .79
Realized and unrealized gain (loss) on
investments--net...................................... (.55) 1.34 (1.36) .71 .04
-------- -------- -------- -------- -------
Total from investment operations........................ .25 2.16 (.59) 1.41 .83
-------- -------- -------- -------- -------
Less dividends and distributions:
Investment income--net................................ (.79) (.83) (.76) (.70) (.81)
Realized gain on investments--net..................... -- -- -- (.11) --
In excess of realized gain on investments--net........ -- -- (.17) -- --
-------- -------- -------- -------- -------
Total dividends and distributions....................... (.79) (.83) (.93) (.81) (.81)
-------- -------- -------- -------- -------
Net asset value, end of year............................ $ 11.91 $ 12.45 $ 11.12 $ 12.64 $ 12.04
======== ======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
Total Investment Return:*
Based on net asset value per share...................... 2.21% 20.14% (4.80%) 12.02% 7.27%
======== ======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses................................................ .49% .50% .54% .63% .78%
======== ======== ======== ======== =======
Investment income--net.................................. 6.67% 7.00% 6.74% 5.86% 6.76%
======== ======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
Supplemental Data:
Net assets, end of year (in thousands).................. $538,394 $489,838 $391,234 $314,091 $84,810
======== ======== ======== ======== =======
Portfolio turnover...................................... 91.88% 90.12% 139.89% 115.26% 82.74%
======== ======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns exclude insurance-related fees and expenses.
See Notes to Financial Statements.
-131-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Financial Highlights (continued)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Quality Equity Fund
-------------------------------------------------------
The following per share data and ratios have been derived For the Year Ended December 31,
from information provided in the financial statements. -------------------------------------------------------
Increase (Decrease) in Net Asset Value: 1996+ 1995+ 1994+ 1993 1992
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Per Share Operating Performance:
Net asset value, beginning of year.......................... $ 32.76 $ 27.74 $ 29.02 $ 25.48 $ 26.35
-------- -------- -------- -------- -------
Investment income--net...................................... .58 .58 .38 .24 .34
Realized and unrealized gain (loss) on investments and
foreign currency transactions--net........................ 4.44 5.48 (.74) 3.46 .32
-------- -------- -------- -------- -------
Total from investment operations............................ 5.02 6.06 (.36) 3.70 .66
-------- -------- -------- -------- -------
Less dividends and distributions:
Investment income--net.................................... (.66) (.45) (.25) (.12) (.58)
Realized gain on investments--net......................... (4.29) (.59) (.67) (.04) (.95)
-------- -------- -------- -------- -------
Total dividends and distributions........................... (4.95) (1.04) (.92) (.16) (1.53)
-------- -------- -------- -------- -------
Net asset value, end of year................................ $ 32.83 $ 32.76 $ 27.74 $ 29.02 $ 25.48
======== ======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
Total Investment Return:*
Based on net asset value per share.......................... 17.90% 22.61% (1.20%) 14.57% 2.69%
======== ======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses.................................................... .49% .51% .54% .62% .74%
======== ======== ======== ======== =======
Investment income--net...................................... 1.89% 1.94% 1.39% 1.07% 1.54%
======== ======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
Supplemental Data:
Net assets, end of year (in thousands)...................... $794,275 $644,551 $464,360 $309,420 $87,977
======== ======== ======== ======== =======
Portfolio turnover.......................................... 88.30% 140.32% 60.57% 88.25% 62.54%
======== ======== ======== ======== =======
Average commission rate paid++.............................. $ .0615 -- -- -- --
======== ======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns exclude insurance-related fees and expenses.
+ Based on average shares outstanding during the period.
++For fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases and
sales of equity securities. The "Average Commission Rate Paid" includes
commissions paid in foreign currencies, which have been converted into US
dollars using the prevailing exchange rate on the date of the transaction.
Such conversions may significantly affect the rate shown.
See Notes to Financial Statements.
-132-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Financial Highlights (concluded)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Reserve Assets Fund
---------------------------------------------------
The following per share data and ratios have been derived from For the Year Ended December 31,
information provided in the financial statements. ---------------------------------------------------
Increase (Decrease) in Net Asset Value: 1996 1995 1994 1993 1992
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Per Share Operating Performance:
Net asset value, beginning of year............................... $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
-------- -------- -------- -------- -------
Investment income--net........................................... .0501 .0543 .0371 .0268 .0320
Realized and unrealized gain (loss) on investments--net.......... (.0005) .0018 (.0009) .0005 .0007
-------- -------- -------- -------- -------
Total from investment operations................................. .0496 .0561 .0362 .0273 .0327
-------- -------- -------- -------- -------
Less dividends and distributions:
Investment income--net......................................... (.0501) (.0543) (.0362) (.0268) (.0320)
Realized gain on investments--net.............................. (.0001) (.0004) -- (.0005) (.0005)
-------- -------- -------- -------- -------
Total dividends and distributions................................ (.0502) (.0547) (.0362) (.0273) (.0325)
-------- -------- -------- -------- -------
Net asset value, end of year..................................... $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
======== ======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
Total Investment Return:*
Based on net asset value per share............................... 5.13% 5.61% 3.79% 2.77% 3.29%
======== ======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses......................................................... .61% .61% .65% .70% .79%
======== ======== ======== ======== =======
Investment income--net, and realized gain on investments--net.... 4.96% 5.47% 3.75% 2.73% 3.36%
======== ======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
Supplemental Data:
Net assets, end of year (in thousands)........................... $22,885 $25,550 $32,196 $30,168 $26,767
======== ======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns exclude insurance-related fees and expenses.
See Notes to Financial Statements.
-133-
<PAGE>
- ------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
Notes to Financial Statements
- ---------------------------------------------------------
1. Significant Accounting Policies:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company, which is comprised of 16 separate funds
("Funds" or "Fund") offering 16 separate classes of shares to the Merrill
Lynch Life Insurance Company, ML Life Insurance Company of New York (indirect
wholly-owned subsidiaries of Merrill Lynch & Co., Inc. "ML & Co."), and other
insurance companies, which are not affiliated with ML & Co., for their
separate accounts to fund benefits under certain variable annuity contracts.
Each Fund is classified as "diversified", as defined in the Investment Company
Act of 1940, except for Developing Capital Markets Focus Fund, Global Bond
Focus Fund, Global Strategy Focus Fund, and Natural Resources Focus Fund, all
of which are classified as "non-diversified". The following is a summary of
significant accounting policies followed by the Funds.
(a) Valuation of investments--Money market securities maturing more than
sixty days after the valuation date are valued at the most recent bid price or
yield equivalent as obtained from dealers that make markets in the securities.
When such securities are valued with sixty days or less to maturity, the
difference between the valuation existing on the sixty-first day before
maturity and maturity value is amortized on a straight-line basis to maturity.
Investments maturing within sixty days from their date of acquisition are
valued at amortized cost, which approximates market value.
Portfolio securities which are traded on stock exchanges are valued at the
last sale price as of the close of business on the day the securities are
being valued, or lacking any sales, at the closing bid price. Securities
traded in the over-the-counter market are valued at the last available bid
price prior to the time of valuation. Portfolio securities which are traded
both in the over-the-counter market and on a stock exchange are valued
according to the broadest and most representative market, and it is expected
that for debt securities this ordinarily will be the over-the-counter market.
Options written are valued at the last sale price in the case of
exchange-traded options or, in the case of options traded in the
over-the-counter market, the last asked price. Options purchased are valued at
the last sale price in the case of exchange-traded options or, in the case of
options traded in the over-the-counter market, the last bid price. Futures
contracts are valued at settlement price at the close of the applicable
exchange. Securities for which market quotations are not readily available are
valued at fair value as determined in good faith by or under the direction of
the Board of Directors of the Company.
(b) Derivative financial instruments--Certain Funds may engage in various
portfolio strategies to seek to increase its return by hedging its portfolio
against adverse movements in the equity, debt and currency markets. Losses may
arise due to changes in the value of the contract or if the counterparty does
not perform under the contract.
- - Forward foreign exchange contracts--Certain Funds are authorized to enter
into forward foreign exchange contracts as a hedge against either specific
transactions or portfolio positions. Such contracts are not entered on the
Funds' records. However, the effect on operations is recorded from the date
the Funds enter into such contracts. Premium or discount is amortized over the
life of the contracts.
- - Options--Certain Funds may write and purchase call and put options. When a
Fund writes an option, an amount equal to the premium received by the Fund is
reflected as an asset and an equivalent liability. The amount of the liability
is subsequently marked to market to reflect the current market value of the
option written. When a security is purchased or sold through an exercise of an
option, the related premium paid or received is added to (or deducted from)
the basis of the security acquired or deducted from (or added to) the proceeds
of the security sold. When an option expires (or the Fund enters into a
closing transaction), the Fund realizes a gain or loss on the option to the
extent of the premiums received or paid (or gain or loss to the extent the
cost of the closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
- - Financial futures contracts--Certain Funds may purchase or sell futures
contracts and options on such futures contracts for the pur-
-134-
<PAGE>
- ------------------------------------------------------------------------------
pose of hedging the market risk on existing securities or the intended
purchase of securities. Futures contracts are contracts for delayed delivery
of securities at a specific future date and at a specific price or yield. Upon
entering into a contract, the Fund deposits and maintains as collateral such
initial margin as required by the exchange on which the transaction is
effected. Pursuant to the contract, the Fund agrees to receive from or pay to
the broker an amount of cash equal to the daily fluctuation in value of the
contract. Such receipts or payments are known as variation margin and are
recorded by the Fund as unrealized gains or losses. When the contract is
closed, the Fund records a realized gain or loss equal to the difference
between the value of the contract at the time it was opened and the value at
the time it was closed.
- - Foreign currency options and futures--Certain Funds may also purchase or
sell listed or over-the-counter foreign currency options, foreign currency
futures and related options on foreign currency futures as a short or long
hedge against possible variations in foreign exchange rates. Such transactions
may be effected with respect to hedges on non-US dollar denominated securities
owned by the Fund, sold by the Fund but not yet delivered, or committed or
anticipated to be purchased by the Fund.
(c) Foreign currency transactions--
Transactions denominated in foreign currencies are recorded at the exchange
rate prevailing when recognized. Assets and liabilities denominated in foreign
currencies are valued at the exchange rate at the end of the period. Foreign
currency transactions are the result of settling (realized) or valuing
(unrealized) assets and liabilities expressed in foreign currencies into US
dollars. Realized and unrealized gains or losses from investments include the
effects of foreign exchange rates on investments.
(d) Income taxes--It is the Company's policy to comply with the requirements
of the Internal Revenue Code applicable to regulated investment companies and
to distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required. Under the applicable
foreign tax law, a withholding tax may be imposed on interest, dividends and
capital gains at various rates.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex-dividend dates. Dividends from foreign
securities where the ex-dividend date may have passed are subsequently
recorded when the Fund has determined the ex-dividend date. Interest income
(including amortization of premium and discount) is recognized on the accrual
basis. Realized gains and losses on security transactions are determined on
the identified cost basis.
(f) Deferred organization expenses and prepaid registration fees--Deferred
organization expenses are charged to expense on a straight-line basis over a
five-year period. Prepaid registration fees are charged to expense as the
related shares are issued.
(g) Dividends and distributions--Dividends and distributions paid by the
Funds are recorded on the ex-dividend dates.
(h) Custodian bank--The Fund recorded an amount payable to the custodian
bank reflecting an overnight overdraft which resulted from a failed trade
which settled the next day.
(i) Reclassification--Generally accepted accounting principles require that
certain components of net assets be adjusted to reflect permanent differences
between financial and tax reporting. These reclassifications have no effect on
net assets or net asset value per share.
2. Investment Advisory Agreement and Transactions with Affiliates:
The Company has entered into an Investment Advisory Agreement with Merrill
Lynch Asset Management, L.P. ("MLAM"). The general partner of MLAM is
Princeton Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML &
Co., which is the limited partner. MLAM is responsible for the management of
the Company's portfolios and provides the necessary personnel, facilities,
equipment and certain other services necessary to the operations of the Funds.
For such services, the Company pays a monthly fee based upon the average
daily value of each Funds' net assets at the following annual rates: 0.65% of
the average daily net assets of each of the Natural Resources Focus Fund and
Global Strategy Focus Fund, 0.55% of the average daily net assets of the
American Balanced Fund, 0.50% of the average daily net assets of each of the
Domestic Money Market Fund and Government Bond Fund, 0.60% of the average
daily net assets of each of the Basic Value Focus Fund, Global Bond Focus Fund
and Global Utility Focus Fund, 0.75% of the average daily net assets of each
of the Equity Growth Fund and the International Equity Focus Fund, 0.30% of
the average daily net assets of the Index 500 Fund, 1.00% of the average daily
net assets of the Developing Capital Markets Focus
-135-
<PAGE>
- ------------------------------------------------------------------------------
Fund, and at the following annual rates with respect to the other Funds:
Reserve Assets Fund
- --------------------------------------------------------------------------
Portion of average daily value of net assets of the Fund:
- --------------------------------------------------------------------------
Advisory
Fee
- --------------------------------------------------------------------------
Not exceeding $500 million...................................... 0.500%
In excess of $500 million but not exceeding $750 million........ 0.425%
In excess of $750 million but not exceeding $1 billion.......... 0.375%
In excess of $1 billion but not exceeding $1.5 billion.......... 0.350%
In excess of $1.5 billion but not exceeding $2 billion.......... 0.325%
In excess of $2 billion but not exceeding $2.5 billion.......... 0.300%
In excess of $2.5 billion....................................... 0.275%
- --------------------------------------------------------------------------
Quality Equity Fund
- --------------------------------------------------------------------------
Portion of average daily value of net assets of the Fund:
- --------------------------------------------------------------------------
Advisory
Fee
- --------------------------------------------------------------------------
Not exceeding $250 million...................................... 0.500%
In excess of $250 million but not exceeding $300 million........ 0.450%
In excess of $300 million but not exceeding $400 million........ 0.425%
In excess of $400 million....................................... 0.400%
- --------------------------------------------------------------------------
High Current Income Fund and Prime Bond Fund
- -------------------------------------------------------------------------
Portion of aggregate average daily value of net
assets of both Funds: Advisory Fee
- -------------------------------------------------------------------------
High Current Prime
Income Bond
Fund Fund
- -------------------------------------------------------------------------
Not exceeding $250 million......................... 0.55% 0.50%
In excess of $250 million but not more
than $500 million................................. 0.50% 0.45%
In excess of $500 million but not more
then $750 million................................. 0.45% 0.40%
In excess of $750 million.......................... 0.40% 0.35%
- ------------------------------------------------------------------------
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by each Fund to 1.25% of
its average daily net assets. Any expenses in excess of 1.25% of average daily
net assets will be reimbursed to the Fund by MLAM which, in turn, will be
reimbursed by MLLA.
For the year ended December 31, 1996, MLAM earned fees of $765,718 for the
Developing Capital Markets Fund of which $52,388 was waived, $297,926 for the
Government Bond Fund of which $264,214 was voluntarily waived, and $1,638 for
the Index 500 Fund, all of which was voluntarily waived. In addition, MLAM has
also reimbursed the Index 500 Fund $1,651 in additional expenses.
For the year ended December 31, 1996, Merrill Lynch, Pierce, Fenner & Smith
Inc. ("MLPF&S"), an affiliate of MLAM, earned commissions on the execution of
portfolio security transactions as follows:
- --------------------------------------------------------------------------
American Balanced Fund........................................... $ 5,808
Basic Value Focus Fund........................................... 24,040
Developing Capital Markets Focus Fund............................ 45,365
Equity Growth Fund............................................... 1,500
Global Bond Focus Fund........................................... 625
Global Strategy Focus Fund....................................... 51,412
Global Utility Focus Fund........................................ 6,780
High Current Income Fund......................................... 3,750
International Equity Focus Fund.................................. 55,842
Natural Resources Focus Fund..................................... 3,285
Quality Equity Fund.............................................. 67,998
- --------------------------------------------------------------------------
Accounting services are provided to the Company by MLAM at cost.
For the year ended December 31, 1996, Merrill Lynch Security Pricing
Service, an affiliate of MLPF&S, earned fees for providing security price
quotations to compute the Fund's net asset values as follows:
- --------------------------------------------------------------------------
American Balanced Fund........................................... $ 278
Global Bond Focus Fund........................................... 3,020
Global Strategy Focus Fund....................................... 175
Global Utility Focus Fund........................................ 77
Government Bond Fund............................................. 822
High Current Income Fund......................................... 7,269
Prime Bond Fund.................................................. 5,884
- --------------------------------------------------------------------------
Merrill Lynch Financial Data Services, Inc. ("MLFDS"), a wholly-owned
subsidiary of ML & Co., is the Company's transfer agent.
Certain officers and/or directors of the Company are officers and/or
directors of MLAM, PSI, MLFDS, Merrill Lynch Funds Distributor, Inc., a
wholly-owned subsidiary of Merrill Lynch Group, Inc., which is the Funds'
distributor, and/or ML & Co.
-136-
<PAGE>
- ------------------------------------------------------------------------------
3. Investments:
Purchases and sales of investments, excluding short-term securities, for the
year ended December 31, 1996 were as follows:
- ------------------------------------------------------------------------------
Purchases Sales
- -------------------------------------------------------------------------------
American Balanced Fund........................ $ 468,212,355 $448,976,551
Basic Value Focus Fund........................ 324,382,250 244,338,802
Developing Capital Markets Focus Fund......... 97,734,651 60,019,618
Domestic Money Market Fund.................... -- --
Equity Growth Fund............................ 363,579,751 282,977,363
Global Bond Focus Fund........................ 204,794,563 211,818,050
Global Strategy Focus Fund.................... 994,958,721 869,964,495
Global Utility Focus Fund..................... 15,474,733 22,987,878
Government Bond Fund.......................... 59,565,793 11,232,578
High Current Income Fund...................... 202,112,872 171,527,776
Index 500 Fund................................ 9,342,346 1,881
International Equity Focus Fund............... 181,926,488 121,558,312
Natural Resources Focus Fund.................. 13,662,240 15,112,240
Prime Bond Fund............................... 488,860,103 421,701,849
Quality Equity Fund........................... 826,913,708 523,148,231
Reserve Assets Fund........................... -- --
- --------------------------------------------------------------------------------
Transactions in options written for the year ended December 31, 1996, were
as follows:
International Equity Focus Fund
- --------------------------------------------------------------------------------
Nominal Value/
Number of Contracts
Covered by Premiums
Call Options Written Written Options Received
- --------------------------------------------------------------------------------
Outstanding call options written, beginning
of year................................... 6,800 $ 54,253
Options written............................ 9,004 685,805
Options expired............................ (15,769) (622,808)
-------- --------
Outstanding call options written, end of
year...................................... 35 $ 117,250
======== ========
- --------------------------------------------------------------------------------
International Equity Focus Fund
- --------------------------------------------------------------------------------
Nominal Value/
Number of Contracts
Covered by Premiums
Put Options Written Written Options Received
- --------------------------------------------------------------------------------
Outstanding put options written, beginning
of year.................................... 914 $ 21,437
Options written............................. 1,240,000 8,866
Options expired............................. (1,240,914) (30,303)
---------- -------
Outstanding put options written, end of
year....................................... -- $ --
========== =======
- --------------------------------------------------------------------------------
Global Bond Focus Fund
- --------------------------------------------------------------------------------
Nominal Value/
Number of Contracts
Covered by Premiums
Call Options Written Written Options Received
- --------------------------------------------------------------------------------
Outstanding call options written, beginning
of year................................... -- --
Options written............................ 17,530,792 $ 203,117
Options expired............................ (4,782,042) (84,608)
Options closed............................. (12,748,750) (118,509)
-------- --------
Outstanding call options written, end of
year...................................... -- $ --
======== ========
- -------------------------------------------------------------------------------
At December 31, 1996, net unrealized appreciation (depreciation) and
aggregate cost for Federal income tax purposes were as follows:
- ------------------------------------------------------------------------------
Basic Developing Domestic
American Value Capital Money
Balanced Focus Markets Market
Fund Fund Focus Fund Fund
- -------------------------------------------------------------------------------
Appreciated
securities......... $ 13,527,140 $ 61,508,505 $11,560,298 $ 26,805
Depreciated
securities......... (1,612,879) (19,839,815) (7,410,808) (46,269)
------------ ------------- ----------- ------------
Net unrealized
appreciation
(depreciation)..... $ 11,914,261 $ 41,668,690 $ 4,149,490 $ (19,464)
============ ============= =========== ============
Cost for Federal
income tax
purposes........... $198,630,949 $ 480,994,692 $92,042,701 $ 278,879,751
============ ============= =========== =============
- -------------------------------------------------------------------------------
Global Global Global
Equity Bond Strategy Utility
Growth Focus Focus Focus
Fund Fund Fund Fund
- -------------------------------------------------------------------------------
Appreciated
securities........ $ 83,280,830 $ 1,830,484 $ 94,154,461 $ 28,483,400
Depreciated
securities........ (29,835,984) (2,656,113) (20,709,668) (3,646,007)
Net unrealized
appreciation
(depreciation).... $ 53,444,846 $ (825,629) $ 73,444,793 $ 24,837,393
Cost for Federal
income tax
purposes.......... $398,360,465 $ 101,173,812 $793,783,774 $117,339,737
- --------------------------------------------------------------------------------
High International
Government Current Index Equity
Bond Income 500 Focus
Fund Fund Fund Fund
- --------------------------------------------------------------------------------
Appreciated
securities......... $ 1,117,721 $ 19,337,378 $ 229,986 $ 33,699,478
Depreciated
securities......... (166,155) (19,093,901) (81,897) (22,707,701)
---------- ------------ ----------- ------------
Net unrealized
appreciation....... $ 951,566 $ 243,477 $ 148,089 $ 10,991,777
========== ============ =========== ============
Cost for Federal
income tax
purposes*.......... $ 86,879,714 $ 410,624,066 $10,696,027 $336,658,090
========== ============ =========== ============
- --------------------------------------------------------------------------------
Natural
Resources Prime Quality Reserve
Focus Bond Equity Assets
Fund Fund Fund Fund
- --------------------------------------------------------------------------------
Appreciated
securities........ $ 7,011,676 $ 8,898,661 $109,167,111 $ 2,247
Depreciated
securities........ (2,329,143) (5,291,507) (10,826,689) (2,499)
------------ ------------ ------------ ------------
Net unrealized $ 4,682,533 $ 3,607,154 $ 98,340,422 $ (252)
appreciation
(depreciation).... $ 4,682,533 $ 3,607,154 $ 98,340,422 $ (252)
============ ============ ============ ============
Cost for Federal
income tax
purposes.......... $ 40,728,643 $ 526,103,574 $696,193,614 $ 23,070,540
============ ============ ============ ============
- -------------------------------------------------------------------------------
*Net of premiums received on options written.
-137-
<PAGE>
- --------------------------------------------------------------------------------
At December 31, 1996, net realized and unrealized gains (losses) were as
follows:
- --------------------------------------------------------------------------------
American Basic Value
Balanced Fund Focus Fund
-------------------------- -------------------------
Realized
Gains Unrealized Realized Unrealized
(Losses) Gains Gains Gains
- -------------------------------------------------------------------------------
Long-term investments.. $21,874,118 $ 11,975,053 $56,406,548 $42,904,143
Short-term
investments........... (4,395) -- -- --
----------- ----------- ----------- -----------
$21,869,723 $ 11,975,053 $56,406,548 $42,904,143
=========== =========== =========== ===========
- -------------------------------------------------------------------------------
Developing Capital Domestic Money
Markets Fund Market Fund
---------------------- ------------------
Realized Unrealized
Gains Gains Realized Unrealized
(Losses) (Losses) Gains Losses
- --------------------------------------------------------------------------------
Long-term investments............ $ (51,802) $4,294,868 -- --
Short-term investments........... 93 -- $12,359 $(19,464)
Foreign currency transactions.... (105,274) (7,570) -- --
--------- ---------- ------- --------
$(156,983) $4,287,298 $12,359 $(19,464)
========= ========== ======= ========
- --------------------------------------------------------------------------------
Equity Growth Global Bond
Fund Focus Fund
------------------------- ------------------------
Realized Realized Unrealized
Gains Unrealized Gains Gains
(Losses) Gains (Losses) (Losses)
- --------------------------------------------------------------------------------
Long-term investments.... $22,199,566 $53,556,643 $1,224,648 $ (805,740)
Short-term investments... (48) -- 168 128
Financial futures
contracts............... -- -- (321,503) (70,548)
Options written.......... -- -- 2,422 --
Currency options
purchased............... -- -- (59,398) --
Currency options
written................. -- -- (119,980) --
Foreign currency
transactions............ -- -- 483,430 (81,490)
Forward foreign exchange
contracts............... -- -- (379,072) (78,492)
----------- ----------- --------- -----------
$22,199,518 $53,556,643 $ 830,715 $(1,036,142)
=========== =========== ========= ===========
- --------------------------------------------------------------------------------
Global Strategy Global Utility
Focus Fund Focus Fund
------------------------- ------------------------
Realized Unrealized Realized
Gains Gains Gains Unrealized
(Losses) (Losses) (Losses) Gains
- --------------------------------------------------------------------------------
Long-term investments.... $45,325,716 $73,858,509 $1,243,303 $24,837,393
Short-term investments... (5,385) -- (72) --
Foreign currency
transactions............ 105,281 (177,090) (46,439) 735
Forward foreign exchange
contracts............... 15,531,801 (2,598,413) -- --
----------- ----------- --------- -----------
$60,957,413 $71,083,006 $1,196,792 $24,838,128
=========== =========== ========= ===========
- --------------------------------------------------------------------------------
Government High Current
Bond Fund Income Fund
-------------------- ----------------------
Realized
Gains Unrealized Realized Unrealized
(Losses) Gains Losses Gains
- --------------------------------------------------------------------------------
Long-term investments.......... $(155,827) $951,566 $(3,777,593) $556,316
Short-term investments......... 1,414 -- (17) --
--------- -------- ----------- --------
$(154,413) $951,566 $(3,777,610) $556,316
========= ======== =========== ========
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Index 500 International Equity
Fund Focus Fund
------------------- ------------------------
Realized Unrealized
Realized Unrealized Gains Gains
Losses Gains (Losses) (Losses)
- --------------------------------------------------------------------------------
Long-term investments.......... $(193) $148,089 $6,741,641 $11,550,686
Short-term investments......... -- -- 9,058 278,746
Stock index futures
contracts..................... -- 5,045 2,000,430 (87,011)
Options purchased.............. -- -- (71,729) (136,324)
Options written................ -- -- 104,705 (37,619)
Foreign currency
transactions.................. -- -- (170,376) (11,494)
Forward foreign exchange
contracts..................... -- -- 89,755 (305)
Currency options written....... -- -- 8,866 --
Currency options purchased..... -- -- 1,226,788 244,194
---- -------- ---------- -----------
$(193) $153,134 $9,939,138 $11,800,873
==== ======== ========== ===========
- --------------------------------------------------------------------------------
Natural Resources
Focus Fund Prime Bond Fund
----------------------- -----------------------
Realized
Gains Unrealized Realized Unrealized
(Losses) Gains Gains Gains
- --------------------------------------------------------------------------------
Long-term investments....... $2,970,799 $4,688,728 $ 215,210 $3,687,559
Short-term investments...... 31 -- -- --
Foreign currency
transactions............... (13,371) 2,065 -- --
--------- ---------- ------- --------
$2,957,459 $4,690,793 $ 215,210 $3,687,559
========= ========== ======= ========
- --------------------------------------------------------------------------------
Quality Equity Fund Reserve Assets Fund
------------------------- --------------------
Realized
Gains Unrealized Realized Unrealized
(Losses) Gains Gains Losses
- -------------------------------------------------------------------------------
Long-term investments...... $36,744,079 $98,807,069 -- --
Short-term investments..... (3,406) -- $3,049 $ (252)
Foreign currency
transactions.............. 147 -- -- --
----------- ----------- ------ -----
$36,740,820 $98,807,069 $3,049 $ (252)
=========== =========== ====== =====
- --------------------------------------------------------------------------------
4. Capital Share Transactions:
Transactions in capital shares were as follows:
American Balanced Fund
- --------------------------------------------------------------------------------
For the Year Ended Dollar
December 31, 1996 Shares Amount
- --------------------------------------------------------------------------------
Shares sold..................................... 578,134 $ 8,724,352
Shares issued to shareholders in reinvestment of
dividends and distributions.................... 554,530 8,210,811
---------- ------------
Total issued.................................... 1,132,664 16,935,163
Shares redeemed................................. (1,921,234) (29,368,082)
---------- ------------
Net decrease.................................... (788,570) $(12,432,919)
========== ============
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
For the Year Ended Dollar
December 31, 1995 Shares Amount
- --------------------------------------------------------------------------------
Shares sold..................................... 2,201,026 $ 30,814,364
Shares issued to shareholders in reinvestment of
dividends...................................... 529,259 7,173,644
--------- ------------
Total issued.................................... 2,730,285 37,988,008
Shares redeemed................................. (850,020) (12,151,661)
--------- ------------
Net increase.................................... 1,880,265 $ 25,836,347
========= ============
- -------------------------------------------------------------------------------
Basic Value Focus Fund
- -------------------------------------------------------------------------------
For the Year Ended Dollar
December 31, 1996 Shares Amount
- -------------------------------------------------------------------------------
Shares sold..................................... 11,000,199 $149,832,843
Shares issued to shareholders in reinvestment of
dividends and distributions.................... 1,724,353 21,518,432
---------- ------------
Total issued.................................... 12,724,552 171,351,275
Shares redeemed................................. (493,551) (6,856,013)
---------- ------------
Net increase.................................... 12,231,001 $164,495,262
========== ============
- -------------------------------------------------------------------------------
-138-
<PAGE>
- ------------------------------------------------------------------------------
- ---------------------------------------------------------
For the Year Ended Dollar
December 31, 1995 Shares Amount
---------------------------------------------------------
Shares sold........................................ 7,762,209 $ 98,591,635
Shares issued to shareholders in reinvestment of
dividends and distributions....................... 1,538,264 10,403,524
--------- ------------
Total issued....................................... 9,300,473 108,995,159
Shares redeemed.................................... (711,444) (8,076,571)
--------- ------------
Net increase....................................... 8,589,029 $100,918,588
========= ============
---------------------------------------------------------
Developing Capital Markets Focus Fund
- ---------------------------------------------------------
For the Year Ended Dollar
December 31, 1996 Shares Amount
---------------------------------------------------------
Shares sold....................................... 4,462,492 $ 44,124,402
Shares issued to shareholders in reinvestment of
dividends........................................ 151,274 1,385,673
----------- ------------
Total issued...................................... 4,613,766 45,510,075
Shares redeemed................................... (1,027,712) (10,264,248)
----------- ------------
Net increase...................................... 3,586,054 $ 35,245,827
=========== ============
---------------------------------------------------------
- ---------------------------------------------------------
For the Year Ended Dollar
December 31, 1995 Shares Amount
---------------------------------------------------------
Shares sold......................................... 2,555,725 $23,265,598
Shares issued to shareholders in reinvestment of
dividends.......................................... 36,009 332,002
----------- ------------
Total issued........................................ 2,591,734 23,597,600
Shares redeemed..................................... (525,636) (4,592,826)
----------- ------------
Net increase........................................ 2,066,098 $19,004,774
=========== ============
---------------------------------------------------------
Domestic Money Market Fund
- ---------------------------------------------------------
For the Year Ended Dollar
December 31, 1996 Shares Amount
---------------------------------------------------------
Shares sold.................................... 103,681,145 $ 103,681,145
Shares issued to shareholders in reinvestment
of dividends and distributions................ 13,824,990 13,824,990
------------ -------------
Total issued................................... 117,506,135 117,506,135
Shares redeemed................................ (146,504,203) (146,504,203)
------------ -------------
Net decrease................................... (28,998,068) $ (28,998,068)
============ =============
---------------------------------------------------------
- ---------------------------------------------------------
For the Year Ended Dollar
December 31, 1995 Shares Amount
---------------------------------------------------------
Shares sold..................................... 111,267,159 $111,267,159
Shares issued to shareholders in reinvestment of
dividends and distributions.................... 17,571,280 17,571,280
------------ ------------
Total issued.................................... 128,838,439 128,838,439
Shares redeemed................................. (188,460,308) (188,460,308)
------------ ------------
Net decrease.................................... (59,621,869) $(59,621,869)
============ ============
---------------------------------------------------------
Equity Growth Fund
- ---------------------------------------------------------
For the Year Ended Dollar
December 31, 1996 Shares Amount
---------------------------------------------------------
Shares sold........................................ 3,897,758 $ 99,038,352
Shares issued to shareholders in reinvestment of
dividends and distributions....................... 1,870,190 45,444,509
--------- ------------
Total issued....................................... 5,767,948 144,482,861
Shares redeemed.................................... (639,891) (16,126,126)
--------- ------------
Net increase....................................... 5,128,057 $128,356,735
========= ============
---------------------------------------------------------
- ---------------------------------------------------------
For the Year Ended Dollar
December 31, 1995 Shares Amount
---------------------------------------------------------
Shares sold..................................... 3,628,361 $ 86,301,010
Shares issued to shareholders in reinvestment of
dividends...................................... 41,296 889,063
------------ ------------
Total issued.................................... 3,669,657 87,190,073
Shares redeemed................................. (353,757) (8,536,475)
------------ ------------
Net increase.................................... 3,315,900 $ 78,653,598
============ ============
---------------------------------------------------------
Global Bond Focus Fund
- ---------------------------------------------------------
For the Year Ended Dollar
December 31, 1996 Shares Amount
---------------------------------------------------------
Shares sold..................................... 844,095 $ 8,236,250
Shares issued to shareholders in reinvestment of
dividends...................................... 704,764 6,810,949
Shares issued resulting from reorganization..... 1,883,889 17,820,572
---------- ------------
Total issued.................................... 3,432,748 32,867,771
Shares redeemed................................. (2,183,963) (21,116,271)
---------- ------------
Net increase.................................... 1,248,785 $ 11,751,500
========== ============
---------------------------------------------------------
- ---------------------------------------------------------
For the Year Ended Dollar
December 31, 1995 Shares Amount
---------------------------------------------------------
Shares sold..................................... 481,318 $ 4,592,255
Shares issued to shareholders in reinvestment of
dividends...................................... 727,949 6,851,555
---------- ------------
Total issued.................................... 1,209,267 11,443,810
Shares redeemed................................. (1,045,651) (9,863,555)
---------- ------------
Net increase.................................... 163,616 $ 1,580,255
========== ============
---------------------------------------------------------
Global Strategy Focus Fund
- ---------------------------------------------------------
For the Year Ended Dollar
December 31, 1996 Shares Amount
---------------------------------------------------------
- ---------------------------------------------------------
Shares sold....................................... 1,190,964 $ 14,964,723
Shares issued to shareholders in reinvestment of
dividends........................................ 1,034,164 12,699,527
Shares issued resulting from reorganization....... 23,634,508 294,328,812
---------- ------------
Total issued...................................... 25,859,636 321,993,062
Shares redeemed................................... (6,200,613) (80,229,132)
---------- ------------
Net increase...................................... 19,659,023 $241,763,930
========== ============
---------------------------------------------------------
- ---------------------------------------------------------
For the Year Ended Dollar
December 31, 1995 Shares Amount
---------------------------------------------------------
Shares sold....................................... 2,383,467 $ 28,913,701
Shares issued to shareholders in reinvestment of
dividends and distributions...................... 1,452,481 17,112,643
---------- ------------
Total issued...................................... 3,835,948 46,026,344
Shares redeemed................................... (4,725,965) (56,008,034)
---------- ------------
Net decrease...................................... (890,017) $ (9,981,690)
========== ============
---------------------------------------------------------
Global Utility Focus Fund
- ---------------------------------------------------------
For the Year Ended Dollar
December 31, 1996 Shares Amount
---------------------------------------------------------
Shares sold....................................... 858,704 $ 9,800,413
Shares issued to shareholders in reinvestment of
dividends........................................ 595,856 6,739,387
---------- ------------
Total issued...................................... 1,454,560 16,539,800
Shares redeemed................................... (2,881,155) (32,963,476)
---------- ------------
Net decrease...................................... (1,426,595) $(16,423,676)
========== ============
---------------------------------------------------------
- ---------------------------------------------------------
For the Year Ended Dollar
December 31, 1995 Shares Amount
---------------------------------------------------------
Shares sold....................................... 782,432 $ 7,896,815
Shares issued to shareholders in reinvestment of
dividends........................................ 517,492 5,144,108
---------- ------------
Total issued...................................... 1,299,924 13,040,923
Shares redeemed................................... (1,545,955) (15,567,315)
---------- ------------
Net decrease...................................... (246,031) $ (2,526,392)
========== ============
---------------------------------------------------------
-139-
<PAGE>
- ------------------------------------------------------------------------------
Government Bond Fund
- ---------------------------------------------------------
Dollar
For the Year Ended December 31, 1996 Shares Amount
---------------------------------------------------------
Shares sold......................................... 4,677,811 $48,169,342
Shares issued to shareholders in reinvestment of
dividends and distributions........................ 354,243 3,668,029
--------- -----------
Total issued........................................ 5,032,054 51,837,371
Shares redeemed..................................... (215,188) (2,234,202)
--------- -----------
Net increase........................................ 4,816,866 $49,603,169
========= ===========
---------------------------------------------------------
- --------------------------------------------------------- Dollar
For the Year Ended December 31, 1995 Shares Amount
---------------------------------------------------------
Shares sold........................................ 2,173,331 $ 22,410,622
Shares issued to shareholders in reinvestment of
dividends......................................... 161,544 1,670,786
--------- -----------
Total issued....................................... 2,334,875 24,081,408
Shares redeemed.................................... (321,060) (3,238,873)
--------- -----------
Net increase....................................... 2,013,815 $ 20,842,535
========= ===========
---------------------------------------------------------
High Current Income Fund
- ---------------------------------------------------------
Dollar
For the Year Ended December 31, 1996 Shares Amount
---------------------------------------------------------
Shares sold....................................... 3,441,094 $ 38,643,510
Shares issued to shareholders in reinvestment of
dividends........................................ 3,229,888 36,130,450
---------- ------------
Total issued...................................... 6,670,982 74,773,960
Shares redeemed................................... (1,968,366) (22,078,243)
---------- ------------
Net increase...................................... 4,702,616 $ 52,695,717
========== ============
---------------------------------------------------------
- --------------------------------------------------------- Dollar
For the Year Ended December 31, 1995 Shares Amount
---------------------------------------------------------
Shares sold....................................... 5,980,682 $ 65,910,048
Shares issued to shareholders in reinvestment of
dividends........................................ 2,792,967 30,645,264
----------- ------------
Total issued...................................... 8,773,649 96,555,312
Shares redeemed................................... (1,184,474) (13,092,078)
----------- ------------
Net increase...................................... 7,589,175 $ 83,463,234
=========== ============
---------------------------------------------------------
Index 500 Fund
---------------------------------------------------------
For the Period December 13, 1996+ to December 31, Dollar
1996 Shares Amount
---------------------------------------------------------
Shares sold......................................... 57,357 $ 582,138
Shares redeemed..................................... (10) (102)
----------- ------------
Net increase........................................ 57,347 $ 582,036
=========== ============
---------------------------------------------------------
+Prior to December 13, 1996 (commencement of operations), the Fund issued
1,000,000 shares to MLLA for $10,000,000.
International Equity Focus Fund
- ---------------------------------------------------------
For the Year Ended Dollar
December 31, 1996 Shares Amount
---------------------------------------------------------
Shares sold.................................. 6,562,205 $ 75,036,616
Shares issued to shareholders in reinvestment
of dividends................................ 334,488 3,669,329
--------- ------------
Total issued................................. 6,896,693 78,705,945
Shares redeemed.............................. (886,963) (10,175,471)
--------- ------------
Net increase................................. 6,009,730 $ 68,530,474
========= ============
---------------------------------------------------------
- ---------------------------------------------------------
For the Year Ended Dollar
December 31, 1995 Shares Amount
---------------------------------------------------------
Shares sold.................................. 2,540,187 $ 26,767,717
Shares issued to shareholders in reinvestment
of dividends and distributions.............. 898,135 9,331,626
-------- ---------
Total issued................................. 3,438,322 36,099,343
Shares redeemed.............................. (2,161,108) (21,945,941)
-------- ---------
Net increase................................. 1,277,214 $ 14,153,402
============
---------------------------------------------------------
Natural Resources Focus Fund
- ---------------------------------------------------------
For the Year Ended Dollar
December 31, 1996 Shares Amount
---------------------------------------------------------
Shares sold.................................... 450,602 $ 5,663,127
Shares issued to shareholders in reinvestment
of dividends and distributions................ 122,221 1,463,255
------- ---------
Total issued................................... 572,823 7,126,382
Shares redeemed................................ (737,357) (9,240,146)
------- ---------
Net decrease................................... (164,534) $ (2,113,764)
============
---------------------------------------------------------
- ---------------------------------------------------------
For the Year Ended Dollar
December 31, 1995 Shares Amount
---------------------------------------------------------
Shares sold.......................................... 474,971 $ 5,198,076
Shares issued to shareholders in reinvestment of
dividends and distributions......................... 63,806 835,171
-------- -----------
Total issued......................................... 538,777 6,033,247
Shares redeemed...................................... (601,388) (6,852,669)
-------- -----------
Net decrease......................................... (62,611) $ (819,422)
======== ===========
---------------------------------------------------------
Prime Bond Fund
- ---------------------------------------------------------
For the Year Ended Dollar
December 31, 1996 Shares Amount
---------------------------------------------------------
Shares sold........................................ 5,521,436 $65,068,417
Shares issued to shareholders in reinvestment of
dividends......................................... 2,739,002 32,511,472
---------- ------------
Total issued....................................... 8,260,439 97,579,889
Shares redeemed.................................... (2,399,918) (28,829,074)
---------- ------------
Net increase....................................... 5,860,520 $68,750,815
========== ============
---------------------------------------------------------
- ---------------------------------------------------------
For the Year Ended Dollar
December 31, 1995 Shares Amount
---------------------------------------------------------
Shares sold........................................ 3,880,829 $45,621,465
Shares issued to shareholders in reinvestment of
dividends......................................... 2,612,921 30,585,478
---------- ------------
Total issued....................................... 6,493,750 76,206,943
Shares redeemed.................................... (2,316,349) (27,181,488)
---------- ------------
Net increase....................................... 4,177,401 $49,025,455
========== ============
---------------------------------------------------------
Quality Equity Fund
- ---------------------------------------------------------
For the Year Ended Dollar
December 31, 1996 Shares Amount
---------------------------------------------------------
Shares sold........................................ 1,934,738 $ 58,210,337
Shares issued to shareholders in reinvestment of
dividends and distributions....................... 3,478,605 98,560,479
--------- ------------
Total issued....................................... 5,413,343 156,770,816
Shares redeemed.................................... (895,337) (26,640,069)
--------- ------------
Net increase....................................... 4,518,006 $130,130,747
========= ============
---------------------------------------------------------
- ---------------------------------------------------------
For the Year Ended Dollar
December 31, 1995 Shares Amount
---------------------------------------------------------
Shares sold........................................ 2,793,165 $ 82,433,320
Shares issued to shareholders in reinvestment of
dividends and distributions....................... 651,881 18,002,604
--------- ------------
Total issued....................................... 3,445,046 100,435,924
Shares redeemed.................................... (509,752) (15,180,783)
--------- ------------
Net increase....................................... 2,935,294 $ 85,255,141
========= ============
---------------------------------------------------------
Reserve Assets Fund
- ---------------------------------------------------------
Dollar
For the Year EndedDecember 31, 1996 Shares Amount
---------------------------------------------------------
Shares sold...................................... 6,967,844 $ 6,967,844
Shares issued to shareholders in reinvestment of
dividends and distributions..................... 1,182,349 1,182,349
----------- -----------
Total issued..................................... 8,150,193 8,150,193
Shares redeemed.................................. (10,800,490) (10,800,490)
----------- -----------
Net decrease..................................... (2,650,297) $ (2,650,297)
=========== ===========
---------------------------------------------------------
-140-
<PAGE>
- ------------------------------------------------------------------------------
- ---------------------------------------------------------
For the Year Ended Dollar
December 31, 1995 Shares Amount
---------------------------------------------------------
Shares sold...................................... 6,811,139 $ 6,811,139
Shares issued to shareholders in reinvestment of
dividends and distributions..................... 1,582,801 1,582,801
----------- -----------
Total issued..................................... 8,393,940 8,393,940
Shares redeemed.................................. (15,081,975) (15,081,975)
----------- -----------
Net decrease..................................... (6,688,035) $ (6,688,035)
=========== ===========
---------------------------------------------------------
5. Capital Loss Carryforward:
At December 31, 1996, the Company had net capital loss carryforwards of
approximately $3,909,000 in the Developing Capital Markets Focus Fund, of
which $91,000 expires in 2003 , $3,728,000 expires in 2003 and $90,000 expires
in 2004; $514,000 in the Global Bond Focus Fund, all of which expires in 2002;
$2,331,000 in the Global Utility Focus Fund, of which $121,000 expires in 2002
and $2,210,000 expires in 2003; $71,000 in the Government Bond Fund, all of
which expires in 2004; $295,000 in the High Current Income Fund, all of which
expires in 2003; $15,651,000 in the Prime Bond Fund, of which $14,796,000
expires in 2002 and $855,000 expires in 2003. These amounts will be available
to offset like amounts of any future taxable gains.
6. Loaned Securities:
At December 31, 1996, the Government Bond Fund, the Prime Bond Fund and the
Quality Equity Fund held US Treasury bonds having aggregate values of
approximately $2,600,000, $6,798,000 and $6,514,000, respectively, as
collateral for portfolio securities loaned having market values of
approximately $2,514,000, $6,515,000 and $6,579,000, respectively.
7. Commitments:
At December 31, 1996, the following Portfolios had entered into foreign
exchange contracts, in addition to the contracts listed on the Schedules of
Investments, under which they agreed to purchase and sell various foreign
currencies with values of approximately:
- ---------------------------------------------------------
Purchase Sell
---------------------------------------------------------
Development Capital Markets.......... $1,282,000 $ 79,000
Global Bond Focus Fund............... 4,107,000 2,659,000
International Equity Focus Fund...... -- 298,000
Natural Resources Focus Fund......... 222,000 39,000
---------------------------------------------------------
8. Acquisition of Flexible Strategy Fund
and International Bond Fund:
On December 9, 1996, Global Strategy Focus Fund acquired all the net assets
of Flexible Strategy Fund pursuant to a plan of reorganization. The
acquisition was accomplished by a tax-free exchange of 23,634,508 Common Stock
shares of Global Strategy Focus Fund for 20,765,107 Common Stock shares of
Flexible Strategy Fund. Flexible Strategy Fund's net assets on that date of
$325,430,454, including $30,966,642 of unrealized appreciation, were combined
with those of Global Strategy Focus Fund. The aggregate net assets of Global
Strategy Focus Fund after the acquisition amounted to $874,098,755.
On December 9, 1996, World Income Focus Fund acquired all the net assets of
International Bond Fund pursuant to a plan of reorganization. The acquisition
was accomplished by a tax-free exchange of 1,883,889 Common Stock shares of
World Income Focus Fund for 1,788,555 Common Stock shares of International
Bond Fund. International Bond Fund's net assets on that date of $18,188,183,
including $232,608 of unrealized appreciation, were combined with those of
World Income Focus Fund. The aggregate net assets of World Income Focus Fund
after the acquisition amounted to $97,534,880. Subsequent to the acquisition,
World Income Focus Fund changed its name to Global Bond Focus Fund.
9. Subsequent Event:
On January 2, 1997, the Board of Directors declared ordinary income
dividends and capital gains distributions per share payable on January 9, 1997
to shareholders of record as of December 31, 1996 as follows:
- ---------------------------------------------------------
Ordinary Capital
Fund Income Gains
---------------------------------------------------------
American Balanced Fund.......................... $ .603285 $1.228672
Basic Value Focus Fund.......................... .665501 .943093
Developing Capital Markets Focus Fund........... .182600 --
Equity Growth Fund.............................. .533168 .831606
Global Strategy Focus Fund...................... .432947 .289873
Global Utility Focus Fund....................... .096870 --
Index 500 Fund.................................. .017480 .002863
International Equity Focus Fund................. .214967 .087059
Natural Resources Focus Fund.................... .205662 .723589
Quality Equity Fund............................. 1.195788 .557701
---------------------------------------------------------
-141-
<PAGE>
UNAUDITED FINANCIAL STATEMENTS FOR THE INDEX 500 FUND
142
<PAGE>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
SCHEDULE OF INVESTMENTS AS OF MARCH 31, 1997 (UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (NOTE 1A)
- --------------------------------------------------------------------------------
<S> <C> <C>
General Electric Company++................................... 21,366 $ 2,120,576
Coca-Cola Co. ............................................... 32,289 1,804,148
Exxon Corp.++................................................ 16,114 1,736,284
Intel Corporation............................................ 10,658 1,482,794
+Microsoft Corporation++..................................... 15,612 1,431,425
Merck & Co., Inc. ........................................... 15,643 1,317,923
Royal Dutch Petroleum Co. N.V. (NY Shares) (ADR)*............ 6,957 1,217,475
Phillip Morris Companies, Inc. .............................. 10,569 1,206,187
Procter & Gamble Co. ........................................ 8,851 1,017,865
International Business Machines Corp. ....................... 6,716 922,611
Johnson & Johnson Co. ....................................... 17,282 913,786
Wal-Mart Companies, Inc. .................................... 29,767 829,755
du Pont (E.I.) de Nemours & Co. ............................. 7,306 774,436
Bristol-Myers Squibb Co. .................................... 12,996 766,764
American Telephone & Telegraph Co. .......................... 21,026 730,654
American International Group, Inc. .......................... 6,094 715,283
Pfizer, Inc. ................................................ 8,366 703,790
Hewlett-Packard Co. ......................................... 13,196 702,687
Mobil Corporation............................................ 5,113 667,886
PepsiCo, Inc. ............................................... 20,161 657,753
Citicorp..................................................... 6,005 650,041
Walt Disney Co............................................... 8,802 642,546
Chevron Corp. ............................................... 8,468 589,585
Lilly (Eli) & Co. ........................................... 7,160 588,910
GTE Corp. ................................................... 12,481 581,927
Abbott Laboratories.......................................... 10,081 565,796
Amoco Corp. ................................................. 6,453 558,991
NationsBank Corp. ........................................... 9,970 552,089
BellSouth Corporation........................................ 12,893 544,729
General Motors Corp. ........................................ 9,811 543,284
Chase Manhattan Corp. ....................................... 5,695 533,194
Gillette Co.................................................. 7,198 522,755
Federal National Mortgage Association........................ 14,170 511,891
American Home Products Corporation........................... 8,289 497,340
Ford Motor Company........................................... 15,384 482,673
BankAmerica Corp. ........................................... 4,657 469,193
Motorola, Inc. .............................................. 7,693 464,465
Boeing Co. .................................................. 4,650 458,606
Minnesota Mining & Manufacturing Co. ........................ 5,424 458,328
Ameritech Corp. ............................................. 7,128 438,372
Lucent Technologies, Inc. ................................... 8,262 435,820
McDonald's Corp. ............................................ 9,055 427,849
SBC Communications Inc. ..................................... 7,834 412,264
+Cisco Systems, Inc. ........................................ 8,533 410,651
Standard & Poors Depositary Receipts......................... 5,300 399,984
Travelers Corporation........................................ 8,311 397,889
Unilever N.V. (ADR)*......................................... 2,077 386,841
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (NOTE 1A)
- --------------------------------------------------------------------------------
<S> <C> <C>
Texaco Inc. .................................................. 3,432 $ 375,804
American Express Company...................................... 6,150 368,231
Kimberly-Clark Corp. ......................................... 3,666 364,309
Schering-Plough Corp. ........................................ 4,794 348,763
Bell Atlantic Corporation..................................... 5,681 345,831
Schlumberger, Ltd. ........................................... 3,197 342,878
Allstate Corp. ............................................... 5,770 342,594
Wells Fargo & Company......................................... 1,201 341,234
+Oracle Corp. ................................................ 8,778 338,502
Home Depot, Inc. ............................................. 6,233 333,466
Eastman Kodak Co. ............................................ 4,324 328,084
Time Warner Inc. ............................................. 7,379 319,142
MCI Communications Corp. ..................................... 8,895 316,884
Warner-Lambert Co. ........................................... 3,520 304,480
First Union Corporation....................................... 3,681 298,621
Columbia/HCA Healthcare Corp. ................................ 8,713 292,975
Monsanto Co. ................................................. 7,631 291,886
Atlantic Richfield Company.................................... 2,087 281,745
Campbell Soup Co. ............................................ 6,068 281,404
Chrysler Corp. ............................................... 9,121 273,630
Anheuser-Busch Companies, Inc. ............................... 6,482 273,054
+Compaq Computer Corp. ....................................... 3,515 269,337
Emerson Electric Co. ......................................... 5,820 261,900
AlliedSignal Inc. ............................................ 3,670 261,488
NYNEX Corp. .................................................. 5,710 260,519
Sears, Roebuck & Co. ......................................... 5,081 255,320
Sara Lee Corporation.......................................... 6,279 254,299
Sprint Corporation............................................ 5,586 254,163
Federal Home Loan Mortgage Corp. ............................. 9,284 252,989
Dow Chemical Company (The).................................... 3,154 252,320
+WorldCom, Inc. .............................................. 11,211 246,642
Pharmacia & Upjohn Inc. ...................................... 6,594 241,505
Xerox Corp. .................................................. 4,212 239,557
Morgan (J.P.) & Company, Inc. ................................ 2,419 237,667
United Technologies Corp. .................................... 3,120 234,780
Nike, Inc. (Class B).......................................... 3,739 231,818
First Chicago Corp. .......................................... 4,138 223,969
Norwest Corporation........................................... 4,806 222,277
BancOne Corp. ................................................ 5,547 220,493
Northern Telecom Ltd. ........................................ 3,354 219,268
US West Communications Group.................................. 6,198 210,732
Lockheed Martin Corp. ........................................ 2,500 210,000
Pacific Telesis Group......................................... 5,559 209,852
Caterpillar, Inc. ............................................ 2,485 199,421
First Data Corp. ............................................. 5,808 196,746
Fleet Financial Group Inc. ................................... 3,404 194,879
Medtronic, Inc. .............................................. 3,109 193,535
WMX Technologies.............................................. 6,296 192,815
Amgen, Inc. .................................................. 3,415 190,813
Colgate-Palmolive Co. ........................................ 1,906 189,885
Heinz (H.J.) Company.......................................... 4,772 188,494
</TABLE>
143
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
SCHEDULE OF INVESTMENTS AS OF MARCH 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (NOTE 1A)
- --------------------------------------------------------------------------------
<S> <C> <C>
Bank of New York Company, Inc. .............................. 5,091 $ 187,094
Seagram Company Ltd. ........................................ 4,842 185,206
Southern Company (The)....................................... 8,742 184,675
Texas Instruments, Inc. ..................................... 2,465 184,567
Computer Associates International Inc. ...................... 4,734 184,034
Rockwell International Corp. ................................ 2,836 183,985
Kellogg Co. ................................................. 2,735 183,929
Merrill Lynch & Co., Inc.,................................... 2,138 183,601
Union Pacific Corp. ......................................... 3,178 180,351
PNC Bank Corp. .............................................. 4,324 172,960
ConAgra Inc. ................................................ 3,124 169,477
General Re Corporation....................................... 1,072 169,376
McDonnell Douglas Corporation................................ 2,753 167,933
Aetna Inc. .................................................. 1,955 167,886
Automatic Data Processing Inc. .............................. 3,768 157,785
+Dell Computer Corp. ........................................ 2,327 157,363
Gannett Co., Inc. ........................................... 1,829 157,065
Aluminum Co. of America...................................... 2,251 153,068
CPC International, Inc. ..................................... 1,866 153,012
Baxter International, Inc. .................................. 3,542 152,749
Penney (J.C.) Co. ........................................... 3,195 152,162
+Viacom, Inc. (Class B)...................................... 4,592 152,110
International Paper Co. ..................................... 3,895 151,418
+US West Media Group ,Inc. .................................. 8,106 150,974
+Airtouch Communications, Inc. .............................. 6,508 149,684
Burlington Northern Santa Fe Inc. ........................... 1,986 146,964
+Seagate Technology, Inc. ................................... 3,254 146,023
Deere & Co. ................................................. 3,353 145,856
Dean Witter, Discover & Co. ................................. 4,171 145,464
May Department Stores Co. ................................... 3,169 144,189
KeyCorp...................................................... 2,925 142,594
+Boston Scientific Corp. .................................... 2,309 142,581
CIGNA Corporation............................................ 975 142,472
Phillips Petroleum Company................................... 3,416 139,629
+Sun Microsystems, Inc. ..................................... 4,816 139,062
Westinghouse Electric Corporation............................ 7,832 139,018
Norfolk & Southern Corp. .................................... 1,624 138,446
Raytheon Company............................................. 3,063 138,218
CoreStates Financial Corp. .................................. 2,889 137,228
National City Corporation.................................... 2,879 134,233
SunTrust Banks, Inc. ........................................ 2,894 134,209
Walgreen Co. ................................................ 3,193 133,707
Bank of Boston Corp. ........................................ 1,986 133,062
Loews Corporation............................................ 1,493 132,690
Corning, Inc. ............................................... 2,985 132,459
Illinois Tool Works Inc. .................................... 1,608 131,253
CSX Corp. ................................................... 2,815 130,898
General Mills, Inc. ......................................... 2,096 130,214
PPG Industries, Inc. ........................................ 2,379 128,466
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (NOTE 1A)
- --------------------------------------------------------------------------------
<S> <C> <C>
First Bank Systems, Inc.. ................................... 1,745 $ 127,385
Edison International......................................... 5,622 126,495
Archer-Daniels-Midland Co. .................................. 7,061 126,215
Pennsylvania Gas & Electric Corporation...................... 5,350 125,725
Enron Corp. ................................................. 3,302 125,476
Unocal Corp. ................................................ 3,249 123,868
Mellon Bank Corp. ........................................... 1,680 122,220
Chubb Corporation............................................ 2,259 121,704
MONA Corp. .................................................. 4,336 120,866
Gap, Inc. ................................................... 3,580 119,930
Tyco International, Ltd. .................................... 2,162 118,910
Barnett Banks, Inc. ......................................... 2,532 117,738
Dayton Hudson Corporation (Class A).......................... 2,812 117,401
Conrail, Inc. ............................................... 1,038 117,035
Wachovia Corp. .............................................. 2,144 116,848
Morgan Stanley Group Inc. ................................... 1,977 116,149
+CUC International Inc. ..................................... 5,149 115,853
Duke Power Company........................................... 2,617 115,475
Weyerhaeuser Co. ............................................ 2,573 114,820
United Healthcare Corporation................................ 2,388 113,728
+EMC Corporation............................................. 3,190 113,245
Pitney Bowes, Inc. .......................................... 1,927 113,211
Textron Inc. ................................................ 1,073 112,665
American Brands, Inc. ....................................... 2,209 111,831
Honeywell, Inc. ............................................. 1,641 111,383
Albertson's Inc. ............................................ 3,270 111,180
Halliburton Company.......................................... 1,625 110,094
Barrick Gold Corporation..................................... 4,634 110,058
ITT Hartford Group Inc. ..................................... 1,524 109,919
Micron Technology, Inc. ..................................... 2,711 109,795
Household Interntional, Inc. ................................ 1,257 108,259
+Applied Materials, Inc. .................................... 2,324 107,776
American General Corp. ...................................... 2,639 107,539
Ralston Purina Co. .......................................... 1,375 107,422
Fifth Third Bank............................................. 1,377 106,718
Marsh & McLennan Companies, Inc. ............................ 932 105,549
+Toys "R' Us, Inc. .......................................... 3,769 105,532
Goodyear Tire & Rubber Co. .................................. 2,016 105,336
Occidental Pete Corp. ....................................... 4,268 105,099
FPL Group, Inc. ............................................. 2,375 104,797
USX Marathon Group, Inc. .................................... 3,732 104,029
TCI Communications, Inc. (Class A)........................... 8,662 103,944
USBANCORP., Inc. ............................................ 1,922 102,827
American Electric Power Company, Inc. ....................... 2,433 100,361
Texas Utilities Company...................................... 2,914 99,804
Hershey Foods Corporation.................................... 1,992 99,600
Alcan Aluminum, Ltd. ........................................ 2,936 99,457
+HFS Inc. ................................................... 1,670 98,321
Air Products and Chemicals, Inc. ............................ 1,447 98,215
</TABLE>
144
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
SCHEDULE OF INVESTMENTS AS OF MARCH 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (NOTE 1A)
- --------------------------------------------------------------------------------
<S> <C> <C>
AMP, Inc. ................................................... 2,851 $ 98,003
+AMR Corp. .................................................. 1,181 97,433
+Tenet Healthcare Corp. ..................................... 3,911 96,308
Consolidated Edison Company of New York...................... 3,050 91,500
Praxair, Inc. ............................................... 2,030 91,096
Service Corporation.......................................... 3,059 91,005
Williams Companies, Inc. .................................... 2,036 90,602
Avon Products, Inc. ......................................... 1,725 90,563
Mattel, Inc. ................................................ 3,747 89,928
+ITT Corp. .................................................. 1,511 88,960
+Federated Department Store, Inc. ........................... 2,697 88,664
Wrigley (WM) Jr. Co. (Class B)............................... 1,508 88,029
Bankers Trust New York Corp. ................................ 1,061 87,002
Union Pacific Resources Group................................ 3,242 86,723
Tenneco, Inc. ............................................... 2,216 86,424
Aon Corporation.............................................. 1,405 86,056
Georgia Pacific Corp. ....................................... 1,186 85,985
Crown Company, Inc. ......................................... 1,664 85,904
TRW Inc. .................................................... 1,649 85,336
Dominion Resources, Inc. .................................... 2,338 85,045
Panenergy Corporation........................................ 1,960 84,525
American Stores Company...................................... 1,890 84,105
+Tellabs, Inc. .............................................. 2,319 83,774
Lowe's Companies, Inc. ...................................... 2,241 83,757
+Kroger Co. (The)............................................ 1,636 83,027
Marriott International, Inc. ................................ 1,660 82,585
PacifiCorp................................................... 3,825 81,759
Delta Air Lines, Inc. ....................................... 969 81,517
Public Service Enterprise Group, Inc. ....................... 3,094 81,217
ALLTEL Corp. ................................................ 2,461 79,983
Browning-Ferris Industries, Inc. ............................ 2,758 79,637
Sysco Corporation............................................ 2,321 79,204
Comerica Inc. ............................................... 1,395 78,643
Morton International, Inc. .................................. 1,849 78,120
Milton Hotels Corporation.................................... 3,207 77,770
Conseco, Inc. ............................................... 2,183 77,769
+HealthSouth Corp. .......................................... 4,058 77,609
+Federal Express Corp. ...................................... 1,479 77,093
Transamerica Corporation..................................... 860 76,970
Dover Corp. ................................................. 1,460 76,650
Freeport-McMoRan Copper & Gold Inc. (Class B)................ 2,509 76,211
+K Mart Corp. ............................................... 6,279 76,133
Clorox Company............................................... 670 75,124
+COSTCO Companies Inc. ...................................... 2,711 74,891
Masco Corporation............................................ 2,083 74,467
+3Com Corp. ................................................. 2,271 74,375
+Advanced Micro Devices Inc. ................................ 1,773 73,580
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (NOTE 1A)
- --------------------------------------------------------------------------------
<S> <C> <C>
Entergy Corp. ............................................... 2,997 $ 73,427
Union Carbide Corp. ......................................... 1,653 73,145
Genuine Parts Company........................................ 1,563 72,875
Becton, Dickinson and Company................................ 1,616 72,720
Lincoln National Corp. ...................................... 1,355 72,492
Great Western Financial Corp. ............................... 1,788 72,191
Baker Hughes, Inc. .......................................... 1,876 71,992
Inco Ltd. ................................................... 2,185 71,286
Carolina Power & Light Company............................... 1,965 71,231
Comcast Corporation.......................................... 4,207 70,993
Eaton Corp. ................................................. 1,001 70,946
Salomon Inc. ................................................ 1,415 70,573
Times Mirror Co. ............................................ 1,283 70,084
CINERGY Corp. ............................................... 2,046 69,820
St. Paul Companies, Inc. .................................... 1,076 69,805
UNUM Corporation............................................. 949 69,277
Burlington Resources Inc. ................................... 1,619 69,212
Newell Co. .................................................. 2,061 69,043
Dresser Industries, Inc. .................................... 2,280 68,970
Donnelley (R.R.) & Sons Company.............................. 1,951 68,041
UST, Inc. ................................................... 2,416 67,346
Pioneer Hi-Bred International, Inc. ......................... 1,068 67,150
Rite Aid Corporation......................................... 1,589 66,738
McGraw-Hill, Inc. ........................................... 1,291 66,002
Coastal Corp. ............................................... 1,366 65,568
Providian Corporation........................................ 1,216 65,056
Winn-Dixie Stores, Incorporated.............................. 1,962 64,746
Tribune Co. ................................................. 1,598 64,719
Cognizant Corporation........................................ 2,220 64,658
Limited, Inc. (The).......................................... 3,517 64,625
Quaker Oats Company.......................................... 1,764 64,386
SAFECO Corporation........................................... 1,603 64,120
Amerada Hess Corp. .......................................... 1,208 64,024
Allegheny Teledyne Inc. ..................................... 2,262 63,619
Houston Industries Inc. ..................................... 3,041 63,481
CVS Corporation.............................................. 1,371 63,237
Republic New York Corporation................................ 717 63,186
International Flavors & Fragrances Inc. ..................... 1,436 62,825
Rohm & Haas Co. ............................................. 830 62,146
Consolidated Natural Gas Co. ................................ 1,231 62,012
Ingersoll-Rand Company....................................... 1,420 61,948
Phelps Dodge Corporation..................................... 841 61,498
Sonat Inc. .................................................. 1,119 60,985
+Computer Sciences Corporation............................... 985 60,824
Cooper Industries, Inc. ..................................... 1,401 60,768
Greentree Financial Corp. ................................... 1,783 60,176
</TABLE>
145
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
SCHEDULE OF INVESTMENTS AS OF MARCH 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (NOTE 1A)
- --------------------------------------------------------------------------------
<S> <C> <C>
Sherwin-Williams Company .................................... 2,228 $ 60,156
+Thermo Electron Corporation................................. 1,935 59,743
+Cabletron Systems, Inc. .................................... 2,027 59,290
Guidant Corp. ............................................... 962 59,163
PECO Energy Co. ............................................. 2,887 58,823
IKON Office Solutions, Inc. ................................. 1,748 58,558
Central and South West Corp. ................................ 2,736 58,482
+LSI Logic Corporation....................................... 1,671 58,067
Fluer Corporation............................................ 1,085 56,963
Northrop Grumman Corp. ...................................... 749 56,643
Champion International Corp. ................................ 1,240 56,420
Placer Dome Inc. ............................................ 3,108 56,332
Hercules Incorporated........................................ 1,328 56,108
Dun & Bradstreet Corp. ...................................... 2,209 56,053
Laidlaw Inc. ................................................ 4,074 56,017
Interpublic Group of Companies, Inc. ........................ 1,053 55,546
New York Times Co. .......................................... 1,256 55,421
VF Corporation............................................... 826 55,239
General Dynamic Corporation.................................. 819 55,180
+Digital Equipment Corporation............................... 2,010 55,024
Unicom Corp. ................................................ 2,798 54,561
East Chemical Co. ........................................... 1,008 54,180
MGIC Investment Corp. ....................................... 765 54,124
MBIA, Inc. .................................................. 560 53,690
Nucor Corporation............................................ 1,138 52,063
Avery Dennison Corporation................................... 1,352 52,052
Baltimore Gas & Electric Company............................. 1,916 51,253
Reynolds Metals Company...................................... 826 51,212
Grace (W.R.) & Co. .......................................... 1,078 51,070
Grainger (W.W.) Inc. ........................................ 689 50,986
Dow Jones & Company, Inc. ................................... 1,253 50,903
DTE Energy Holdings Company.................................. 1,883 50,606
Torchmark Corporation........................................ 913 50,557
General Public Utilities Corp. .............................. 1,565 50,276
Jefferson Pilot Corp. ....................................... 924 50,242
Newmont Mining Corporation................................... 1,293 50,104
Ahmanson (H.P.) & Co. ....................................... 1,369 49,969
+National Semiconductor Corporation.......................... 1,797 49,417
Union Electric Company....................................... 1,325 48,859
Knight-Ridder, Inc. ......................................... 1,218 48,568
Rubbermaid Inc. ............................................. 1,944 48,357
Case Corp. .................................................. 952 48,314
Raychem Corporation.......................................... 581 47,860
Golden West Financial Corporation, Com....................... 744 46,686
+Humana Inc. ................................................ 2,110 46,420
Dillard Department Stores Inc. .............................. 1,473 46,400
Whirlpool Corporation........................................ 965 45,958
Hasbro, Inc. ................................................ 1,677 45,908
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (NOTE 1A)
- --------------------------------------------------------------------------------
<S> <C> <C>
+Bay Networks Inc. .......................................... 2,561 $ 45,778
Willamette Industries, Inc. ................................. 725 45,312
Beneficial Corp. ............................................ 697 45,044
+Silicon Graphics, Inc. ..................................... 2,270 44,265
+Autozone, Inc. ............................................. 1,947 43,808
Stanley Works................................................ 1,154 43,708
Dana Corp. .................................................. 1,321 43,428
Johnson Controls, Inc. ...................................... 537 43,228
+Novell, Inc. ............................................... 4,536 43,092
TJX Companies Inc. .......................................... 1,008 43,092
Harcourt General Inc. ....................................... 923 42,920
Brown-Forman Corp. (Class B)................................. 896 42,784
PP&L Resources Inc. ......................................... 2,107 42,667
Union Camp Corp. ............................................ 904 42,601
Northern Status Power Company................................ 896 42,448
Circuit City Stores, Inc. ................................... 1,271 42,420
+Western Atlas, Inc. ........................................ 697 42,256
Andrew Corporation........................................... 1,167 42,158
Ohio Edison Company.......................................... 1,981 41,849
Southwest Airlines Co. ...................................... 1,882 41,639
Columbia Gas System, Inc. ................................... 716 41,439
+Fruit of the Loom, Inc. .................................... 998 41,417
Parker Mannifin Corp. ....................................... 965 41,254
+General Instrument Corp. ................................... 1,777 40,649
+Woolworth Corp. ............................................ 1,733 40,509
Liz Claiborne, Incorporated.................................. 928 40,484
Nordstrom, Inc. ............................................. 1,060 40,147
Block (H&R), Inc. ........................................... 1,349 39,627
Mallinckradt Group Inc. ..................................... 959 39,439
Sigma-Aldrich Corporation.................................... 1,275 39,366
Black & Decker
Corporation................................................. 1,224 39,321
Engelhard Corporation........................................ 1,867 39,207
Kerr-Mogee Corporation....................................... 630 38,981
Harris Corp. ................................................ 505 38,822
Frontier Corp. .............................................. 2,123 37,949
Tandy Corp. ................................................. 757 37,945
Temple-Inland Inc. ......................................... 720 37,800
Great Lakes Chemical Corporation............................. 821 37,766
Pall Corporation............................................. 1,628 37,647
Parkin-Elmer Corporation..................................... 560 36,050
Mead Corp. .................................................. 679 35,987
+St. Jude Medical, Inc. ..................................... 1,051 35,077
Armstrong World Industries, Inc. ............................ 536 34,706
Wendy's International, Inc. ................................. 1,679 34,629
Deluxe Corporation........................................... 1,068 34,577
PACCAR Inc. ................................................. 515 34,376
Brunswick Corporation........................................ 1,277 34,319
ITT Industries Inc. ......................................... 1,532 34,279
Ashland Oil Inc. ............................................ 836 33,649
Pacific Enterprises.......................................... 1,103 33,366
</TABLE>
146
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
SCHEDULE OF INVESTMENTS AS OF MARCH 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (NOTE 1A)
- --------------------------------------------------------------------------------
<S> <C> <C>
Westvaco Corporation......................................... 1,322 $ 33,215
Whitman Corporation.......................................... 1,346 32,977
Nalco Chemical Company....................................... 874 32,666
James River Corp. of Virginia................................ 1,117 32,533
Reebok International Ltd. ................................... 721 32,355
USF&G Corporation............................................ 1,501 32,271
+Ceridian Corp. ............................................. 896 32,144
+DSC Communications Corp. ................................... 1,526 31,951
Ecolab Inc. ................................................. 838 31,844
Pennzoil Company............................................. 605 31,309
American Greetings Corp. (Class A)........................... 979 31,267
Ryder System, Inc. .......................................... 1,063 31,093
Snap-On, Inc. ............................................... 790 30,612
+ALZA Corp. ................................................. 1,099 30,223
Harnischreger Industries, Inc. .............................. 637 29,621
+FMC Corporation............................................. 482 29,523
Thomas & Betts Corporation................................... 688 29,412
Louisiana-Pacific Corp. ..................................... 1,410 29,257
USX-US Steel Group, Inc. .................................... 1,095 29,154
+Apple Computer Inc. ........................................ 1,590 29,018
Homestake Mining Company..................................... 1,904 28,798
Cyprus Amax Minerals Co. .................................... 1,211 28,761
Bausch & Lomb, Incorporated.................................. 720 28,440
Santa Fe Pacific Gold Corp. ................................. 1,705 28,132
Echlin Inc. ................................................. 804 27,336
Bemis Company, Inc. ......................................... 679 27,160
Tupperware Corporation....................................... 808 27,068
Owens Corning Fiberglass Corp. .............................. 669 26,927
Maytag Corp. ................................................ 1,300 26,812
Cummins Engine Company, Inc. ................................ 513 26,291
+Oryx Energy Co. ............................................ 1,360 26,180
Noram Energy Corp. .......................................... 1,782 26,062
Super Valu, Inc. ............................................ 873 25,972
Moore Corp Ltd. ............................................. 1,297 25,940
Goodrich (B.F.) Comp. ...................................... 697 25,528
Biomet, Incorporated......................................... 1,512 25,515
General Signal Corporation................................... 647 25,314
+Rowan Companies, Inc. ...................................... 1,109 25,091
United States Surgical Corporation........................... 814 24,827
Giant Food, Inc. (Class A)................................... 775 24,800
Allergan, Inc. .............................................. 850 24,756
Sun Company, Inc. ........................................... 947 24,740
Pep Boys-Manny, Moe & Jack................................... 811 24,330
National Service Industries, Inc. ........................... 617 24,140
Millipore Corporation........................................ 561 23,772
Polaroid Corp. .............................................. 590 23,452
Worthington Industries, Inc. ................................ 1,217 23,275
+Harrah's Entertainment, Inc. ............................... 1,335 22,862
Mercantile Stores Company, Inc. ............................. 478 22,167
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (NOTE 12)
- --------------------------------------------------------------------------------
<S> <C> <C>
Timken Company (The)......................................... 406 $ 21,721
Tektronix, Inc. ............................................. 426 21,513
Bard (C.R.) Inc. ............................................ 740 21,090
Louisiana Land & Exploration Co. ............................ 443 20,987
USLIFE Corporation........................................... 448 20,944
NICOR Inc. .................................................. 646 20,672
+USAir Group, Inc. .......................................... 834 20,433
Manor Care, Inc. ............................................ 814 19,841
Cooper Tire & Rubber Company................................. 1,068 19,758
Battle Mountain Gold Company................................. 2,915 19,312
Boise Cascade Corporation.................................... 629 19,185
Alberto-Culver Company (Class B)............................. 724 18,915
Crane Co..................................................... 596 18,700
Foster Wheeler Corp. ........................................ 527 18,643
ENSERCH Corporation.......................................... 905 18,553
+Beverly Enterprises, Inc.................................... 1,288 18,354
+Tandem Computers, Inc....................................... 1,534 18,216
Autodesk, Inc................................................ 574 17,794
+King World Productions, Inc. ............................... 485 17,702
Russell Corp. ............................................... 495 17,696
Briggs & Stratton Corporation................................ 375 16,828
+Santa Fe Energy Resources, Inc. ............................ 1,177 16,331
Darden Restaurants, Inc. .................................... 2,046 16,112
Meredith Corporation......................................... 694 16,049
+Niagara Mohawk Power Corp. ................................. 1,874 15,929
ASARCO, Inc. ................................................ 556 15,638
Potlatch Corporation......................................... 374 15,381
Scientific-Atlanta, Inc. .................................... 1,004 15,311
McDermott International, Inc. ............................... 712 15,219
Peoples Energy Corporation................................... 453 15,006
Helmerich & Payne, Inc. ..................................... 323 14,939
+Amdahl Corporation.......................................... 1,574 14,756
+Unisys Corp. ............................................... 2,269 14,465
Stone Container Corp. ....................................... 1,287 14,318
Shared Medical Systems Corporation........................... 305 14,182
Caliber Systems, Inc. ....................................... 508 13,462
Centex Acceptance Corp. ..................................... 369 13,007
EG&G, Inc. .................................................. 615 12,838
Great Atlantic & Pacific Tea Co., Inc. ...................... 495 12,561
Inland Steel Co. ............................................ 636 12,402
Trinova Corporation.......................................... 363 12,160
Echo Bay Mines Ltd. ......................................... 1,807 11,971
+Bethlehem Steel Corporation................................. 1,450 11,963
Longs Drug Stores Corp. ..................................... 507 11,914
Springs Industries, Inc. .................................... 262 11,724
Fleetwood Enterprises, Inc. ................................. 462 11,550
Jostens, Inc. ............................................... 503 11,380
Safety-Kleen Corp. .......................................... 756 11,151
</TABLE>
147
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
SCHEDULE OF INVESTMENTS AS OF MARCH 31, 1997 (CONCLUDED)
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (NOTE 1A)
- --------------------------------------------------------------------------------
<S> <C> <C>
Ball Corporation............................................. 397 $ 10,521
Coors (Adolph) Company,
(Class B)................................................... 482 10,243
Cincinnati Milacron, Inc..................................... 518 9,713
Stride Rite Corp. ........................................... 643 9,645
Harland John H. Company (The)................................ 402 9,548
ONEOK, Inc. ................................................. 354 9,204
+Navistar International Corporation.......................... 956 8,962
Pulte Corporation............................................ 302 8,833
+Data General Corporation.................................... 509 8,653
Fleming Companies, Inc. ..................................... 490 8,575
Eastern Enterprises.......................................... 264 8,151
+Charming Shoppes, Inc. ..................................... 1,342 7,213
Kaufman and Broad Home Corp. ................................ 505 6,691
Giddings & Lewis, Inc. ...................................... 440 6,545
+Armco, Inc. ................................................ 1,384 5,536
Nacco Industries Incorporation, (Class A).................... 107 5,270
+Intergraph Corporation...................................... 592 4,588
- --------------------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST--78,189,988)--76.4% 75,633,792
- --------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
FACE VALUE
SHORT-TERM OBLIGATIONS--COMMERCIAL PAPER** AMOUNT (NOTE 1A)
- -------------------------------------------------------------------------------
<S> <C> <C>
American Home Products Corporation, 5.42% due
4/11/1997............................................ $2,500,000 $ 2,496,236
CSW Credit, Inc., 5.55% due 4/14/1997................. 4,300,000 4,291,382
International Securitization Corp., 5.40% due
4/14/1997............................................ 5,000,000 4,990,250
McKenna Triangle National Corp., 5.57% due 4/04/1997.. 2,500,000 2,498,840
-----------
14,276,708
- -------------------------------------------------------------------------------
<CAPTION>
SHORT-TERM OBLIGATIONS--US GOVERNMENT AGENCY
OBLIGATIONS**
- -------------------------------------------------------------------------------
<S> <C> <C>
Federal Home Loan Banks, 5.40% due 4/01/1997.......... 6,965,000 6,965,000
Federal Home Loan Mortgage Corp., 5.26% due
4/18/1997............................................ 3,000,000 2,992,548
-----------
9,957,548
- -------------------------------------------------------------------------------
TOTAL SHORT-TERM OBLIGATIONS (COST--24,234,256)--24.5% 24,234,256
- -------------------------------------------------------------------------------
TOTAL INVESTMENTS (COST--$102,424,244)--101.1%........ 99,868,048
VARIATION MARGIN ON STOCK INDEX FUTURES CONTRACTS***--
(1.2)%............................................... (1,229,855)
OTHER ASSETS LESS LIABILITIES--0.1%................... 112,968
-----------
NET ASSETS--100.0%.................................... $98,751,161
===========
</TABLE>
- -------------------------------------------------------------------------------
+ Non-income producing security.
++ Portion of holdings pledged as collateral for open stock index futures
contracts.
* American Depositary Receipts (ADR).
** Commercial Paper and certain US Government Agency Obligations are traded on
a discount basis; the interest rate shown is the discount rate paid at the
time of purchase by the Fund.
*** Stock index futures contracts purchased as of March 31, 1997 were as
follows:
<TABLE>
- ------------------------------------------------------------------------------------------
<CAPTION>
NUMBER OF EXPIRATION VALUE
CONTRACTS ISSUE DATE (NOTE 1B)
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
67 S&P 500 Stock Index June 1997 $25,393,000
- ------------------------------------------------------------------------------------------
TOTAL STOCK INDEX FUTURES CONTRACTS PURCHASED
(CONTRACT PRICE--$26,906,070).......................... $25,393,000
===========
- ------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
148
<PAGE>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.
STATEMENT OF ASSETS AND LIABILITIES AS OF MARCH 31, 1997 (UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
INDEX 500
FUND
- -------------------------------------------------------------------------------
<S> <C> <C>
ASSETS:
Investments, at value (identified cost--
$102,424,244) (Note 1a)........................... $ 99,868,048
Cash............................................... 703,472
Receivables:
Securities sold................................... $ 5,555,000
Capital shares sold............................... 695,078
Dividends......................................... 135,600 6,385,678
------------
Deferred organization expenses (Note 1f)........... 14,852
Prepaid registration fees and other assets (Note
1f)............................................... 7,910
------------
Total assets...................................... 106,979,960
------------
- -------------------------------------------------------------------------------
LIABILITIES:
Payables:
Securities purchased.............................. 6,975,453
Variation margin on stock index futures contracts
(Note 1b)........................................ 1,229,855
Investment adviser (Note 2)....................... 5,066
Capital shares redeemed........................... 34 8,210,408
------------
Accrued expenses and other liabilities............. 18,391
------------
Total liabilities................................. 8,228,799
------------
- -------------------------------------------------------------------------------
NET ASSETS......................................... $ 98,751,161
============
- -------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Common Stock, $0.10 par value, 100,000,000 shares
authorized........................................ $ 950,821
Paid-in capital in excess of par................... 101,025,846
Undistributed investment income--net............... 452,226
Undistributed realized capital gains on invest-
ments--net........................................ 391,534
Unrealized depreciation on investments--net........ (4,069,266)
------------
NET ASSETS--Equivalent to $10.39 per share based on
9,508,208 shares outstanding...................... $ 98,751,161
============
- -------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
149
<PAGE>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.
STATEMENT OF OPERATIONS FOR THE PERIOD JANUARY 1, 1997 TO MARCH 31, 1997
(UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
INDEX 500
FUND
- ------------------------------------------------------------------------------
<S> <C> <C>
INVESTMENT INCOME (NOTES 1d & 1e):
Dividends (net of $366 foreign withholding tax)..... $ 245,433
Interest and discount earned........................ 218,743
-----------
Total income........................................ $ 464,176
-----------
- ------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)................... 45,906
Registration fees (Note 1f)......................... 4,096
Accounting services (Note 2)........................ 2,699
Custodian fees...................................... 2,280
Amortization of organization expenses (Note 1f)..... 1,962
Professional fees................................... 970
Transfer agent fees (Note 2)........................ 727
Directors' fees and expenses........................ 133
Pricing services.................................... 93
Other............................................... 173
-----------
Total expenses before reimbursement................. 59,039
Reimbursement of expenses (Note 2).................. (47,099)
-----------
Expenses after reimbursement........................ 11,940
-----------
Investment income--net.............................. 452,236
-----------
- ------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS--
NET (NOTES 1b, 1e, & 3):
Realized gain on investment--net.................... 396,577
Change in unrealized appreciation--net.............. (4,222,400)
-----------
NET DECREASE IN NET ASSETS RESULTING FROM OPERA-
TIONS.............................................. $(3,373,587)
===========
- ------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
150
<PAGE>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
INDEX 500
FUND
------------------------------------
FOR THE PERIOD
JANUARY 1, 1997 TO FOR THE PERIOD
MARCH 31, DEC. 13, 1996+ TO
1997 DEC. 31,
INCREASE (DECREASE) IN NET ASSETS: (UNAUDITED) 1996
- -------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net................... $ 452,236 $ 16,863
Realized gain (loss) on investments--
net..................................... 396,577 (193)
Change in unrealized appreciation on in-
vestments--net.......................... (4,222,400) 153,134
----------- -----------
Net increase (decrease) in net assets re-
sulting from operations................. (3,373,587) 169,804
----------- -----------
- -------------------------------------------------------------------------------
DIVIDENDS & DISTRIBUTIONS TO SHAREHOLDERS
(NOTE 1g):
Investment income--net................... (16,873) --
Realized gain on investments--net........ (4,850) --
----------- -----------
Net decrease in net assets resulting from
dividends and distributions to
shareholders............................ (21,723) --
----------- -----------
- -------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net increase in net assets derived from
capital share transactions.............. 91,394,631 582,036
----------- -----------
- -------------------------------------------------------------------------------
NET ASSETS:
Total increase in net assets............. 87,999,321 751,840
Beginning of period...................... 10,751,840 10,000,000
----------- -----------
End of period*........................... $98,751,161 $10,751,840
=========== ===========
- -------------------------------------------------------------------------------
* Undistributed investment income--net... $ 452,226 $ 16,863
=========== ===========
- -------------------------------------------------------------------------------
+ Commencement of Operations.
- -------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
151
<PAGE>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THE FOLLOWING PER SHARE DATA AND RATIOS
HAVE BEEN DERIVED
FROM INFORMATION PROVIDED IN THE FINANCIAL INDEX 500 FUND
STATEMENTS. ------------------------------------
FOR THE PERIOD FOR THE PERIOD
JANUARY 1, 1997 TO DEC. 13, 1996+ TO
MARCH 31, 1997 DEC. 31, 1996
INCREASE (DECREASE) IN NET ASSET VALUE: (UNAUDITED)
- --------------------------------------------------------------------------------
<S> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period...... $ 10.17 $ 10.00
------- -------
Investment income--net.................... .05 .02
Realized and unrealized gain on invest-
ments--net............................... .19 .15
------- -------
Total from investment operations.......... .24 .17
------- -------
Less dividends and distributions:
Investment income--net................... (.02) --
Realized gain on investments--net........ -- ## --
------- -------
Total dividends and distributions......... (.02) --
------- -------
Net asset value, end of period............ $ 10.39 $ 10.17
======= =======
- --------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share........ 2.37%# 1.70%#
======= =======
- --------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement............ .08%* .00%*
======= =======
Expenses.................................. .39%* .60%*
======= =======
Investment income--net.................... 2.96%* 3.08%*
======= =======
- --------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands).. $98,751 $10.752
======= =======
Portfolio turnover........................ .15% .04%
======= =======
Average commission rate paid.............. $ .0161 $ .0120
======= =======
- --------------------------------------------------------------------------------
</TABLE>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of Operations.
# Aggregate total investment return.
## Amount is less than $.01 per share.
See Notes to Financial Statements.
152
<PAGE>
- -------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.
NOTES TO FINANCIALS STATEMENTS (UNAUDITED)
- -------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end man-
agement investment company, which is comprised of 16 separate funds ("Funds"
or "Fund") offering 16 separate classes of shares to the Merrill Lynch Life
Insurance Company, ML Life Insurance Company of New York (indirect wholly-
owned subsidiaries of Merrill Lynch & Co., Inc. "ML & Co."), and other insur-
ance companies, which are not affiliated with ML & Co., for their separate ac-
counts to fund benefits under certain variable annuity contracts. These unau-
dited financial statements reflect all adjustments which are, in the opinion
of management, necessary to a fair statement of the results for the interim
period presented. All such adjustments are of a normal recurring nature. Each
Fund is classified as "diversified", as defined in the Investment Company Act
of 1940, except for Developing Capital Markets Focus Fund, Global Bond Focus
Fund, Global Strategy Focus Fund, and Natural Resources Focus Fund, all of
which are classified as "non-diversified". The following is a summary of sig-
nificant accounting policies followed by the Funds.
(a) Valuation of investments--Money market securities maturing more than
sixty days after the valuation date are valued at the most recent bid price or
yield equivalent as obtained from dealers that make markets in the securities.
When such securities are valued with sixty days or less to maturity, the dif-
ference between the valuation existing on the sixty-first day before maturity
and maturity value is amortized on a straight-line basis to maturity. Invest-
ments maturing within sixty days from their date of acquisition are valued at
amortized cost, which approximates market value.
Portfolio securities which are traded on stock exchanges are valued at the
last sale price as of the close of business on the day the securities are be-
ing valued, or lacking any sales, at the closing bid price. Securities traded
in the over-the-counter market are valued at the last available sale price
prior to the time of valuation. Portfolio securities which are traded both in
the over-the-counter market and on a stock exchange are valued according to
the broadest and most representative market, and it is expected that for debt
securities this ordinarily will be the over-the-counter market. Options writ-
ten are valued at the last sale price in the case of exchange-traded options
or, in the case of option traded in the over-the-counter market, the last
asked price. Options purchased are valued at the last sale price in the case
of exchange-traded options or, in the case of options traded in the over-the-
counter market, the last bid price. Futures contracts are valued at settlement
price at the close of the applicable exchange. Securities for which market
quotations are not readily available are valued at fair value as determined in
good faith by or under the direction of the Board of Directors of the Company.
(b) Derivative financial instruments--Certain Funds may engage in various
portfolio strategies to seek to increase their returns by hedging its portfo-
lio against adverse movements in the equity, debt and currency markets. Losses
may arise due to changes in the value of the contract or if the counterparty
does not perform under the contract.
. Forward foreign exchange contracts--Certain Funds are authorized to enter
into forward foreign exchange contracts as a hedge against either specific
transactions or portfolio positions. Such contracts are not entered on the
Funds' records. However, the effect on operations is recorded from the date
the Funds enter into such contracts. Premium or discount is amortized over the
life of the contracts.
. Options--Certain Funds may write and purchase call and put options. When a
Fund writes an option, an amount equal to the premium received by the Fund is
reflected as an asset and an equivalent liability. The amount of the liability
is subsequently marked to market to reflect the current market value of the
option written. When a security is purchased or sold through an exercise of an
option, the related premium paid or received is added to (or deducted from)
the basis of the security acquired or deducted from (or added to) the proceeds
of the security sold. When an option expires (or the Fund enters into a clos-
ing transaction), the Fund realizes a gain or loss on the option to the extent
of the premiums received or paid (or gain or loss to the extent the cost of
the closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
. Financial futures contracts--Certain Funds may purchase or sell futures con-
tracts and options on such futures contracts for the purpose
153
<PAGE>
- -------------------------------------------------------------------------------
of hedging the market risk on existing securities or the intended purchase of
securities. Futures contracts are contracts for delayed delivery of securities
at a specific future date and at a specific price or yield. Upon entering into
a contract, the Fund deposits and maintains as collateral such initial margin
as required by the exchange on which the transaction is effected. Pursuant to
the contract, the Fund agrees to receive from or pay to the broker an amount
of cash equal to the daily fluctuation in value of the contract. Such receipts
or payments are known as variation margin and are recorded by the Fund as
unrealized gains or losses. When the contract is closed, the Fund records a
realized gain or loss equal to the difference between the value of the con-
tract at the time it was opened and the value at the time it was closed.
. Foreign currency options and futures--Certain Funds may also purchase or
sell listed or over-the-counter foreign currency options, foreign currency
futures and related options on foreign currency futures as a short or long
hedge against possible variations in foreign exchange rates. Such transactions
may be effected with respect to hedges on non-US dollar denominated securities
owned by the Fund, sold by the Fund but not yet delivered, or committed or an-
ticipated to be purchased by the Fund.
(c) Foreign currency transactions--Transactions denominated in foreign cur-
rencies are recorded at the exchange rate prevailing when recognized. Assets
and liabilities denominated in foreign currencies are valued at the exchange
rate at the end of the period. Foreign currency transactions are the result of
settling (realized) or valuing (unrealized) assets and liabilities expressed
in foreign currencies into US dollars. Realized and unrealized gains or losses
from investments include the effects of foreign exchange rates on investments.
(d) Income taxes--It is the Company's policy to comply with the requirements
of the Internal Revenue Code applicable to regulated investment companies and
to distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required. Under the applicable
foreign tax law, a withholding tax may be imposed on interest, dividends and
capital gains at various rates.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex-dividend dates. Dividends from foreign
securities where the ex-dividend date may have passed are subsequently re-
corded when the Fund has determined the ex-dividend date. Interest income (in-
cluding amortization of premium and discount) is recognized on the accrual ba-
sis. Realized gains and losses on security transactions are determined on the
identified cost basis.
(f) Deferred organization expenses and prepaid registration fees--Deferred
organization expenses are charged to expense on a straight-line basis over a
five-year period. Prepaid registration fees are charged to expense as the
related shares are issued.
(g) Dividends and distributions--Dividends and distributions paid by the
Funds are recorded on the ex-dividend dates.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill
Lynch Asset Management, L.P. ("MLAM"). The general partner of MLAM is Prince-
ton Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co.,
which is the limited partner. MLAM is responsible for the management of the
Company's portfolios and provides the necessary personnel, facilities, equip-
ment and certain other services necessary to the operations of the Funds.
For such services, the Company pays a monthly fee based upon the average
daily value of each Funds' net assets at the following annual rates: 0.30% of
the average daily net assets of the Index 500 Fund.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an agree-
ment which limits the operating expenses paid by each Fund to 1.25% of its av-
erage daily net assets. Any expenses in excess of 1.25% of average daily net
assets will be reimbursed to the Fund by MLAM which, in turn, will be reim-
bursed by MLLA.
For the period January 1, 1997 to March 31, 1997, MLAM earned fees of $45,906
for the Index 500 Fund, all of which was voluntarily waived. In addition, MLAM
has also reimbursed the Index 500 Fund $1,193 in additional expenses.
Accounting services are provided to the Company by MLAM at cost.
Merrill Lynch Financial Data Services, Inc. ("MLFDS"), a wholly-owned subsid-
iary of ML & Co., is the Company's transfer agent.
154
<PAGE>
- -------------------------------------------------------------------------------
Certain officers and/or directors of the Company are officers and/or direc-
tors of MLAM, PSI, MLFDS, Merrill Lynch Funds Distributor, Inc., a wholly-
owned subsidiary of Merrill Lynch Group, Inc., which is the Funds' distribu-
tor, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
period January 1, 1997 to March 31, 1997 were as follows:
<TABLE>
- --------------------------------------------------------------------------------
<CAPTION>
PURCHASES SALES
- --------------------------------------------------------------------------------
<S> <C> <C>
Index 500 Fund.............................................. $68,915,885 $70,709
- --------------------------------------------------------------------------------
</TABLE>
Transactions in options written for the period January 1, 1997 to March 31,
1997 were as follows:
<TABLE>
<CAPTION>
INDEX 500 FUND
- ------------------------------------------------------------------------------
NOMINAL VALUE/
NUMBER OF
CONTRACTS
COVERED BY PREMIUMS
PUT OPTIONS WRITTEN WRITTEN OPTIONS RECEIVED
- ------------------------------------------------------------------------------
<S> <C> <C>
Outstanding put options written, beginning of peri-
od.................................................. -- --
Options written...................................... 300 $ 5,541
Options closed....................................... (300) (5,541)
---- -------
Outstanding put options written, end of period....... -- --
==== =======
- ------------------------------------------------------------------------------
</TABLE>
At March 31, 1997, net unrealized appreciation/depreciation and aggregate
cost for Federal income tax purposes were as follows:
<TABLE>
- -------------------------------------------------------------------------------
<CAPTION>
INDEX
500
FUND
- -------------------------------------------------------------------------------
<S> <C>
Appreciated securities........................................... $ 988,294
Depreciated securities........................................... (3,544,490)
------------
Net unrealized depreciation...................................... $ (2,556,196)
============
Cost for Federal income tax purposes............................. $102,424,244
============
- -------------------------------------------------------------------------------
</TABLE>
At March 31, 1997, net realized and unrealized gains (losses) were as fol-
lows:
<TABLE>
- -------------------------------------------------------------------------------
<CAPTION>
INDEX 500
FUND
---------------------
REALIZED
GAINS UNREALIZED
(LOSSES) (LOSSES)
- -------------------------------------------------------------------------------
<S> <C> <C>
Long-term investments................................... $ 4,539 $(2,556,196)
Short-term Investments.................................. (936) --
Financial futures contracts............................. 383,535 (1,513,070)
Investment options purchased............................ 5,707 --
Investment options written.............................. 3,732 --
-------- -----------
$396,577 $(4,069,266)
======== ===========
- -------------------------------------------------------------------------------
</TABLE>
4. CAPITAL SHARE TRANSACTIONS:
Transactions in capital shares were as follows:
<TABLE>
<CAPTION>
INDEX 500 FUND
- --------------------------------------------------------------------------------
FOR THE PERIOD JANUARY 1, 1997 TO DOLLAR
MARCH 31, 1997 (UNAUDITED) SHARES AMOUNT
- --------------------------------------------------------------------------------
<S> <C> <C>
Shares sold........................................... 9,436,509 $102,247,743
Shares issued to shareholders in reinvestment of divi-
dends and distributions.............................. 1,829 18,482
--------- ------------
Total issued.......................................... 9,438,338 102,266,225
Shares redeemed....................................... (987,477) (10,871,594)
--------- ------------
Net increase.......................................... 8,450,861 $ 91,394,631
========= ============
- --------------------------------------------------------------------------------
<CAPTION>
FOR THE PERIOD DECEMBER 13, 1996+ DOLLAR
TO DECEMBER 31, 1996 SHARES AMOUNT
- --------------------------------------------------------------------------------
<S> <C> <C>
Shares sold........................................... 57,357 $ 582,138
Shares redeemed....................................... (10) (102)
--------- ------------
Net increase.......................................... 57,347 $ 582,036
========= ============
- --------------------------------------------------------------------------------
</TABLE>
+ Prior to December 13, 1996 (commencement of operations), the Fund issued
1,000,000 shares to MLA for $10,000,000.
155
