<PAGE>
As filed with the Securities and Exchange Commission
on May 1, 1997
Registration No. 33-51126
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-4
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
Pre-Effective Amendment No. ___ [ ]
Post-Effective Amendment No. 7 [X]
---
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
Amendment No. 8 [X]
---
(Check appropriate box or boxes)
Separate Account II of National Integrity Life Insurance Company
(Exact Name of Registrant)
National Integrity Life Insurance Company
(Name of Depositor)
515 West Market Street, Louisville, KY 40202
(Address of Depositor's Principal Executive Offices) (Zip Code)
Depositor's Telephone Number, including Area Code (502) 582-7900
----------------
John McGeeney
National Integrity Life Insurance Company
515 West Market Street
Louisville, Kentucky 40202
(Name and Address of Agent for Service)
Approximate Date of Proposed Public Offering: As soon after the effective date
of this Registration Statement as is practicable.
It is proposed that this filing will become effective (check appropriate box)
[X] immediately upon filing pursuant to paragraph (b) of Rule 485
[ ] on (date) pursuant to paragraph (b) of Rule 485
[ ] 60 days after filing pursuant to paragraph (a)(1) of Rule 485
[ ] on (date) pursuant to paragraph (a)(1) of Rule 485
If appropriate, check the following box:
[ ] this post-effective amendment designates a new effective date for a
previously filed post-effective amendment.
The registrant has registered an indefinite amount of securities under the
Securities Act of 1933 pursuant to Rule 24f-2 under the Investment Company Act
of 1940. The Rule 24f-2 Notice for the issuer's most recent fiscal year was
filed on February 19, 1997.
<PAGE>
CROSS REFERENCE SHEET - Pinnacle(version II)
Showing Location in Part A (Prospectus) and Part B (Statement of Additional
Information) of Information required By Form N-4
PART A: INFORMATION REQUIRED IN PROSPECTUS - Pinnacle(version II)
<TABLE>
<CAPTION>
Form N-4 Item No. Location in Prospectus
<S> <C>
1. Cover Page Cover Page
2. Definitions Part 1 - Summary
3. Synopsis Part 1 - Summary; Table of Annual
Fees and Expenses; Examples
4. Condensed Financial Information Part 1 - Financial Information
5. General Description of Registrant, Part 2 - National Integrity and the
Annuity Contracts Separate Account; Part 3 - Your
Investment Options
6. Deductions Part 4 - Deductions and Charges
7. General Description of Variable Part 5 - Terms of Your Variable
Annuity contracts Annuity Contract
8. Annuity Period Part 5 - Terms of Your Variable
Annuity Contract
9. Death Benefit Part 5 - Terms of Your Variable
Annuity Contract
10. Purchases and Contract Value Part 5 - Terms of Your Variable
Annuity Contract
11. Redemptions Part 5 - Terms of Your Variable
Annuity Contract
12. Taxes Part 7 - Tax Aspects of the Contracts
13. Legal Proceedings Not Applicable
14. Table of Contents of the Statement Table of Contents
of Additional Information
</TABLE>
<PAGE>
PART B: INFORMATION REQUIRED IN STATEMENT OF ADDITIONAL
INFORMATION - Pinnacle(version II)
<TABLE>
<CAPTION>
Form N-4 Item No. Location in Statement of Additional
Information
<S> <C>
15. Cover Page Cover Page
16. Table of Contents Cover Page
17. General Information and History Part 1 - National Integrity and
Custodian
18. Services Part 1 - National Integrity and
Custodian
19. Purchase of Securities Being Offered Part 2 - Distribution of the
Contracts
20. Underwriters Part 2 - Distribution of the
Contracts
21. Calculation of Performance Data Part 3 - Performance Information
22. Annuity Payments Part 4 - Determination of Annuity
Unit Values
23. Financial Statements Part 6 - Financial Statements
</TABLE>
<PAGE>
Prospectus
==========
Pinnacle(version II)
Flexible Premium Variable Annuity
issued by National Integrity Life Insurance Company
This prospectus describes a flexible premium variable annuity offered by
National Integrity Life Insurance Company, an indirect wholly owned subsidiary
of ARM Financial Group, Inc. The individual contracts and group certificates
(contracts) offered by this prospectus provide several types of benefits, some
of which have tax-favored status under the Internal Revenue Code of 1986, as
amended. Contributions under the contracts may be allocated to the various
investment divisions of our Separate Account II (Variable Account Options, or
individually, Option) or to our fixed rate Guaranteed Rate Options (GROs), or
both.
Contributions to the Variable Account Options are invested in shares of
corresponding portfolios of The Legends Fund, Inc. (the Fund), and the values
allocated to the Options reflect the investment performance of the Fund's
portfolios. The prospectus for the Fund describes the investment objectives,
policies and risks of each of the Fund's portfolios. There are ten Variable
Account Options available:
Morgan Stanley Asian Growth Harris Bretall Sullivan & Smith Equity
Growth
Morgan Stanley Worldwide High Income Dreman Value
Renaissance Balanced Zweig Equity (Small Cap)
Zweig Asset Allocation Pinnacle Fixed Income
Nicholas-Applegate Balanced ARM Capital Advisors Money Market
Your allocation to a GRO accumulates at a fixed interest rate we declare at the
beginning of the duration you select. A market value adjustment (Market Value
Adjustment) will be made for withdrawals, surrenders, transfers and certain
other transactions before the expiration of your GRO Account, but your value
under a GRO Account may not be decreased below an amount equal to your
allocation plus interest compounded at an annual effective rate of 3% (Minimum
Value), less previous withdrawals and any applicable contingent withdrawal
charges.
This prospectus contains information about the contracts that you should know
before investing. You should read this prospectus and any supplements, and
retain them for future reference. This prospectus is not valid unless provided
with the current prospectus for the Fund, which you should also read.
For further information and assistance, you should contact our Administrative
Office at National Integrity Life Insurance Company, 200 Park Avenue, 20th
Floor, New York, New York 10166. You may also call the following toll-free
number: 1-800-433-1778.
A registration statement relating to the contracts, which includes a Statement
of Additional Information (SAI) dated May 1, 1997, has been filed with the
Securities and Exchange Commission. The SAI is incorporated by reference into
this prospectus. A copy of the SAI is available free of charge by writing to or
calling our Administrative Office. A table of contents for the SAI follows the
table of contents for this prospectus.
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.
The date of this Prospectus is May 1, 1997.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Part 1 - Summary Page
<S> <C>
Your Variable Annuity Contract......................... 1
Your Benefits.......................................... 1
How Your Contract is Taxed............................. 1
Your Contributions..................................... 1
Your Investment Options................................ 1
Variable Account Options............................... 1
Account Value, Adjusted Account Value and Cash Value... 2
Transfers.............................................. 2
Charges and Fees....................................... 2
Withdrawals............................................ 2
Your Initial Right to Revoke........................... 3
Table of Annual Fees and Expenses...................... 4
Financial Information.................................. 7
Part 2 - National Integrity And The Separate Account
National Integrity Life Insurance Company.............. 8
The Separate Account and the Variable Account Options.. 8
Assets of Our Separate Account......................... 8
Changes In How We Operate.............................. 8
Part 3 - Your Investment Options
The Legends Fund....................................... 9
The Fund's Investment Manager and Sub-Advisers......... 9
Investment Objectives of the Portfolios................ 10
Guaranteed Rate Options................................ 13
Renewals of GRO Accounts............................... 13
Market Value Adjustments............................... 14
Part 4 - Deductions and Charges
Separate Account Charges............................... 15
Annual Administrative Charge........................... 15
Fund Charges........................................... 15
State Premium Tax Deduction............................ 15
Contingent Withdrawal Charge........................... 16
Transfer Charge........................................ 16
Tax Reserve............................................ 17
Part 5 - Terms of Your Variable Annuity
Contributions Under Your Contract...................... 17
Your Account Value..................................... 17
Your Purchase of Units in Our Separate Account......... 18
How We Determine Unit Value............................ 18
Transfers.............................................. 19
Withdrawals............................................ 19
Assignments............................................ 19
Death Benefits and Similar Benefit Distributions....... 20
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Page
<S> <C>
Annuity Benefits....................................... 20
Annuities.............................................. 20
Annuity Payments....................................... 21
Timing of Payment...................................... 22
How You Make Requests and Give Instructions............ 22
Part 6 - Voting Rights
Fund Voting Rights..................................... 22
How We Determine Your Voting Shares.................... 23
How Fund Shares Are Voted.............................. 23
Separate Account Voting Rights......................... 23
Part 7 - Tax Aspects of the Contracts
Introduction........................................... 23
Your Contract is an Annuity............................ 24
Taxation of Annuities Generally........................ 24
Distribution-at-Death Rules............................ 25
Diversification Standards.............................. 25
Tax-Favored Retirement Programs........................ 25
Individual Retirement Annuities...................... 26
Tax-Sheltered Annuities.............................. 26
Simplified Employee Pensions......................... 26
Corporate and Self-Employed (H.R. 10 and Keogh)
Pension and Profit Sharing Plans.................... 26
Deferred Compensation Plans of State and Local
Governments and Tax-Exempt Organizations............ 27
Distributions Under Tax-Favored Retirement Programs.... 27
Federal and State Income Tax Withholding............... 28
Impact of Taxes to National Integrity.................. 28
Transfers Among Investment Options..................... 28
Part 8 - Additional Information
Systematic Withdrawals................................. 29
Dollar Cost Averaging.................................. 29
Individual Asset Rebalancing........................... 29
Systematic Contributions............................... 30
Performance Information................................ 30
Appendix A - Illustration of a Market Value Adjustment. 31
</TABLE>
THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFERING IN ANY JURISDICTION IN WHICH
SUCH OFFERING MAY NOT LAWFULLY BE MADE. NO PERSON IS AUTHORIZED TO MAKE ANY
REPRESENTATIONS IN CONNECTION WITH THIS OFFERING OTHER THAN THOSE CONTAINED
IN THIS PROSPECTUS.
<PAGE>
SAI Table of Contents
Part 1 National Integrity and Custodian
Part 2 Distribution of the Contracts
Part 3 Performance Information
Part 4 Determination of Annuity Unit Values
Part 5 Death Benefit Information for Contracts Issued Prior to January 1,
1995
Part 6 Financial Statements
If you would like to receive a copy of the Statement of Additional Information,
please complete the form below and send it to:
Administrative Office
National Integrity Life Insurance Company
200 Park Avenue, 20th Floor
New York, New York 10166
ATTN: Request for SAI of Separate Account II
Name:_____________________________________________________________________
Address:__________________________________________________________________
City:________________________________ State:_________ Zip:________________
<PAGE>
PART 1 -- SUMMARY
Your Variable Annuity Contract
In this prospectus, we, our and us mean National Integrity Life Insurance
Company (National Integrity), a subsidiary of Integrity Life Insurance Company
(Integrity) and an indirect wholly owned subsidiary of ARM Financial Group, Inc.
(ARM). We offer individual variable annuity contracts. In certain states, we
offer certificates under a group variable annuity contract instead of contracts.
When we use the words contract or certificate, we are referring to both the
individual contracts and the group certificates.
You can invest for retirement by purchasing a contract if you properly complete
a Customer Profile form (an application or enrollment form may be required in
some states) and make a minimum initial contribution. In this prospectus, you
and your mean the Annuitant, the person upon whose life the Annuity Benefit and
the Death Benefit are based, usually the Owner of the contract. If the Annuitant
does not own the contract, all of the rights under the contract belong to the
Owner until annuity payments begin.
Your retirement or endowment date (Retirement Date) will be no later than your
85th birthday or the tenth contract anniversary, whichever is later, unless you
notify us of a different date.
Your Benefits
Your contract provides an Account Value, an annuity benefit, and a death
benefit. See "Your Account Value," "Death Benefits and Similar Benefit
Distributions" and "Annuity Benefits" in Part 5.
Your benefits may be received under a contract subject to the usual rules for
taxation of annuities, including the tax-deferral of earnings until withdrawal.
The contract also can provide your benefits under certain tax-favored retirement
programs, which are subject to special rules covering such matters as
eligibility and contribution amounts. See Part 7, "Tax Aspects of the
Contracts" for detailed information.
How Your Contract is Taxed
Under current law, any increases in the value of your contributions to your
contract are tax deferred and will not be included in your taxable income until
withdrawn. See Part 7, "Tax Aspects of the Contracts."
Your Contributions
The minimum initial contribution in most states is currently $10,000.
Subsequent contributions of at least $1,000 can be made. Special rules for lower
minimum initial and subsequent contributions apply for certain tax-favored
retirement plans. See "Contributions Under Your Contract" in Part 5.
Your Investment Options
You may allocate contributions to the Variable Account Options or to the GROs,
or both. The Variable Account Options and the GROs are together referred to as
the Investment Options. Contributions may be allocated to up to nine Investment
Options at any one time. See "Contributions Under Your Contract" in Part 5. To
select Investment Options most suitable for you, see Part 3, "Your Investment
Options."
Variable Account Options
The Variable Account Options (also referred to as Divisions) invest in shares of
corresponding investment portfolios of the Fund, a "series" type of mutual fund.
Each investment portfolio is referred to as a Portfolio. The investment
objective of each Variable Account Option and its corresponding Portfolio is the
same. Your value in a Variable Account Option will vary depending on the
performance of the corresponding Portfolio. For a full description of the Fund,
see the Fund's prospectus and the Fund's Statement of Additional Information.
1
<PAGE>
Account Value, Adjusted Account Value and Cash Value
The sum of your values under GROs plus your values in the Variable Account
Options is referred to as the Account Value. Your Adjusted Account Value is your
Account Value, as increased or decreased (but not below the Minimum Value) by
any Market Value Adjustments. Your Cash Value is equal to your Adjusted Account
Value, reduced by any applicable contingent withdrawal charge and will be
reduced by the pro rata portion of the annual administrative charge, if
applicable. See "Charges and Fees" below.
Transfers
You may transfer all or portions of your Account Value among the Investment
Options, subject to the conditions described under "Transfers" in Part 5.
Transfers from any Investment Option must be for at least $250. Transfers may be
arranged through our telephone transfer service. See Part 5, "Transfers."
Transfers may also be made under special services we offer to dollar cost
average or rebalance your investment in the Variable Account Options. See Part
8, "Additional Information - Dollar Cost Averaging," and "Additional Information
- - Individual Asset Rebalancing."
Charges and Fees
If your Account Value is less than $50,000 as of the last day of any contract
year prior to your Retirement Date, an annual administrative expense charge of
$30 is deducted from your contract. See Part 4, "Deductions and Charges."
A charge at an effective annual rate of 1.35% of the Account Value of the assets
in each Variable Account Option is made daily. We make this charge to cover
mortality and expense risks (1.20%) and certain administrative expenses (.15%).
The charge will never be greater than an effective annual rate of 1.35% of the
Account Value of the assets in each Variable Account Option. If your contract
is issued on or after January 1, 1995, the effective annual rate will reduce to
1.10% after your contract has been in effect for six years. See Part 4,
"Deductions and Charges."
Investment management fees and other expenses are deducted from amounts invested
by the Separate Account in the Fund. For providing investment management
services to the Portfolios of the Fund, ARM Capital Advisors, Inc. (ARM Capital
Advisors), the investment manager of the Fund, receives fees from the Portfolios
ranging from an annual rate of .50% to 1.05% of the average net assets of the
Portfolio. ARM Capital Advisors has entered into a sub-advisory agreement for
each Portfolio except the Money Market Portfolio, and ARM Capital Advisors pays
fees to the sub-advisers ranging from an annual rate of .50% to .90% of average
net assets of each Portfolio. The fees paid to ARM Capital Advisors and the sub-
advisers cannot be increased without the consent of Fund shareholders. See
"Table of Annual Fees and Expenses" below and "The Fund's Investment Manager and
Sub-Advisers" in Part 3.
If you frequently transfer funds from one Investment Option to another, certain
transfers may become subject to a charge. We will not, however, charge more than
$20 per transfer. See "Transfer Charge" in Part 4.
When you make withdrawals from your contract, a contingent withdrawal charge may
be deducted from your Account Value. This sales charge will be in addition to
the Market Value Adjustment applicable to early withdrawals from GRO Accounts.
See "Withdrawals" below and "Guaranteed Rate Options" in Part 3.
Withdrawals
You may make an unlimited number of withdrawals from your contract as frequently
as you wish. Each withdrawal must be for at least $300. A sales charge of up to
7% of the contribution amount withdrawn, in excess of any free withdrawal
amount (defined below), will be deducted from your Account Value, unless one of
the exceptions applies. This charge defrays marketing expenses. See "Contingent
Withdrawal Charge" in Part 4. Most withdrawals made by you prior to age 59-1/2
are also subject to a 10% federal
2
<PAGE>
tax penalty. In addition, some tax-favored retirement programs limit
withdrawals. See Part 7, "Tax Aspects of the Contracts." For partial
withdrawals, the amount deducted from your Account Value will include the
withdrawal amount requested, any applicable Market Value Adjustment, and any
applicable withdrawal charge, so that the net amount you receive will be the
amount requested.
The free withdrawal amount is a non-cumulative amount which you may take as a
partial withdrawal each contract year without being subject to the contingent
withdrawal charge or any Market Value Adjustment. It is equal to the greater of
(i) 10% of the Account Value, minus cumulative prior withdrawals in the current
contract year, and (ii) the investment gain under the contract during the prior
contract year, minus such cumulative withdrawals. However, as explained above,
a tax penalty still applies if you are under age 59-1/2.
Your Initial Right to Revoke
Within ten days after you receive your contract, you may cancel it by returning
it to our Administrative Office. The 10-day period may be extended if required
by state law. We will refund all your contributions with an adjustment for any
investment gain or loss on the contributions put into each Variable Account
Option from the date units were purchased until the date your contract is
received by us, including any charges deducted. If state law instead requires a
refund of your contributions without any adjustment, we will return that amount
to you. For allocations to any of the GROs, we will refund to you the amount of
your contributions.
3
<PAGE>
Table of Annual Fees and Expenses
Contract Owner Transaction Expenses
- -----------------------------------
Sales Load on Purchases..........................$0
Deferred Sales Load (1)..................7% Maximum
Exchange Fee (2).................................$0
Annual Administrative Charge (3)................$30
Separate Account Annual Expenses (as a
percentage of average account value) (4)
- ----------------------------------------
Mortality and Expense Risk Fees............. 1.20%
Administrative Expenses..................... .15%
-----
Total Separate Account Annual Expenses...... 1.35%
=====
Fund Annual Expenses After Reimbursement
(as a percentage of average net assets) (5)
- -------------------------------------------
<TABLE>
<CAPTION>
Management Other Total Annual
Portfolio Fees Expenses (5) Expenses (5)
- --------- ---------- ------------ ------------
<S> <C> <C> <C>
Morgan Stanley Asian Growth.................... 1.00% 1.00% 2.00%
Morgan Stanley Worldwide High Income........... .85% 1.00% 1.85%
Renaissance Balanced........................... .65% .36% 1.01%
Zweig Asset Allocation......................... .90% .36% 1.26%
Nicholas-Applegate Balanced.................... .65% .34% .99%
Harris Bretall Sullivan & Smith Equity Growth.. .65% .40% 1.05%
Dreman Value................................... .65% .50% 1.15%
Zweig Equity (Small Cap)....................... 1.05% .50% 1.55%
Pinnacle Fixed Income.......................... .70% .50% 1.20%
ARM Capital Advisors Money Market.............. .50% .50% 1.00%
</TABLE>
- -------------------------
(1) See "Deductions and Charges - Contingent Withdrawal Charge" in Part 4. You
may make a partial withdrawal of up to 10% of the Account Value in any contract
year or the investment gain under the contract during the previous contract
year, whichever is greater, less withdrawals during the current contract year,
without assessment of any withdrawal charge.
(2) After the first twelve transfers during a contract year, National Integrity
has the right to impose a transfer charge of $20 per transfer. This charge would
not apply to transfers made for dollar cost averaging or individual asset
rebalancing. See "Deductions and Charges - Transfer Charge" in Part 4.
(3) The annual administrative charge is $30. This charge applies only if the
Account Value is less than $50,000 at the end of any contract year prior to your
Retirement Date. See "Deductions and Charges - Annual Administrative Charge" in
Part 4.
(4) See "Deductions and Charges - Separate Account Charges" in Part 4. If your
contract is issued on or after January 1, 1995, Mortality and Expense Risk Fees
will reduce to .95% so that Total Separate Account Annual Expenses will then be
1.10% after your contract has been in effect for six years.
4
<PAGE>
(5) The Fund's expenses for the fiscal year ended June 30, 1996 have been
restated due to material changes in the annual expense structure. The Manager of
the Fund has agreed to reimburse each of the Portfolios for operating expenses
(excluding management fees) above an annual rate of 1.00% of average net assets
for Morgan Stanley Asian Growth Portfolio and Morgan Stanley Worldwide High
Income Portfolio, and above an annual rate of .50% of average net assets for all
other Portfolios. Without reimbursements, total annual restated expenses for the
Funds's fiscal year ended June 30, 1996 would have been 2.77% for the Morgan
Stanley Asian Growth Portfolio, 2.17% for the Morgan Stanley Worldwide High
Income Portfolio, 1.19% for the Dreman Value Portfolio, 1.88% for the Zweig
Equity (Small Cap) Portfolio, 1.48% for the Pinnacle Fixed Income Portfolio, and
1.39% for the ARM Capital Advisors Money Market Portfolio. The Manager has
reserved the right to withdraw or modify its policy of expense reimbursement for
the Portfolios, but has no current intention to do so during 1997. In the Fund's
prospectus, see "Management of the Fund."
Examples
The examples below show the expenses that would be borne by the Annuitant per
$1,000 investment, assuming a $60,000 average contract value and a 5% annual
rate of return on assets.
Expenses per $1,000 investment if you surrender your contract at the end of the
- -------------------------------------------------------------------------------
applicable period:
- ------------------
<TABLE>
<CAPTION>
Option 1 year 3 years 5 years 10 years
- ------ ------- ------- ------- --------
<S> <C> <C> <C> <C>
Morgan Stanley Asian Growth.................... $104.83 $155.96 $209.12 $371.28
Morgan Stanley Worldwide High Income........... $103.29 $151.44 $201.75 $357.40
Renaissance Balanced........................... $ 94.68 $125.86 $159.54 $275.61
Zweig Asset Allocation......................... $ 97.24 $133.52 $172.26 $300.69
Nicholas-Applegate Balanced.................... $ 94.48 $125.24 $158.52 $273.57
Harris Bretall Sullivan & Smith Equity Growth.. $ 95.09 $127.08 $161.59 $279.66
Dreman Value................................... $ 96.12 $130.15 $166.68 $289.73
Zweig Equity (Small Cap)....................... $100.22 $142.36 $186.85 $328.99
Pinnacle Fixed Income.......................... $ 96.63 $131.68 $169.22 $294.73
ARM Capital Advisors Money Market.............. $ 94.58 $125.55 $159.03 $274.59
</TABLE>
5
<PAGE>
Expenses per $1,000 investment if you do not surrender your contract at the end
- -------------------------------------------------------------------------------
of the applicable period:
- -------------------------
<TABLE>
<CAPTION>
Option 1 year 3 years 5 years 10 years
- ------ ------ ------- ------- --------
<S> <C> <C> <C> <C>
Morgan Stanley Asian Growth.................... $34.83 $105.96 $179.12 $371.28
Morgan Stanley Worldwide High Income........... $33.29 $101.44 $171.75 $357.40
Renaissance Balanced........................... $24.68 $ 75.86 $129.54 $275.61
Zweig Asset Allocation......................... $27.24 $ 83.52 $142.26 $300.69
Nicholas-Applegate Balanced.................... $24.48 $ 75.24 $128.52 $273.57
Harris Bretall Sullivan & Smith Equity Growth.. $25.09 $ 77.08 $131.59 $279.66
Dreman Value................................... $26.12 $ 80.15 $136.68 $289.73
Zweig Equity (Small Cap)....................... $30.22 $ 92.36 $156.85 $328.99
Pinnacle Fixed Income.......................... $26.63 $ 81.68 $139.22 $294.73
ARM Capital Advisors Money Market.............. $24.58 $ 75.55 $129.03 $274.59
</TABLE>
Expenses per $1,000 investment if you elect the normal form of annuity at the
- -----------------------------------------------------------------------------
end of the applicable period:
- -----------------------------
Same expenses per $1,000 investment as shown in table above.
These examples assume the current level of fixed charges that are borne by the
Separate Account and the investment management fees and other expenses of the
Fund as they were for the fiscal year ended June 30, 1996. Actual Fund expenses
may be greater or less than those on which these examples were based. The annual
rate of return assumed in the examples is not an estimate or guarantee of future
investment performance. The table also assumes an estimated $60,000 average
contract value, so that the administrative charge per $1,000 of net asset value
in the Separate Account is $0.50. Such per $1,000 charge would be higher for
smaller Account Values and lower for higher values.
The above table and examples are intended to assist your understanding of the
various costs and expenses that apply to your contract, directly or indirectly.
These tables reflect expenses of the Separate Account as well as those of the
Portfolios. Premium taxes upon annuitization also may be applicable.
6
<PAGE>
Financial Information
The table below shows the unit value for each Variable Account Option at
inception, the number of units outstanding at December 31 of each year since
inception, and the unit value at the beginning and end of each period.
<TABLE>
<CAPTION>
Year Ended December 31
1996 1995 1994 1993 Inception*
-------- -------- -------- -------- ----------
<S> <C> <C> <C> <C> <C>
Morgan Stanley Asian Growth Division
Unit value at beginning of period........................ $10.07 $9.21 - - $10.00
Unit value at end of period.............................. $10.48 $10.07 $9.21 -
Number of units outstanding at end of period............. 331,807 240,475 241,331 -
Morgan Stanley Worldwide High Income Division
Unit value at beginning of period........................ $11.23 $9.44 - - $10.00
Unit value at end of period.............................. $13.79 $11.23 $9.44 -
Number of units outstanding at end of period............. 69,613 30,033 36,427 -
Renaissance Balanced Division
Unit value at beginning of period........................ $12.83 $10.49 $11.01 - $10.00
Unit value at end of period.............................. $13.84 $12.83 $10.49 $11.01
Number of units outstanding at end of period............. 591,461 685,870 549,857 197,669
Zweig Asset Allocation Division
Unit value at beginning of period........................ $12.75 $10.65 $10.75 - $10.00
Unit value at end of period.............................. $14.45 $12.75 $10.65 $10.75
Number of units outstanding at end of period............. 389,517 421,439 535,776 205,268
Nicholas-Applegate Balanced Division
Unit value at beginning of period........................ $13.15 $11.11 $11.28 - $10.00
Unit value at end of period.............................. $14.97 $13.15 $11.11 $11.28
Number of units outstanding at end of period............. 779,102 797,185 753,834 341,488
Harris Bretall Sullivan & Smith Equity Growth Division
Unit value at beginning of period........................ $13.08 $10.07 $9.81 - $10.00
Unit value at end of period.............................. $14.71 $13.08 $10.07 $9.81
Number of units outstanding at end of period............. 438,465 374,724 280,091 83,619
Dreman Value Division
Unit value at beginning of period........................ $14.98 $10.43 $10.65 - $10.00
Unit value at end of period.............................. $18.39 $14.98 $10.43 $10.65
Number of units outstanding at end of period............. 297,625 244,538 156,325 80,112
Zweig Equity (Small Cap) Division
Unit value at beginning of period........................ $12.57 $10.52 $10.73 - $10.00
Unit value at end of period.............................. $14.69 $12.57 $10.52 $10.73
Number of units outstanding at end of period............. 138,864 234,629 180,961 68,249
Pinnacle Fixed Income Division
Unit value at beginning of period........................ $11.43 $9.90 $10.43 - $10.00
Unit value at end of period.............................. $11.48 $11.43 $9.90 $10.43
Number of units outstanding at end of period............. 132,283 143,799 142,037 84,916
ARM Capital Advisors Money Market Division
Unit value at beginning of period........................ $10.54 $10.18 $10.02 - $10.00
Unit value at end of period.............................. $10.86 $10.54 $10.18 $10.02
Number of units outstanding at end of period............. 123,973 336,264 190,506 97,936
</TABLE>
* Inception Dates for the Variable Account Options were January 13, 1993 for all
Options except for the Morgan Stanley Asian Growth and Morgan Stanley
Worldwide High Income Options, which were June 15, 1994.
7
<PAGE>
PART 2 - NATIONAL INTEGRITY AND THE SEPARATE ACCOUNT
National Integrity Life Insurance Company
National Integrity is a stock life insurance company organized under the laws of
New York. Our home office is in New York, New York. We are authorized to sell
life insurance and annuities in eight states and the District of Columbia. In
addition to the contracts, we sell flexible premium annuity contracts with an
underlying investment medium other than the Fund, and fixed single premium
annuity contracts. We are currently licensed to sell variable contracts in five
states. In addition to issuing annuity products, we have entered into agreements
with other insurance companies to provide administrative and investment support
for products to be designed, underwritten and sold by these companies.
National Integrity is an indirect wholly owned subsidiary of ARM. ARM
specializes in the asset accumulation business, providing retail and
institutional customers with products and services designed to serve the growing
long-term savings and retirement markets. At December 31, 1996, ARM had $4.8
billion of assets under management.
The Separate Account and the Variable Account Options
The Separate Account is established and maintained under the insurance laws of
the State of New York. It is a unit investment trust registered with the
Securities and Exchange Commission (the SEC) under the Investment Company Act of
1940 (1940 Act). A unit investment trust is a type of investment company. SEC
registration does not involve any supervision by the SEC of the management or
investment policies of the Separate Account. Each Variable Account Option
invests in shares of a corresponding Portfolio of the Fund. We may establish
additional Options, some of which may not be available for your allocations. The
Variable Account Options currently available to you are listed on the cover page
of this prospectus.
Assets of Our Separate Account
Under New York law, we own the assets of our Separate Account and use them to
support the variable portion of your contract and other variable annuity
contracts. Annuitants under other variable annuity contracts will participate in
the Separate Account in proportion to the amounts relating to their contracts.
The Separate Account's assets supporting the variable portion of these variable
contracts may not be used to satisfy liabilities arising out of any other
business of ours. Under certain unlikely circumstances, one Variable Account
Option may be liable for claims relating to the operations of another Option.
Income, gains and losses, whether or not realized, from assets allocated to the
Separate Account are credited to or charged against the Separate Account without
regard to our other income, gains or losses. We may permit charges owed to us to
stay in the Separate Account, and thus may participate proportionately in the
Separate Account. Amounts in the Separate Account in excess of reserves and
other liabilities belong to us, and we may transfer them to our general account
(General Account).
Changes In How We Operate
We may modify how we or our Separate Account operate, subject to your approval
when required by the 1940 Act or other applicable law or regulation. You will be
notified if any changes result in a material change in the underlying
investments of a Variable Account Option. We may:
- - add Options to, or remove Options from, our Separate Account, combine two
or more Options within our Separate Account, or withdraw assets relating to
your contract from one Option and put them into another;
- - register or end the registration of the Separate Account under the 1940
Act;
- - operate our Separate Account under the direction of a committee or
discharge such a committee at any time (the committee may be composed of a
majority of persons who are "interested persons" of National Integrity
under the 1940 Act);
8
<PAGE>
- - restrict or eliminate any voting rights of Owners or others who have voting
rights that affect our Separate Account;
- - cause one or more Options to invest in a mutual fund other than or in
addition to the Fund;
- - operate our Separate Account or one or more of the Options in any other
form the law allows, including a form that allows us to make direct
investments. We may make any legal investments we wish. In choosing these
investments, we will rely on our own or outside counsel for advice.
PART 3 - YOUR INVESTMENT OPTIONS
The Legends Fund
The Legends Fund, Inc., a Maryland corporation (the Fund), is an open-end
diversified management investment company registered under the 1940 Act. Such
registration does not involve supervision by the SEC of the investments or
investment policies of the Fund. The Fund is a "series" type of investment
company with diversified portfolios. The Fund does not impose a sales charge or
"load" for buying and selling its shares. The shares of the Portfolios of the
Funds are bought and sold by the Separate Account at their respective net asset
values.
The Fund is designed to serve as an investment vehicle for variable annuity and
variable life contracts of insurance companies. Shares of the Portfolios of the
Fund currently are available to the separate accounts of National Integrity and
Integrity, the parent of National Integrity.
Shares of Portfolios of the Fund are made available to the Separate Account
under a Participation Agreement (Participation Agreement). The Participation
Agreement is among the Fund, ARM Securities Corporation (ARM Securities), a
wholly owned subsidiary of ARM which is the principal underwriter for Fund
shares, and National Integrity. If state or federal law precludes the sale of
the Fund's or any Portfolio's shares to the Separate Account, or in certain
other circumstances, sales of shares to the Separate Account may be suspended
and/or the Participation Agreement may be terminated as to the Fund or the
affected Portfolio. Also, the Participation Agreement may be terminated by any
party thereto with one year's written notice.
Notwithstanding termination of the Participation Agreement, the Fund and ARM
Securities are obligated to continue to make the Fund's shares available for
contracts outstanding on the date the Participation Agreement terminates, unless
the Participation Agreement was terminated due to an irreconcilable conflict
among contract owners of different separate accounts. If for any reason the
shares of any Portfolio are no longer available for purchase by the Separate
Account for outstanding contracts, the parties to the Participation Agreement
have agreed to cooperate to comply with the 1940 Act in arranging for the
substitution of another funding medium as soon as reasonably practicable and
without disruption of sales of shares to the Separate Account or any Variable
Account Option.
The Fund's Investment Manager and Sub-Advisers. ARM Capital Advisors became the
investment adviser to the Fund on February 1, 1996. ARM Capital Advisors is a
wholly owned subsidiary of ARM registered as an investment adviser under the
Investment Advisers Act of 1940. Its offices are located at 200 Park Avenue,
20th Floor, New York, New York 10166. It is the intention of ARM Capital
Advisors to change its name to Integrity Capital Advisors, Inc., during the
calendar year 1997.
9
<PAGE>
ARM Capital Advisors has entered into a sub-advisory agreement with a
professional manager for investment of the assets of each of the Portfolios,
except for the Money Market Portfolio. The sub-adviser for each Portfolio is
listed under "Investment Objectives of the Portfolios" below. The Portfolios pay
monthly investment management fees to ARM Capital Advisors, and ARM Capital
Advisors pays the sub-advisers for their services to the Portfolios. ARM Capital
Advisors retains a management fee at an annual rate between .15% and .20% of
Portfolio net assets (depending upon Portfolio) as compensation for providing
certain services to the Portfolios (except that ARM Capital Advisors retains the
full management fee for the ARM Capital Advisors Money Market Portfolio which it
manages directly without a sub-adviser.) The management fees paid by each
Portfolio to ARM Capital Advisors as a percentage of net assets are set forth
below:
Portfolio Management Fee
--------- --------------
Morgan Stanley Asian Growth.................... 1.00%
Morgan Stanley Worldwide High Income........... .85%
Renaissance Balanced........................... .65%
Zweig Asset Allocation......................... .90%
Nicholas-Applegate Balanced.................... 65%
Harris Bretall Sullivan & Smith Equity Growth.. .65%
Dreman Value................................... .65%
Zweig Equity (Small Cap)....................... 1.05%
Pinnacle Fixed Income.......................... .70%
ARM Capital Advisors Money Market.............. .50%
Investment Objectives of the Portfolios. Set forth below is a summary of the
investment objectives of the Portfolios of the Fund. There can be no assurance
that these objectives will be achieved. You should read the Fund's prospectus
carefully before investing.
Morgan Stanley Asian Growth Portfolio
-------------------------------------
Morgan Stanley Asian Growth Portfolio seeks long-term capital appreciation
through investment primarily in the common stocks of Asian issuers, excluding
Japan. The production of any current income is incidental to this objective.
Under normal market conditions, the Portfolio will invest at least 65% of the
value of its total assets in common stocks that are traded on recognized stock
exchanges of Asian countries and in common stocks of companies organized under
the laws of an Asian country whose business is conducted principally in Asia.
The remaining portion of the Portfolio will be kept in any combination of debt
instruments, bills and bonds of governmental entities in Asia and the United
States, in notes, debentures and bonds of companies in Asia and in money market
instruments of the United States. The Portfolio does not intend to invest in
securities which are traded in markets in Japan or in companies organized under
the laws of Japan. Morgan Stanley Asset Management Inc. is the sub-adviser to
the Portfolio.
Morgan Stanley Worldwide High Income Portfolio
----------------------------------------------
Morgan Stanley Worldwide High Income Portfolio seeks high current income
consistent with relative stability of principal and, secondarily, capital
appreciation through investing primarily in a portfolio of high-yielding fixed-
income securities of issuers located throughout the world. The Portfolio seeks
to achieve its investment objective by allocating its assets among any or all
of three investment sectors: U.S. corporate lower-rated and unrated debt
securities, emerging country debt securities and global fixed-income securities
offering high real yields. Under normal conditions, the Portfolio will invest
between 80% and 100% of its total assets in some or all of these three
categories of higher yielding securities, some of which may entail increased
credit and market risk. The Portfolio may invest a portion of its assets, which
may be up to 100% of its total assets, in lower-rated and unrated bonds ("junk
bonds") considered to be speculative with regard to the payment of interest and
return of principal, and purchasers should carefully assess the risks
associated with an investment in this Portfolio. Additional
10
<PAGE>
information concerning the investment objectives and policies of the Morgan
Stanley Worldwide High Income Portfolio can be found in the Fund's prospectus,
which should be read carefully before making any allocation to this Portfolio.
Morgan Stanley Asset Management Inc. is the sub-adviser to the Portfolio.
Renaissance Balanced Portfolio
------------------------------
Renaissance Balanced Portfolio seeks capital appreciation and income in rising
markets and the preservation of capital in declining markets. Its assets are
allocated among common stocks of issuers with large capitalizations, United
States government and high-quality corporate debt securities, and high quality
cash equivalent issues, such as commercial paper. Equity investments will
generally range from 10% to 75% of the total assets in the Portfolio, and under
normal market conditions at least 25% of total assets will be invested in
senior fixed income securities. Renaissance Investment Management is the sub-
adviser to the Portfolio.
Zweig Asset Allocation Portfolio
--------------------------------
Zweig Asset Allocation Portfolio seeks long-term capital appreciation. It
invests primarily in Blue Chip Stocks, consistent with preservation of capital
and the reduction of portfolio exposure to market risk, as determined by the
sub-adviser to the Portfolio. Blue Chip Stocks are stocks which the sub-adviser
considers comparable to the stocks included in the S&P 500 at the time of
purchase, and that have a minimum of $400 million market capitalization,
average daily trading volume of 50,000 shares or $425 million in total assets,
and which are traded on the New York Stock Exchange (NYSE), American Stock
Exchange (AMEX), over-the-counter (OTC) or on foreign exchanges. Zweig/Glaser
Advisers is the sub-adviser to the Portfolio.
Nicholas-Applegate Balanced Portfolio
-------------------------------------
Nicholas-Applegate Balanced Portfolio seeks maximum total return in both the
equity and fixed income portion of its investments. Under normal market
conditions, the Portfolio will have 60% to 65% of its total assets invested in
equity securities, including common stocks and securities convertible into or
exchangeable for common stocks (such as convertible preferred stocks and
convertible debentures). The remaining 35% to 40% of total assets will be
invested in United States government securities or cash equivalent issues.
Nicholas-Applegate Capital Management is the sub-adviser to the Portfolio.
Harris Bretall Sullivan & Smith Equity Growth Portfolio
-------------------------------------------------------
Harris Bretall Sullivan & Smith Equity Growth Portfolio seeks long-term capital
appreciation. It primarily invests in stocks of established companies with
proven records of superior and consistent growth. The Portfolio may invest all
or a portion of its assets in cash and cash equivalents if the sub-adviser
considers the equity markets to be overvalued. The Portfolio may invest in U.S.
government securities when this appears desirable in light of the Portfolio's
investment objective or when market conditions warrant. Harris Bretall Sullivan
& Smith, Inc. is the sub-adviser to the Portfolio.
Dreman Value Portfolio
----------------------
Dreman Value Portfolio seeks primarily long-term capital appreciation with a
secondary objective of current income. It invests principally in a diversified
portfolio of securities believed by the sub-adviser to be undervalued. The sub-
adviser's philosophy centers on identifying stocks of large, well-known
companies with solid financial strength and generous dividend yields that have
low price-earnings ratios and have been generally overlooked by the market.
Dreman Value Advisors, Inc. is the sub-adviser to the Portfolio.
11
<PAGE>
Zweig Equity (Small Cap) Portfolio
----------------------------------
Zweig Equity (Small Cap) Portfolio seeks long-term capital appreciation. It
invests primarily in Small Company Stocks, consistent with preservation of
capital and reduction of portfolio exposure to market risk, as determined by
the sub-adviser. Current income is not an objective. Small Company Stocks are
the 2,500 stock positions immediately after the 500 largest stocks ranked in
terms of market capitalization and/or trading volume, and which are traded on
the NYSE, AMEX, OTC or on foreign exchanges. Zweig/Glaser Advisers is the sub-
adviser to the Portfolio.
Pinnacle Fixed Income Portfolio
-------------------------------
Pinnacle Fixed Income Portfolio seeks as high a level of current income as is
consistent with the preservation of capital. It invests primarily in corporate
debt securities; U.S. Government securities (including mortgage-backed
securities issued by the Government National Mortgage Association, the Federal
National Mortgage Association, and the Federal Home Loan Mortgage Corporation);
obligations of other governmental issuers such as the Federal Farm Credit
System and the Federal Home Loan Banks; asset-backed securities; repurchase
agreements with respect to securities in which the Portfolio may invest; and
instruments used in certain hedging and related income strategies. The
Portfolio may also invest in certain private placements and in debt securities
of foreign governments and governmental entities. The Portfolio will
principally invest in securities rated at least investment grade, or, if not
rated, determined by the sub-adviser to be of comparable quality. However, the
Portfolio may invest up to 15% of its total assets in securities rated below
investment grade or of equivalent quality, if not rated, including defaulted
securities. J.P. Morgan Investment Management Inc. is the sub-adviser to the
Portfolio.
ARM Capital Advisors Money Market Portfolio
-------------------------------------------
ARM Capital Advisors Money Market Portfolio seeks maximum current income
consistent with liquidity and conservation of capital. It invests in high grade
money market instruments, with remaining maturities of 13 months or less, and
repurchase agreements secured by such instruments, and maintains a dollar-
weighted average portfolio maturity of 90 days or less. ARM Capital Advisors is
the adviser to the Portfolio.
12
<PAGE>
Guaranteed Rate Options
Because of applicable exemptive and exclusionary provisions, interests in
contracts attributable to GROs have not been registered under the Securities
Act of 1933 ("1933 Act"), nor under the Investment Company Act of 1940 ("1940
Act"). Thus, neither such contracts nor our General Account, which guarantees
the values and benefits under those contracts, are generally subject to
regulation under the provisions of the 1933 Act or the 1940 Act. Accordingly,
we have been advised that the staff of the Securities and Exchange Commission
has not reviewed the disclosure in this prospectus relating to the GROs or the
General Account. Disclosures regarding the GROs or the General Account may,
however, be subject to certain generally applicable provisions of the Federal
securities laws relating to the accuracy and completeness of statements made in
prospectuses.
We offer GROs with durations of two, four, six and ten years. We may from time
to time change the durations available. Each allocation to a GRO locks in a
fixed effective annual interest rate declared by us (Guaranteed Interest Rate)
for the duration you select (your GRO Account). The duration of your GRO
Account is the Guarantee Period. Each contribution or transfer to a GRO
establishes a new GRO Account at the then-current Guaranteed Interest Rate
declared by us. We will not declare an interest rate less than 3%. Each GRO
Account expires at the end of the duration you have selected. See "Renewals of
GRO Accounts" below. Values and benefits under your contract attributable to
GROs are guaranteed by the reserves in our GRO separate account as well as by
our General Account.
The value of each of your GRO Accounts is referred to as a GRO Value. The GRO
Value at the expiration of the GRO Account, assuming you have not transferred
or withdrawn any amounts, will be the amount allocated plus interest at the
Guaranteed Interest Rate. We credit interest daily at an effective annual rate
equal to the Guaranteed Interest Rate. We allocate interest at the end of each
contract year and at the time of any transfer, full or partial withdrawal,
payment of a death benefit or purchase of any annuity benefit.
We may declare a higher rate of interest in the first year for any Contribution
allocated to a GRO which will exceed the Guaranteed Interest Rate credited
during the remaining years of the Guarantee Period (Enhanced Rate). This
Enhanced Rate will be guaranteed for the Guaranteed Period's first year and
declared at the time of purchase. We reserve the right to declare and credit
additional interest based on Contribution, Account Value, withdrawal dates,
economic conditions or on any other lawful, nondiscriminatory basis (Additional
Interest). Any Enhanced Rate and Additional Interest credited to your GRO
Account will be separate from the Guaranteed Interest Rate and not used in the
Market Value Adjustment formula. The Enhanced Rate or Additional Interest may
not be made applicable under contracts issued in certain states.
Each group of GRO Accounts of the same duration is referred to as a GRO, (i.e.
all of your two-year GRO Accounts are one GRO while all of your four-year GRO
Accounts are another GRO).
You may obtain information about our current Guaranteed Interest Rates by
calling our Administrative Office.
Allocations to GROs may not be made under contracts issued in certain states.
Renewals of GRO Accounts. When a GRO Account expires, a new GRO Account of the
same duration, at the then-current Guaranteed Interest Rate, will be
established unless you withdraw your GRO Value or transfer it to another
Investment Option. We will notify you in writing before the expiration of your
GRO Accounts. You must notify us prior to the expiration of your GRO Accounts
of any changes you desire to make. See "Transfers" in Part 5.
Any renewal of a GRO Account will be implemented on the expiration date of the
GRO Account. You will receive the current Guaranteed Interest Rate applicable
on the expiration date. If a GRO Account expires and it cannot be renewed for
the same duration, it will be renewed for the next shortest
13
<PAGE>
available duration, unless you instruct us otherwise within 30 days prior to
expiration of the GRO Account. You may not choose, and we will not renew, a GRO
Account that expires after your Retirement Date.
Market Value Adjustments. A Market Value Adjustment is an adjustment, either up
or down, in your GRO Value prior to the expiration of your GRO Account. A
Market Value Adjustment will be made for each transfer, partial withdrawal in
excess of the free withdrawal amount, surrender, or purchase of an annuity
benefit from a GRO Account that occurs other than within 30 days prior to the
expiration of the GRO Account. There will be no Market Value Adjustment made
for a death benefit. The market adjusted value may be higher or lower than the
GRO Value. In no event, however, may the market adjusted value in each GRO
Account be less than the Minimum Value, an amount equal to your allocation to
such GRO Account plus 3% interest, compounded annually, less previous
withdrawals from such GRO Account and less any applicable contingent withdrawal
charges. The Minimum Value for partial withdrawals or transfers will be
calculated on a pro-rata basis.
The Market Value Adjustment applicable to a GRO Account prior to its expiration
reflects the relationship between the Guaranteed Interest Rate for such GRO
Account and the then-current Guaranteed Interest Rate applicable to a newly
elected GRO Account of a duration equal to the time remaining in your GRO
Account. The Market Value Adjustment will reduce the GRO Value (but not below
the Minimum Value) if the current Guaranteed Interest Rate is higher than the
Guaranteed Interest Rate being credited to amounts under your GRO Account.
Conversely, the Market Value Adjustment will increase the GRO Value if the
current Guaranteed Interest Rate is lower than the Guaranteed Interest Rate
being credited to amounts under your GRO Account.
The Market Value Adjustment (MVA) for a GRO Account is determined under the
following formula:
MVA = GRO Value x [(1 + A)/N/12/ / (1 + B + .0025)/N/12/ - 1], where
A is the Guaranteed Interest Rate being credited to the GRO Account subject
to the Market Value Adjustment,
B is the current Guaranteed Interest Rate, as of the effective date of the
application of the Market Value Adjustment, for current allocations to a
GRO Account, the length of which is equal to the number of whole months
remaining in your GRO Account. Subject to certain adjustments, if such
remaining period is not equal to an exact period for which we have declared
a new Guaranteed Interest Rate, B will be determined by interpolating
between the Guaranteed Interest Rates for GRO Accounts of durations closest
to (next higher and next lower) the remaining period described above.
N is the number of whole months remaining in your GRO Account.
For contracts issued in certain states, the formula above will be adjusted to
comply with applicable state requirements.
If the remaining term of your GRO Account is 30 days or less, the Market Value
Adjustment for your GRO Account shall be zero. If for any reason we are no
longer declaring current Guaranteed Interest Rates, then for purposes of
determining B we will use the yield to maturity of United States Treasury Notes
with the same remaining term as your GRO Account, interpolating when necessary,
in place of the current Guaranteed Interest Rate or Rates.
For illustrations of the application of the Market Value Adjustment formula,
see Appendix A.
14
<PAGE>
PART 4 -- DEDUCTIONS AND CHARGES
Separate Account Charges
National Integrity deducts from the unit value every calendar day an amount
equal to an effective annual rate of 1.35% of the Account Value in the Variable
Account Options. This daily expense rate cannot be increased without your
consent. If your contract is issued on or after January 1, 1995, the effective
annual rate will reduce to 1.10% after your contract has been in effect for six
years. Various portions of this total charge, as described below, pay for
certain services to the Separate Account and the contracts.
A daily charge equal to an effective annual rate of .15% of the value of each
Variable Account Option is deducted for administrative expenses not covered by
the annual administrative charge described below. The daily administrative
charge, like the annual administrative charge, is designed to reimburse
National Integrity for expenses actually incurred, without profit.
A daily charge equal to an effective annual rate of 1.20% of the value of each
Variable Account Option is deducted for National Integrity's assuming the
expense risk (.85%) and the mortality risk (.35%) under the contract. If your
contract is issued on or after January 1, 1995, the effective annual rate will
reduce to .95% after your contract has been in effect for six years, of which
.60% covers expense risk and .35% covers mortality risk. The expense risk is
the risk that our actual expenses of administering the contracts will exceed
the annual administrative expense charge. In this context, mortality risk
refers to the cost of insuring the risk National Integrity takes that
annuitants, as a class of persons, will live longer than estimated and
therefore require National Integrity to pay out more annuity benefits than
anticipated. The relative proportion of the mortality and expense risk charges
may be modified, but the total effective annual risk charge of 1.20% of the
value of the Variable Account Options may not be increased on your Contract.
National Integrity may realize a gain from these daily charges to the extent
they are not needed to meet the actual expenses incurred.
Annual Administrative Charge
If your Account Value is less than $50,000 on the last day of any contract year
prior to the your Retirement Date, National Integrity charges an annual
administrative charge of $30. This charge is deducted from your Account Value
in each Investment Option on a pro-rata basis. The portion of the charge
applicable to the Variable Account Options will reduce the number of units
credited to you. The portion of the charge applicable to the GROs is withdrawn
in dollars. The annual administrative charge will be pro-rated based on the
number of days that have elapsed in the contract year in the event of the
Annuitant's retirement, death, or termination of a contract during a contract
year.
Fund Charges
Our Separate Account purchases shares of the Fund at net asset value. That
price reflects investment management fees and other direct expenses that have
already been deducted from the assets of the Fund. The amount charged for
investment management may not be increased without the prior approval of the
Fund's shareholders. See "The Legends Fund" in Part 3.
State Premium Tax Deduction
National Integrity will not deduct state premium taxes from your contributions
before applying the contributions to the Investment Options, unless required to
pay such taxes under applicable state law. If the Annuitant elects an annuity
benefit, National Integrity will deduct any applicable state premium taxes from
the amount otherwise available for an annuity benefit. State premium taxes, if
applicable, currently range up to 4%.
15
<PAGE>
Contingent Withdrawal Charge
No sales charges are applied when you make a contribution to the contract.
Contributions withdrawn will be subject to a withdrawal charge of up to 7%. As
shown below, the percentage charge varies, depending upon the "age" of the
contributions included in the withdrawal-that is, the contract year in which
each contribution was made. The maximum percentage of 7% would apply if the
entire amount of the withdrawal consisted of contributions made during your
current contract year. No withdrawal charge applies when you withdraw
contributions made earlier than your fifth prior contract year. For purposes of
calculating the withdrawal charge, (1) the oldest contributions will be treated
as the first withdrawn and more recent contributions next, and (2) partial
withdrawals up to the free withdrawal amount will not be considered a
withdrawal of any contributions. For partial withdrawals, the total amount
deducted from your Account Value will include the withdrawal amount requested,
any applicable Market Value Adjustment and any applicable withdrawal charge, so
that the net amount you receive will be the amount requested.
During any contract year, no charge will be applied to your partial withdrawals
that do not exceed the free withdrawal amount. On any Business Day, the free
withdrawal amount is the greater of (i) 10% of your Account Value and (ii) any
investment gain during the prior contract year, less withdrawals during the
current contract year. Investment gain is calculated as the increase in the
Account Value during the prior contract year, minus contributions during such
year, plus withdrawals made during such year. If any partial withdrawal
exceeds the free withdrawal amount, we will deduct the applicable contingent
withdrawal charge with respect to such excess amount. The contingent withdrawal
charge is a sales charge to defray our costs of selling and promoting the
contracts. We do not expect that revenues from contingent withdrawal charges
will cover all of such costs. Any shortfall will be made up from our General
Account assets, including any profits from other charges under the contracts.
<TABLE>
<CAPTION>
Contract Year in Which Charge as a % of the
Withdrawn Contribution Was Made Contribution Withdrawn
------------------------------- ----------------------
<S> <C>
Current.................. 7%
First Prior.............. 6
Second Prior............. 5
Third Prior.............. 4
Fourth Prior............. 3
Fifth Prior.............. 2
Sixth Prior and Earlier.. 0
</TABLE>
No contingent withdrawal charge will be applied to any amount withdrawn if the
Annuitant uses the withdrawal either to purchase from National Integrity an
immediate annuity benefit with life contingencies or an immediate annuity
without life contingencies which provides for level payments over five or more
years, with a restricted prepayment option. Similarly, no charge will be
applied if the Annuitant dies and the withdrawal is made by the Annuitant's
beneficiary. See "Death Benefits and Similar Benefit Distributions" in Part 5.
Unless specifically instructed otherwise, National Integrity will make
withdrawals (including any applicable charges) from the Investment Options in
the same ratio the Annuitant's Account Value in each Investment Option bears to
the Annuitant's total Account Value. The minimum withdrawal permitted is $300.
Transfer Charge
No charge is made for your first twelve transfers among the Variable Account
Options or the GROs during a contract year. We are, however, permitted to
charge up to $20 for each additional transfer during that contract year. (No
transfer charge will apply to transfers under our Dollar Cost Averaging or
Individual Asset Rebalancing programs, nor will such transfers count towards
the twelve transfers you
16
<PAGE>
may make in a contract year before we may impose a transfer charge.) See
"Transfers" in Part 5. Transfers from a GRO may be subject to a Market Value
Adjustment. See "Guaranteed Rate Options" in Part 3.
Tax Reserve
We have the right to make a charge in the future for taxes or for reserves set
aside for taxes, which will reduce the investment experience of the Variable
Account Options.
PART 5 -- TERMS OF YOUR VARIABLE ANNUITY
Contributions Under Your Contract
You can make contributions of at least $1,000 at any time up to the Annuitant's
Retirement Date. Your first contribution, however, cannot be less than $10,000.
We will accept contributions of at least $50 for salary allotment programs. We
have special rules for minimum contribution amounts for tax-favored retirement
programs. See "Special Rules for Tax-Favored Retirement Programs" in Part 7.
We may limit the total contributions under one contract to $1,000,000 if you
are under age 76 or to $250,000 if you are 76 to 79 years of age. Once you
reach eight years before your Retirement Date, we may refuse to accept any
contribution made for you. Contributions may also be limited by various laws or
prohibited by National Integrity for all Annuitants under the contract. If your
contributions are made under a tax-favored retirement program, we will not
measure them against the maximum limits set by law.
Contributions are applied to the various Investment Options selected by you and
are used to pay annuity and death benefits.
Each contribution is credited as of the date we have received (as defined
below) at our Administrative Office both the contribution and instructions for
allocation among the Investment Options, provided that at any time you may have
amounts in not more than nine Investment Options. For purposes of calculating
the nine Investment Options, each of your GRO Accounts counts as one Investment
Option. Wire transfers of federal funds are deemed received on the day of
transmittal if credited to our account by 3 p.m. Eastern Time, otherwise they
are deemed received on the next Business Day. Contributions by check or mail
are deemed received not later than the second Business Day after they are
delivered to our Administrative Office. A Business Day is any day other than a
weekend or a national bank holiday.
You can change your choice of Investment Options at any time by writing to the
Administrative Office. The request should indicate your contract number and the
specific change, and you should sign the request. When it is received by the
Administrative Office, the change will be effective for any contribution which
accompanies it and for all future contributions.
Your Account Value
Your Account Value reflects various charges. See Part 4, "Deductions and
Charges." Annual deductions are made as of the last day of each contract year.
Withdrawal charges and Market Value Adjustments, if applicable, are made as of
the effective date of the transaction. Charges against our Separate Account are
reflected daily. Any amount allocated to a Variable Account Option will go up
or down in value depending on the investment experience of that Option. For
contributions allocated to the Variable Account Options, there are no
guaranteed values. The value of your contributions allocated to the GROs is
guaranteed, subject to any applicable Market Value Adjustments. See "Guaranteed
Rate Options" in Part 3.
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Your Purchase of Units in Our Separate Account
Allocations to the Variable Account Options are used to purchase units. On any
given day, the value you have in a Variable Account Option is the unit value
multiplied by the number of units credited to you in that Option. The units of
each Variable Account Option have different unit values.
The number of units purchased or redeemed (sold) in any Variable Account Option
is calculated by dividing the dollar amount of the transaction by the Option's
unit value, calculated after the close of business that day. The number of
units for a Variable Account Option at any time is the number of units
purchased less the number of units redeemed. The value of units fluctuates with
the investment performance of the corresponding Portfolios of the Fund which in
turn reflects the investment income and realized and unrealized capital gains
and losses of the Portfolios, as well as the Fund's expenses. The unit values
also change because of deductions and charges we make to our Separate Account.
The number of units credited to you, however, will not vary because of changes
in unit values. Units of a Variable Account Option are purchased when you
allocate new contributions or transfer prior contributions to that Option.
Units are redeemed when you make withdrawals or transfer amounts from a
Variable Account Option. We also redeem units to pay the death benefit when the
Annuitant dies and to pay the annual administrative charge.
How We Determine Unit Value
We determine unit values for each Variable Account Option on the Valuation
Date. The Valuation Date for purposes of determining unit values is 4 p.m.
Eastern Time on each day the New York Stock Exchange is open for business.
The unit value of each Variable Account Option for any day on which we
determine unit values is equal to the unit value for the last day on which a
unit value was determined multiplied by the net investment factor for that
Option on the current day. We determine a net investment factor for each Option
as follows:
- First, we take the value of the shares belonging to the Option in the
corresponding Portfolio at the close of business that day (before giving
effect to any transactions for that day, such as contributions or
withdrawals). For this purpose, we use the share value reported to us by
the Funds.
- Next, we add any dividends or capital gains distributions by the Fund on
that day.
- Then, we charge or credit for any taxes or amounts set aside as a
reserve for taxes.
- Then, we divide this amount by the value of the amounts in the Option at
the close of business on the last day on which a unit value was determined
(after giving effect to any transactions on that day).
- Finally, we subtract a daily asset charge for each calendar day since the
last day on which a unit value was determined (for example, a Monday
calculation will include charges for Saturday and Sunday). The daily charge
is .00003721, which is an effective annual rate of 1.35%. This charge is
for the mortality risk, administrative expenses and expense risk assumed by
us under the contract.
Generally, this means that we adjust unit values to reflect what happens to the
Fund, and also for the mortality and expense risk charge and any charge for
administrative expenses or taxes.
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Transfers
You may transfer your Account Value among the Variable Account Options and the
GROs, subject to National Integrity's then current transfer restrictions.
Transfers to a GRO must be to a newly elected GRO (i.e. to a GRO that you have
not elected before) at the then-current Guaranteed Interest Rate, unless
National Integrity otherwise consents. Transfers from a GRO other than within
30 days prior to the expiration date of a GRO Account are subject to a Market
Value Adjustment. See "Guaranteed Rate Options" in Part 3. For amounts in GROs,
transfers will be made according to the order in which monies were originally
allocated to any GRO.
The amount transferred must be at least $250 or, if less, the entire amount in
the Investment Option. After twelve transfers have been made by you during a
contract year, a charge of up to $20 may apply to each additional transfer
during that contract year, except that no charge will be made for transfers
under our Dollar Cost Averaging or Individual Asset Rebalancing programs,
described in Part 8. Once annuity payments begin, transfers are no longer
permitted.
Written transfer requests must be sent directly to the Administrative Office.
Each Annuitant's request for a transfer must specify the contract number, the
amounts to be transferred and the Investment Options to and from which the
amounts are to be transferred. Transfers may also be arranged through our
telephone transfer service provided you have established a Personal
Identification Number (PIN Code). We will honor telephone transfer instructions
from any person who provides correct identifying information, and we are not
responsible in the event of a fraudulent telephone transfer which is believed
to be genuine in accordance with these procedures. Accordingly, you bear the
risk of loss if unauthorized persons make transfers on your behalf.
A transfer request will be effective as of the Business Day it is received by
our Administrative Office. A transfer request does not change the allocation of
current or future contributions among the Investment Options. Telephone
transfers may be requested from 8:30 a.m. - 5:00 p.m., Eastern Time, on any day
we are open for business. You will receive the Variable Account Options' unit
values as of the close of business on the day you call. Accordingly, transfer
requests received after 4:00 p.m. Eastern Time will be processed using unit
values as of the close of business on the next Business Day after the day you
call. All transfers will be confirmed in writing.
Withdrawals
You may make an unlimited number of withdrawals from your contract as
frequently as you wish. Each withdrawal must be for at least $300. A
withdrawal charge of up to 7% of the contribution amount withdrawn, as adjusted
for any applicable Market Value Adjustment and the withdrawal charge itself
will be deducted from your Account Value, unless one of the exceptions applies.
See "Guaranteed Rate Options" in Part 3 and "Contingent Withdrawal Charge" in
Part 4. Most withdrawals made by you prior to age 59-1/2 are also subject to a
10% federal tax penalty. In addition, some tax-favored retirement programs
limit withdrawals. See Part 7, "Tax Aspects of the Contracts" for further
information regarding various tax consequences associated with the contracts.
Assignments
You may not assign the contract as collateral or security for a loan, but an
Owner whose contract is not related to a tax-favored program may otherwise
assign the contract before the Annuitant's Retirement Date. An assignment of
the contract as a gift may, however, have adverse tax consequences. See Part 7,
"Tax Aspects of the Contracts." National Integrity will not be bound by an
assignment unless it is in writing and we have received it at the
Administrative Office.
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Death Benefits and Similar Benefit Distributions
A death benefit is available to a beneficiary if the Annuitant dies prior to
the Retirement Date.
The amount of the death benefit is the greatest of:
. your Account Value
. the highest Account Value at the beginning of any contract year, plus
subsequent contributions and minus subsequent withdrawals
. your total contributions less the sum of withdrawals
"Subsequent withdrawals" for purposes of calculation of a death benefit reflect
any market value adjustments applicable to such withdrawals.
See the Statement of Additional Information dated May 1, 1997 regarding death
benefit information for contracts issued prior to January 1, 1995.
The death benefit amount is determined as of the date proof of death and
instructions for payment of proceeds are received by the Administrative Office.
Death benefits (and benefit distributions required because of a separate
Owner's death) can be paid in a lump sum or as an annuity. If no benefit option
is selected for the beneficiary at the Annuitant's death, the beneficiary can
select an option.
The beneficiary of the death benefit under a contract is selected by the Owner.
An Owner may change beneficiaries by submitting the appropriate form to the
Administrative Office. If no Annuitant's beneficiary survives the Annuitant,
then the death benefit is generally paid to the Annuitant's estate. No death
benefit will be paid after the Annuitant's death if there is a contingent
Annuitant. In that case, the contingent Annuitant becomes the new Annuitant
under the contract.
Generally, the Owner also may select his or her own beneficiary. If the Owner
dies before the Annuitant's Retirement Date, an Owner's beneficiary will become
the Owner of the contract and may be required to receive benefit distributions.
Annuity Benefits
All annuity benefits under your contract are calculated as of the Retirement
Date selected by you. The Retirement Date can be changed by written notice to
the Administrative Office any time prior to the Retirement Date. The Retirement
Date may be no later than your 85th birthday or the tenth contract anniversary,
whichever is later. The terms of the contracts applicable to the various
retirement programs, along with the federal tax laws, establish certain minimum
and maximum retirement ages.
Annuity benefits may take the form of a lump sum payment or an annuity. A lump
sum payment will provide the Annuitant with the Cash Value under the contract,
shortly after the Retirement Date. The amount applied for the purchase of an
annuity benefit will be the Adjusted Account Value, except that the Cash Value
will be the amount applied if the annuity benefit does not have a life
contingency and either the term is less than five years or the annuity can be
commuted to a lump sum payment without a withdrawal charge applying.
Annuities
Alternate forms of annuity benefits can provide for fixed or variable payments
which may be made monthly, quarterly, semi-annually or annually. Variable
payments will be funded through one or more Separate Account Divisions. For
any annuity, the minimum amount applied to the annuity must be $2,000 and the
minimum initial payment must be at least $20.
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If you have not already selected a form of annuity, we will send you, within
six months prior to your Retirement Date, an appropriate notice form on which
you may indicate the type of annuity you desire or confirm to us that the
normal form of annuity, as defined below, is to be provided. However, if we do
not receive a completed form from you on or before your Retirement Date, we
will deem the Retirement Date to have been extended until we receive your
written instructions at our Administrative Office. During such extension, the
values under your contract in the various Investment Options will remain
invested in such options and amounts remaining in Variable Account Options will
continue to be subject to the investment risks associated with those Options.
However, your Retirement Date cannot be extended beyond your 85th birthday or
the tenth contract anniversary, whichever is later. You will receive a lump sum
benefit if you do not make an election by such date.
We currently offer the following types of annuities:
A period certain annuity provides for fixed or variable payments, or both, to
the Annuitant or the Annuitant's beneficiary (the payee) for a fixed period.
The amount is determined by the period selected. The Annuitant, or if the payee
dies before the end of the period selected, the payee's beneficiary, may elect
to receive the total present value of future payments in cash.
A period certain life annuity provides for fixed or variable payments, or both,
for at least the period selected and thereafter for the life of the payee or
the payee and another annuitant under a joint and survivor annuity. You may not
change or redeem the annuity once payments have begun. If the payee (or the
payee and the other annuitant under a joint and survivor annuity) dies before
the period selected ends, the remaining payments will go to another named payee
who may have the right to redeem the annuity and secure the present value of
future guaranteed payments in a lump sum. The normal form of annuity is a fixed
life income annuity with 10 years of payments guaranteed, funded through our
General Account.
A life income annuity provides fixed payments for the life of the payee or the
payee and another annuitant under a joint and survivor annuity. Once a life
income annuity is selected, the form of annuity cannot be changed or redeemed
for a lump sum payment by the Annuitant or any payee.
Annuity Payments
Fixed annuity payments will not change and are based upon annuity rates
provided in your contract. The size of payments will depend on the form of
annuity that was chosen and, in the case of a life income annuity, on the
payee's age (or payee and a joint annuitant in the case of a joint and survivor
annuity) and sex (except under most tax-favored retirement programs). If
National Integrity's current annuity rates then in effect would yield a larger
payment, those current rates will apply instead of the tables.
Variable annuity payments are funded only in the Separate Account Divisions
through the purchase of annuity units. The Variable Account Option or Options
selected cannot be changed after annuity payments begin. The SAI provides
further information concerning the determination of annuity payments. The
number of units purchased is equal to the amount of the first annuity payment
divided by the new annuity unit value for the valuation period which includes
the due date of the first annuity payment. The amount of the first annuity
payment is determined in the same manner for a variable annuity as it is for a
fixed annuity. The number of annuity units stays the same for the annuity
payment period but the new annuity unit value changes to reflect the investment
income and the realized and unrealized capital gains and losses of the Variable
Account Option or Options selected, after charges made against it. Annuity unit
values assume a base rate of net investment return of 5%, except in states
which require a lower rate in which case 3.5% will be used. The annuity unit
value will rise or fall depending on whether the actual rate of net investment
return is higher or lower than the assumed base rate. In the SAI, see
"Determination of Annuity Unit Values."
If the age or sex of an annuitant has been misstated, any benefits will be
those which would have been purchased at the correct age and sex. Any
overpayments or underpayments made by us will be charged
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or credited with interest at the rate of 6% per year. If we have made
overpayments because of incorrect information about age or sex, we will deduct
the overpayment from the next payment or payments due. We add underpayments to
the next payment.
Timing of Payment
We normally make payments from the Variable Account Options, or apply your
Adjusted Account Value to the purchase of an annuity within seven days after
receipt of the required form at our Administrative Office. Our action can be
deferred, however, for any period during which (1) the New York Stock Exchange
has been closed or trading on it is restricted; (2) sales of securities or
determination of the fair value of Separate Account assets is not reasonably
practicable because of an emergency; or (3) the SEC, by order, permits National
Integrity to defer action in order to protect persons with interests in the
Separate Account. National Integrity can defer payment of your GRO Values for
up to six months, and interest will be paid on any such payment delayed for 30
days or more.
How You Make Requests and Give Instructions
When you communicate in writing with our Administrative Office, use the
address on the first page of this prospectus. Your request or instruction
cannot be honored unless it is in proper and complete form. Whenever possible,
use one of our printed forms, which may be obtained from our Administrative
Office.
PART 6 - VOTING RIGHTS
Fund Voting Rights
National Integrity is the legal owner of the shares of the Fund held by the
Separate Account and, as such, has the right to vote on certain matters. Among
other things, we may vote to elect the Fund's Board of Directors, to ratify the
selection of independent auditors for the Fund, and on any other matters
described in the Fund's current prospectus or requiring a vote by shareholders
under the 1940 Act.
Whenever a shareholder vote is taken, we give you the opportunity to tell us
how to vote the number of shares purchased as a result of contributions to your
contract. We will send you Fund proxy materials and a form for giving us voting
instructions.
If we do not receive instructions in time from all Owners, we will vote shares
in a Portfolio for which no instructions have been received in the same
proportion as we vote shares for which we have received instructions. Under
eligible deferred compensation plans and certain Qualified Plans, your voting
instructions must be communicated to us indirectly, through your employer, but
we are not responsible for any failure by your employer to solicit your
instructions or to communicate your instructions to us. We will vote any Fund
shares that we are entitled to vote directly, because of amounts we have
accumulated in our Separate Account, in the same proportions that other Owners
vote. If the federal securities laws or regulations or interpretations of them
change so that we are permitted to vote shares of the Fund in our own right or
to restrict Owner voting, we may do so.
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How We Determine Your Voting Shares
You may participate in voting only on matters concerning the Portfolios in
which your contributions have been invested. We determine the number of Fund
shares in each Variable Account Option that are attributable to your contract
by dividing the amount of your Account Value allocated to that Option by the
net asset value of one share of the corresponding Portfolio as of the record
date set by the Fund's Board for the Fund's shareholders' meeting. The record
date for this purpose must be no more than 60 days before the meeting of the
Fund. We count fractional shares. After annuity payments have commenced, voting
rights are calculated in a similar manner based on the actuarially determined
value of your interest in each Variable Account Option.
How Fund Shares Are Voted
All Fund shares are entitled to one vote; fractional shares have fractional
votes. Voting is on a Portfolio-by-Portfolio basis, except for certain matters
(for example, election of Directors) which require collective approval. On
matters on which the interests of the individual Portfolios differ, the
approval of the shareholders in one Portfolio is not needed in order to make a
decision in another Portfolio. To the extent shares of the Fund are sold to
separate accounts of other insurance companies, the shares voted by such
companies in accordance with instructions received from their contract holders
will dilute the effect of voting instructions received by National Integrity
from its Owners.
Separate Account Voting Rights
Under the 1940 Act, certain actions (such as some of those described under
"Changes in How We Operate" in Part 2) may require Owner approval. In that
case, you will be entitled to a number of votes based on the value you have in
the Variable Account Options, as described above under "How We Determine Your
Voting Shares." We will cast votes attributable to amounts we have in the
Variable Account Options in the same proportions as votes cast by Owners.
PART 7 - TAX ASPECTS OF THE CONTRACTS
Introduction
The effect of federal income taxes on the amounts held under a contract, on
annuity payments, and on the economic benefits to the Owner, Annuitant, and the
beneficiary or other payee may depend on National Integrity's tax status, on
the type of retirement plan, if any, for which the contract is purchased, and
upon the tax and employment status of the individuals concerned.
The following discussion of the federal income tax treatment of the contract is
not exhaustive, does not purport to cover all situations and is not intended to
be tax advice. It is based upon understanding of the present federal income tax
laws as currently interpreted by the Internal Revenue Service (IRS). No
representation is made regarding the likelihood of continuation of the present
federal income tax laws or of the current interpretations by the IRS or the
courts. Future legislation may affect annuity contracts adversely. Moreover, no
attempt has been made to consider any applicable state or other laws. Because
of the inherent complexity of such laws and the fact that tax results will vary
according to the particular circumstances of the individual involved and, if
applicable, the qualified plan, any person contemplating the purchase of a
contract, contemplating selection of annuity payments under the contract, or
receiving annuity payments under a contract should consult a qualified tax
adviser. NATIONAL INTEGRITY DOES NOT MAKE ANY GUARANTEE REGARDING THE TAX
STATUS, FEDERAL, STATE, OR LOCAL, OF ANY CONTRACT OR ANY TRANSACTION INVOLVING
THE CONTRACTS.
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Your Contract is an Annuity
Under the federal tax law, any individual can purchase an annuity with after-
tax dollars and exclude any annuity earnings in taxable income until an actual
distribution is taken from the annuity. Alternatively, the individual (or
employer) may purchase the annuity to fund a tax-favored retirement program
(contributions are with pre-tax dollars), such as an IRA or qualified plan.
This prospectus covers the basic tax rules that apply to an annuity purchased
directly with after-tax dollars, (nonqualified annuity), and some of the
special tax rules which apply to an annuity purchased to fund a tax-favored
retirement program, (qualified annuity). A qualified annuity may restrict your
rights and benefits in order to qualify for its special treatment under the
federal tax law.
Taxation of Annuities Generally
Section 72 of the Internal Revenue Code of 1986, as amended (the Code), governs
the taxation of annuities. In general, an Owner is not taxed on increases in
value under a contract until some form of withdrawal or distribution is made
under the contract. However, under certain circumstances, the increase in value
may be subject to current federal income tax. For example, corporations,
partnerships, trusts and other non-natural persons cannot defer the taxation of
current income credited to the contract unless an exception applies. In
addition, if an Owner transfers an annuity as a gift to someone other than a
spouse (or divorced spouse), any increase in its value will be taxed at the
time of transfer. The assignment or pledge of any portion of the value of a
contract will be treated as a distribution of that portion of the value of the
contract.
Section 72 provides that the proceeds of a full or partial withdrawal from a
contract prior to the date on which annuity payments begin are treated first as
taxable income to the extent that the Account Value exceeds the "investment" or
"basis" in the contract and then as non-taxable recovery of the investment or
basis in the contract. Generally, the investment or basis in the contract equals
the contributions made by or on your behalf, less any amounts previously
withdrawn which were not treated as taxable income. Special rules may apply if
the contract includes contributions made prior to August 14, 1982 which were
rolled over to the contract in a tax-free exchange.
Once annuity payments begin, the Annuitant recovers a portion of the investment
tax-free from each payment. The non-taxable portion of each payment is based on
the ratio of the Annuitant's investment to his or her expected return under the
contract (exclusion Ratio). The remainder of each payment will be ordinary
income.
After you have recovered your total investment, future payments are fully
included in income. If the Annuitant dies prior to recovering the total
investment, a deduction for the remaining basis will generally be allowed on
the Annuitant's final federal income tax return.
Withholding of federal income taxes on all distributions may be required unless
the recipient who is eligible elects not to have any amounts withheld and
properly notifies National Integrity of that election.
The taxable portion of a distribution is treated as ordinary income and is
taxed at ordinary income tax rates. In addition, a tax penalty of 10% applies
to the taxable portion of a distribution unless the distribution is: (1) on or
after the date on which the taxpayer attains age 59-1/2; (2) as a result of the
death of the Owner; (3) attributable to the taxpayer becoming disabled within
the meaning of Code Section 72(m)(7); (4) from certain qualified plans (note,
however, other penalties may apply); (5) under a qualified funding asset (as
defined in Section 130(d) of the Code); (6) purchased by an employer on
termination of certain types of qualified plans and held by the employer until
the employee separates from service; or (7) under an immediate annuity as
defined in Code Section 72(u)(4).
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All annuity contracts issued by National Integrity or its affiliates to one
Annuitant during any calendar year are treated as a single contract in
measuring the taxable income that results from surrenders and withdrawals under
any one of the contracts.
Distribution-at-Death Rules
Under section 72(s) of the Code, in order to be treated as an annuity, a
contract must provide the following distribution rules: (a) if any Owner dies
on or after the Retirement Date and before the entire interest in the contract
has been distributed, then the remaining portion of such interest must be
distributed at least as quickly as the method in effect on the date of the
Owner's death; and (b) if any Owner dies before the Retirement Date, the entire
interest in the contract must be distributed within five years after the date
of the Owner's death. To the extent such interest is payable to a beneficiary,
however, such interest may be annuitized over the life of that beneficiary or
over a period not extending beyond the life expectancy of that beneficiary, so
long as distributions commence within one year after the Owner's death. If the
beneficiary is the spouse of the Owner, the contract (along with the deferred
tax status) may be continued in the name of the spouse as the Owner.
If the Owner is not an individual, the "primary annuitant," as defined in the
Code, is considered the Owner. The primary annuitant is the individual who is
of primary importance in affecting the timing of the amount of payout under a
contract. In addition, when the Owner is not an individual, a change in the
primary annuitant is treated as the death of the Owner. Finally, in the case
of joint owners, the distribution-at-death rules will be applied at the death
of the first Owner.
Diversification Standards
Each Portfolio of the Fund will be required to adhere to regulations adopted by
the Treasury Department pursuant to Section 817(h) of the Code prescribing
asset diversification requirements for investment companies whose shares are
sold to insurance company separate accounts funding variable contracts. The
investment manager for the Fund monitors the investments in order to comply
with the regulations to assure that the contracts continue to be treated as
annuities for federal income tax purposes.
The IRS has stated in published rulings that a variable contract owner will be
considered the owner of separate account assets if the contract owner possesses
incidents of ownership in those assets, such as the ability to exercise
investment control over the assets. In those circumstances, income and gains
from the separate account assets would be includable in the variable contract
owner's gross income. The Treasury Department also announced, in connection
with the issuance of regulations concerning 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 (i.e., the Owner), 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 the underlying assets." As of the date of
this prospectus, no such guidance has been issued.
Tax-Favored Retirement Programs
The contract is designed for use in connection with certain types of retirement
plans which receive favorable treatment under the Code. Numerous special tax
rules apply to the participants in such qualified plans and to the contracts
used in connection with such qualified plans. These tax rules vary according
to the type of plan and the terms and conditions of the plan itself. Owners,
Annuitants, and beneficiaries are cautioned that the rights of any person to
any benefits under qualified plans may be subject to the terms and conditions
of the plans themselves, regardless of the terms and conditions of the
contract. In addition, loans from qualified contracts, where allowed, are
subject to a variety of limitations, including restrictions as to the amount
that may be borrowed, the duration of the loan, and the manner in which the
loans must be repaid. (Owners should always consult their tax advisors and
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retirement plan fiduciaries prior to exercising their loan privileges.) Also,
special rules apply to the time at which distributions must commence and the
form in which the distributions must be paid. Therefore, no attempt is made to
provide more than general information about the use of contracts with the
various types of qualified plans.
National Integrity reserves the right to change its administrative rules, such
as minimum contribution amounts, as needed to comply with the Code as to tax-
favored retirement programs.
Following are brief descriptions of various types of qualified plans in
connection with which National Integrity may issue a contract.
Individual Retirement Annuities
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Code Section 408 permits eligible individuals to contribute to an individual
retirement program known as an IRA. An individual who receives compensation and
who has not reached age 70-1/2 by the end of the tax year may establish an IRA
and make contributions up to the deadline for filing his or her federal income
tax return for that year (without extensions). IRAs are subject to limitations
on the amount that may be contributed, the persons who may be eligible, and on
the time when distributions may commence. An individual may also rollover
amounts distributed from another IRA or another tax-favored retirement program
to an IRA contract. Your IRA contract will be issued with a rider outlining the
special terms of your contract which apply to IRAs.
Tax Sheltered Annuities
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Section 403(b) of the Code permits the purchase of tax-sheltered annuities
(TSA) by public schools and certain charitable, educational and scientific
organizations described in Section 501(c)(3) of the Code. The contract is not
intended to accept other than employee contributions. Such contributions are
not includible in the gross income of the employee until the employee receives
distributions from the contract. The amount of contributions to the TSA is
limited to certain maximums imposed by Code sections 403(b), 415 and 402(g).
Furthermore, the Code sets forth additional restrictions governing such items
as transferability, distributions and withdrawals. Any employee should obtain
competent tax advice as to the tax treatment and suitability of such an
investment. Your contract will be issued with a rider outlining the special
terms which apply to a TSA.
Simplified Employee Pensions
- ----------------------------
Section 408(k) of the Code allows employers to establish simplified employee
pension plans (SEP-IRAs) for their employees, using the employees' IRAs for
such purposes, if certain criteria are met. Under these plans the employer may,
within specified limits, make deductible contributions on behalf of the
employees to IRAs. Employers intending to use the contract in connection with
such plans should seek competent advice. The SEP-IRA will be issued with a
rider outlining the special terms of the contract.
Corporate and Self-Employed (H.R. 10 and Keogh) Pension and Profit Sharing
- --------------------------------------------------------------------------
Plans
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Sections 401(a) and 403(a) of the Code permit corporate employers to establish
various types of tax-favored retirement plans for employees. The Self-Employed
Individuals' Tax Retirement Act of 1962, as amended, commonly referred to as
"H.R. 10" or "Keogh," permits self-employed individuals also to establish such
tax-favored retirement plans for themselves and their employees. Such
retirement plans may permit the purchase of the contract in order to provide
benefits under the plans. Employers intending to use the contract in connection
with such plans should seek competent advice. The Company reserves the right to
request documentation to substantiate that a qualified plan exists and is being
properly administered. National Integrity does not administer such plans.
26
<PAGE>
Deferred Compensation Plans of State and Local Governments and Tax-Exempt
- -------------------------------------------------------------------------
Organizations
- -------------
Section 457 of the Code permits employees of state and local governments and
tax-exempt organizations to defer a portion of their compensation without
paying current taxes. The employees must be participants in an eligible
deferred compensation plan. To the extent the contracts are used in connection
with an eligible plan, employees are considered general creditors of the
employer and the employer as Owner of the contract has the sole right to the
proceeds of the contract. However, Section 457(g), as added by the Small
Business and Jobs Protection Act (SBJPA) of 1996, provides that on and after
August 20, 1996, a plan maintained by an eligible governmental employer must
hold all assets and income of the plan in a trust, custodial account, or
annuity contract for the exclusive benefit of participants and their
beneficiaries. If the plan is in existence on August 20, 1996, the employer
need not establish a trust, custodial account, or annuity contract until
January 1, 1999. Loans to employees may be permitted under such plans;
however, a Section 457 plan is not required to allow loans. Contributions to a
contract in connection with an eligible government plan are subject to
limitations. Those who intend to use the contracts in connection with such
plans should seek competent advice. The Company reserves the right to request
documentation to substantiate that a qualified plan exists and is being
properly administered. National Integrity does not administer such plans.
Distributions Under Tax-Favored Retirement Programs
Distributions from tax-favored plans are subject to certain restrictions. Prior
to the enactment of the 1996 SBJPA, distributions of minimum amounts specified
by the Code must have commenced by April 1 of the calendar year following the
calendar year in which the participant reaches age 70-1/2. The SBJPA provides
participants in qualified plans, with the exception of five-percent owners and
IRA holders, to begin receiving distributions by April 1 of the calendar year
following the later of either (i) the calendar year in which the employee
reaches age 70-1/2, or (ii) the calendar year in which the employee retires.
Additional distribution rules apply after the participant's death. Failure to
make mandatory distributions may result in the imposition of a 50% penalty tax
on any difference between the required distribution amount and the amount
distributed. Distributions to a participant from all plans (other than 457
plans) in a calendar year that exceed a specific limit under the Code are
generally subject to a 15% penalty tax (in addition to any ordinary income tax)
on the excess portion of the distributions. However, the SBJPA of 1996 has
suspended the excise tax on excess distributions. The provision relating to
the excise tax on excess distributions is effective with respect to
distributions received in 1997, 1998 and 1999.
Distributions from a tax-favored plan (not including an IRA subject to Code
Section 408) to an employee, surviving spouse, or former spouse who is an
alternate payee under a qualified domestic relations order, in the form of a
lump sum settlement or periodic annuity payments for a fixed period of fewer
than 10 years are subject to mandatory income tax withholding of 20% of the
taxable amount of the distribution, unless (1) the distributee directs the
transfer of such amounts in cash to another plan or an IRA; or (2) the payment
is a minimum distribution required under the Code. The taxable amount is the
amount of the distribution less the amount allocable to after-tax
contributions. All other types of taxable distributions are subject to
withholding unless the distributee elects not to have withholding apply.
We are not permitted to make distributions from a contract unless a request has
been made. It is therefore your responsibility to comply with the minimum
distribution rules. You should consult your tax adviser regarding these rules
and their proper application.
The above description of the federal income tax consequences of the different
types of tax-favored retirement plans which may be funded by the contract is
only a brief summary and is not intended as tax advice. The rules governing the
provisions of plans are extremely complex and often difficult to comprehend.
Anything less than full compliance with all applicable rules, all of which are
subject to change, may have adverse tax consequences. A prospective Owner
considering adoption of a plan and purchase of a contract in connection
therewith should first consult a qualified and competent tax adviser, with
regard to the suitability of the contract as an investment vehicle for the
plan.
27
<PAGE>
Federal and State Income Tax Withholding
National Integrity will withhold and remit to the U.S. government a part of the
taxable portion of each distribution made under a contract unless the
distributee notifies National Integrity at or before the time of the
distribution of an election not to have any amounts withheld. In certain
circumstances, National Integrity may be required to withhold tax, as explained
above. The withholding rates applicable to the taxable portion of periodic
annuity payments (other than eligible rollover distributions) are the same as
the withholding rates generally applicable to payments of wages. In addition,
the withholding rate applicable to the taxable portion of non-periodic payments
(including withdrawals prior to the maturity date) is 10%. As discussed above,
the withholding rate applicable to eligible rollover distributions is 20%.
Certain states have indicated that pension and annuity withholding will apply
to payments made to residents. Generally, an election out of federal
withholding will also be considered an election out of state withholding. For
more information concerning a particular state, call our Administrative Office
at the toll-free number.
Impact of Taxes to National Integrity
The contracts provide that National Integrity may charge the Separate Account
for taxes. National Integrity can also set up reserves for taxes.
Transfers Among Investment Options
There will not be any tax liability if you transfer any part of the Account
Value among the Investment Options of your contract.
28
<PAGE>
PART 8 - ADDITIONAL INFORMATION
Systematic Withdrawals
We offer a program for systematic withdrawals that allows you to pre-authorize
periodic withdrawals from your contract prior to your Retirement Date. You may
choose to have withdrawals made monthly, quarterly, semi-annually or annually
and may specify the day of the month (other than the 29th, 30th or 31st) on
which the withdrawal is to be made. You may specify a dollar amount for each
withdrawal or an annual percentage to be withdrawn. The minimum systematic
withdrawal currently is $100. You may also specify an account for direct
deposit of your systematic withdrawals. To enroll under our systematic
withdrawal program, you must deliver the appropriate administrative form to our
Administrative Office. Withdrawals may begin not less than one business day
after our receipt of the form. You or we may terminate your participation in
the program upon one day's prior written notice, and we may terminate or amend
the systematic withdrawal program at any time. If on any withdrawal date you do
not have sufficient values to make all of the withdrawals you have specified,
no withdrawals will be made and your enrollment in the program will be ended.
Amounts withdrawn by you under the systematic withdrawal program may be within
the free withdrawal amount in which case neither a contingent withdrawal charge
nor a Market Value Adjustment will be made. See "Contingent Withdrawal Charge"
in Part 4. Amounts withdrawn under the systematic withdrawal program in excess
of the free withdrawal amount will be subject to a contingent withdrawal charge
and a Market Value Adjustment if applicable. Withdrawals also may be subject to
the 10% federal tax penalty for early withdrawals under the contracts and to
income taxation. See Part 7, "Tax Aspects of the Contracts."
Dollar Cost Averaging
We offer a dollar cost averaging program under which allocations to the ARM
Capital Advisors Money Market Option are automatically transferred on a
monthly, quarterly, semi-annual or annual basis to one or more other Variable
Account Options. You must specify a dollar amount to be transferred into each
Variable Account Option, and the current minimum transfer to each Option is
$250. No transfer charge will apply to transfers under our dollar cost
averaging program, and such transfers will not count towards the twelve
transfers you may make in a contract year before we may impose a transfer
charge.
To enroll under our dollar cost averaging program, you must deliver the
appropriate administrative form to our Administrative Office. You or we may
terminate your participation in the program upon one day's prior written
notice, and we may terminate or amend the dollar cost averaging program at any
time. If you do not have sufficient funds in the ARM Capital Advisors Money
Market Option to transfer to each Variable Account Option specified, no
transfer will be made and your enrollment in the program will be ended.
Individual Asset Rebalancing
We offer an asset rebalancing program whereby you can select the frequency for
rebalancing. Frequencies available include rebalancing monthly, quarterly,
semi-annually or annually. The value in the Variable Account Options will be
automatically rebalanced by transfers among such Variable Account Options and
you will receive a confirmation notice after each rebalancing. Transfers will
occur only to and from those Variable Account Options where you have current
contribution allocations. No transfer charge will apply to transfers under our
Individual Asset Rebalancing program, and such transfers will not count towards
the twelve transfers you may make in a contract year before we may impose a
transfer charge.
GROs are not eligible for the Individual Asset Rebalancing program.
29
<PAGE>
To enroll under our Individual Asset Rebalancing program, you must deliver the
appropriate administrative form to our Administrative Office. You should be
aware that other allocation programs, such as dollar cost averaging, as well as
transfers and withdrawals that you make, may not work in concert with the
Individual Asset Rebalancing program. You should, therefore, monitor your use
of such other programs, transfers, and withdrawals while the Individual Asset
Rebalancing program is in effect. You or we may terminate your participation in
the program upon one day's prior written notice, and we may terminate or amend
the Individual Asset Rebalancing program at any time.
Systematic Contributions
We offer a program for systematic contributions that allows you to pre-
authorize monthly withdrawals from your checking account for payment to us. To
enroll under our program, you must deliver the appropriate administrative form
to our Administrative Office. You or we may terminate your participation in the
program upon 30 days' prior written notice. Your participation may be
terminated by us if your bank declines to make any payment. The minimum amount
for systematic contributions is $1,000 per month.
Performance Information
Performance data for the Variable Account Options, including the yield and
effective yield of the ARM Capital Advisors Money Market Option, the yield of
the other Options, and the total return of all of the Options may appear in
advertisements or sales literature. Performance data for any Option reflects
only the performance of a hypothetical investment in the Option during the
particular time period on which the calculations are based. Performance
information should be considered in light of the investment objectives and
policies of the Portfolio in which the Option invests and the market conditions
during the given time period, and it should not be considered as a
representation of performance to be achieved in the future.
Total returns are based on the overall dollar or percentage change in value of a
hypothetical investment in an Option. Total return quotations reflect changes in
Fund share price, the automatic reinvestment by the Option of all distributions
and the deduction of applicable contract charges and expenses, including any
contingent withdrawal charge that would apply if an Owner surrendered the
contract at the end of the period indicated. Total returns also may be shown
that do not take into account the contingent withdrawal charge or the annual
administrative charge applicable where the Account Value is less than $50,000 at
the end of a contract year.
A cumulative total return reflects an Option's performance over a stated period
of time. An average annual total return reflects the hypothetical annually
compounded return that would have produced the same cumulative total return if
the Option's performance had been constant over the entire period. Because
average annual total returns tend to smooth out variations in an Option's
returns, you should recognize that they are not the same as actual year-by-year
results.
Some Options may also advertise yield. These measures reflect the income
generated by an investment in the Option over a specified period of time. This
income is annualized and shown as a percentage. Yields do not take into account
capital gains or losses or the contingent withdrawal charge.
The ARM Capital Advisors Money Market Option may advertise its current and
effective yield. Current yield reflects the income generated by an investment
in the Option over a specified 7-day period. Effective yield is calculated in a
similar manner except that income earned is assumed to be reinvested. The
Pinnacle Fixed Income Option may advertise a 30-day yield which reflects the
income generated by an investment in such Option over a specified 30-day
period.
For a detailed description of the methods used to determine yield and total
return for the Variable Account Options, see the SAI.
30
<PAGE>
APPENDIX A
ILLUSTRATION OF A MARKET VALUE ADJUSTMENT
Contribution:................ $50,000.00
GRO Account duration:........ 6 Years
Guaranteed Interest Rate:.... 5% Annual Effective Rate
The following examples illustrate how the Market Value Adjustment and the
contingent withdrawal charge may affect the values of a contract upon a
withdrawal. The 5% assumed Guaranteed Interest Rate is the same rate used in
the Example under "Table of Annual Fees and Expenses" in this Prospectus. In
these examples, the withdrawal occurs three years after the initial
contribution. The Market Value Adjustment operates in a similar manner for
transfers. No contingent withdrawal charge applies to transfers.
The GRO Value for this $50,000 contribution is $67,004.78 at the expiration of
the GRO Account. After three years, the GRO Value is $57,881.25. It is also
assumed, for the purposes of these examples, that no prior partial withdrawals
or transfers have occurred.
The Market Value Adjustment will be based on the rate we are then crediting (at
the time of the withdrawal) on new contributions to GRO Accounts of the same
duration as the time remaining in your GRO Account, rounded to the next higher
number of complete months. If we do not declare a rate for the exact time
remaining, we will interpolate between the Guaranteed Interest Rates for GRO
Accounts of durations closest to (next higher and next lower) the remaining
period described above. Three years after the initial contribution, there would
have been three years remaining in your GRO Account. These examples also show
the withdrawal charge which would be calculated separately.
Example of a Downward Market Value Adjustment:
A downward Market Value Adjustment results from a full or partial withdrawal
that occurs when interest rates have increased. Assume interest rates have
increased three years after the initial contribution and we are then crediting
6.5% for a three-year GRO Account. Upon a full withdrawal, the Market Value
Adjustment, applying the above formula would be:
-0.0483785 = [(1 + .05)/36/12/ / (1 + .065 + .0025)/36/12/]- 1
The Market Value Adjustment is a reduction of $2,800.21 from the GRO Value:
-$2,800.21 = -0.0483785 X $57,881.25
The Market Adjusted Value would be:
$55,081.04 = $57,881.25 - $2,800.21
A withdrawal charge of 4% would be assessed against the $50,000 original
contribution:
$2,000.00 = $50,000.00 X .04
Thus, the amount payable on a full withdrawal would be:
$53,081.04 = $57,881.25 - $2,800.21 - $2,000.00
31
<PAGE>
If instead of a full withdrawal, $20,000 was requested, we would first
determine the free withdrawal amount:
Greater of:
a) $5,788.13 = $57,881.25 X .10
or
b) $2,756.25 = gain in prior contract year
Free Amount = $5,788.13
The non-free amount would be:
$14,211.87 = $20,000.00 - $5,788.13
The Market Value Adjustment, which is only applicable to the non-free amount,
would be:
- $687.55 = -0.0483785 X $14,211.87
The withdrawal charge would be:
$620.81 = [($14,211.87 + $687.55)/(1 - .04)] - ($14,211.87 + 687.55)
Thus, the total amount needed to provide $20,000 after the Market Value
Adjustment and withdrawal charge would be:
$21,308.36 = $20,000.00 + $687.55 + $620.81
The ending Account Value would be:
$36,572.89 = $57,881.25 - $21,308.36
Example of an Upward Market Value Adjustment:
An upward Market Value Adjustment results from a full or partial withdrawal
that occurs when interest rates have decreased. Assume interest rates have
decreased three years after the initial contribution and we are then crediting
4% for a three-year GRO Account. Upon a full withdrawal, the Market Value
Adjustment, applying the formula set forth in the prospectus, would be:
0.0217384 = [(1 + .05)/36/12/ / (1 + .04 + .0025)/36/12/]- 1
The Market Value Adjustment is an increase of $1,258.25 to the GRO Value:
$1,258.25 = 0.0217384 X $57,881.25
The Market Adjusted Value would be:
$59,139.50 = $57,881.25 + $1,258.25
A withdrawal charge of 4% would be assessed against the $50,000 original
contribution:
$2,000.00 = $50,000.00 X .04
32
<PAGE>
Thus, the amount payable on a full withdrawal would be:
$57,139.50 = $57,881.25 + $1,258.25 - $2,000.00
If instead of a full withdrawal, $20,000 was requested, the free withdrawal
amount and non-free amount would first be determined as above:
Free Amount = $5,788.13
Non-Free Amount = $14,211.87
The Market Value Adjustment would be:
$308.94 = .0217384 X $14,211.87
The withdrawal charge would be:
$572.29 = [($14,211.87 - $308.94)/(1 - .04)] - ($14,211.87 - $308.94)
Thus, the total amount needed to provide $20,000 after the Market Value
Adjustment and withdrawal charge would be:
$20,270.35 = $20,000.00 - $308.94 + $579.29
The ending Account Value would be:
$37,610.90 = $57,881.25 - $20,270.35
Actual Market Value Adjustments may have a greater or lesser impact than shown
in the examples, depending on the actual change in interest crediting rate and
the timing of the withdrawal or transfer in relation to the time remaining in
the GRO Account. Also, the Market Value Adjustment can never decrease the
Account Value below premium plus 3% interest, before any applicable charges.
Account values less than $50,000 will be subject to a $30 annual charge.
33
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
May 1, 1997
FOR
PINNACLE(version II)
FLEXIBLE PREMIUM VARIABLE ANNUITY
ISSUED BY
NATIONAL INTEGRITY LIFE INSURANCE COMPANY
AND
FUNDED THROUGH ITS SEPARATE ACCOUNT II
<TABLE>
<CAPTION>
Table of Contents
Page
<S> <C>
Part 1 - National Integrity and Custodian...............................................2
Part 2 - Distribution of the Contracts..................................................3
Part 3 - Performance Information........................................................3
Part 4 - Determination of Annuity Unit Values..........................................11
Part 5 - Death Benefit Information for Contracts Issued Prior to January 1, 1995.......12
Part 6 - Financial Statements..........................................................12
</TABLE>
This Statement of Additional Information (SAI) is not a prospectus. It should be
read in conjunction with the prospectus for the contracts, dated May 1, 1997.
For definitions of special terms used in the SAI, please refer to the
prospectus.
A copy of the prospectus to which this SAI relates is available at no charge by
writing the Administrative Office at National Integrity Life Insurance Company
("National Integrity"), 200 Park Avenue, 20th Floor, New York, New York 10166,
or by calling 1-800-325-8583.
<PAGE>
PART 1 - NATIONAL INTEGRITY AND CUSTODIAN
National Integrity is a New York stock life insurance company that sells life
insurance and annuities. Its offices are located at 200 Park Avenue, 20th Floor,
New York, New York 10166. National Integrity, the depositor of Separate Account
II, is a wholly owned subsidiary of Integrity Life Insurance Company. Integrity
Life Insurance Company is a wholly owned subsidiary of Integrity Holdings, Inc.,
a Delaware corporation which is a holding company engaged in no active business.
All outstanding shares of Integrity Holdings, Inc. are owned by ARM Financial
Group, Inc. (ARM), a Delaware corporation which is a financial services company
focusing on the long-term savings and retirement marketplace by providing retail
and institutional products and services throughout the United States. ARM owns
100% of the stock of (i) ARM Securities Corporation (ARM Securities), a
Minnesota corporation registered with the SEC as a broker-dealer and a member of
the National Association of Securities Dealers, Inc., (ii) ARM Capital Advisors,
Inc., a New York corporation registered with the SEC as an investment adviser,
(iii) SBM Certificate Company, a Minnesota corporation registered with the SEC
as an issuer of face-amount certificates, and (iv) ARM Transfer Agency, Inc., a
Delaware corporation registered with the SEC as a transfer and dividend
disbursing agency. Approximately 91% of the outstanding voting stock of ARM is
owned by The Morgan Stanley Leveraged Equity Fund II, L.P., Morgan Stanley
Capital Partners III, L.P., Morgan Stanley Capital Investors, L.P., and MSCP III
892 Investors, L.P., each of which is a Delaware limited partnership
(collectively, the MSCP Funds). The MSCP Funds are private equity funds
sponsored by Morgan Stanley Group, Inc., a Delaware corporation that, through
its subsidiaries, provides a wide range of financial services on a global basis
(Morgan Stanley). The general partner of each of the MSCP Funds is a wholly
owned subsidiary of Morgan Stanley. Oldarm Limited Partnership, a Kentucky
limited partnership, New ARM, LLC, a Kentucky limited liability company, and
certain current and former employees and management of ARM own in the aggregate
approximately 9% of the voting stock of ARM.
No person has the direct or indirect power to control Morgan Stanley except
insofar as he or she may have such power by virtue of his or her capacity as a
director or executive officer thereof. Morgan Stanley is publicly held; no
individual beneficially owns more than 5% of the common shares; however,
approximately 31% of such shares are subject to a stockholders' agreement or
voting agreement among certain current and former principals and employees of
Morgan Stanley and its predecessor.
Beginning in 1994, ARM provided substantially all of the services required to be
performed on behalf of the Separate Account. Total fees paid to ARM by National
Integrity for management services in 1995 and 1996, including services
applicable to the Registrant, were $5,640,827 and $6,007,766, respectively.
National Integrity is the custodian for the shares of The Legends Fund, Inc.
owned by the Separate Account. The Fund's shares are held in book-entry form.
Reports and marketing materials, from time to time, may include information
concerning the rating of National Integrity, as determined by A.M. Best Company,
Moody's Investor Service, Standard & Poor's Corporation, Duff & Phelps
Corporation, or other recognized rating services. National Integrity is
currently rated "A" (Excellent) by A.M. Best Company, and has received claims
paying ability ratings of "A" (Good) from Standard & Poor's Corporation, "Baa1"
from Moody's Investors Service, Inc., and "A+" (High) from Duff and Phelps
Credit Rating Company. However, National Integrity does not guarantee the
investment performance of the portfolios, and these ratings do not reflect
protection against investment risk.
2
<PAGE>
PART 2 - DISTRIBUTION OF THE CONTRACTS
ARM Securities, a wholly owned subsidiary of ARM, is the principal underwriter
of the contracts. ARM Securities is registered with the SEC as a broker-dealer
and is a member in good standing of the National Association of Securities
Dealers, Inc. ARM Securities' address is 515 West Market Street, Louisville,
Kentucky 40202. The contracts are offered through ARM Securities on a
continuous basis.
We generally pay a maximum distribution allowance of 6% of initial
contributions. The amount of distribution allowances paid was $51,204, $123,719
and $684,838 for the years ended December 31, 1996, 1995, and 1994,
respectively. No distribution allowances were retained by ARM Securities during
these years. National Integrity may from time to time pay or allow additional
promotional incentives, in the form of cash or other compensation, to broker-
dealers that sell contracts. In some instances, such other incentives may be
offered only to certain broker-dealers that sell or are expected to sell during
specified time periods certain minimum amounts of the contracts.
PART 3 - PERFORMANCE INFORMATION
Each Variable Account Option may from time to time include the Average Annual
Total Return, the Cumulative Total Return, and Yield of its shares in
advertisements or in information furnished to shareholders. The ARM Capital
Advisors Money Market Option may also from time to time include the Yield and
Effective Yield of its shares in information furnished to shareholders.
Performance information is computed separately for each Option in accordance
with the formulas described below. At any time in the future, total return and
yields may be higher or lower than in the past and there can be no assurance
that any historical results will continue.
Total Returns
Total returns reflect all aspects of an Option's return, including the automatic
reinvestment by the Option of all distributions and the deduction of all
applicable charges to the Option on an annual basis, including mortality risk
and expense charges, the annual administrative charge and other charges against
contract values. Quotations also will assume a termination (surrender) at the
end of the particular period and reflect the deductions of the contingent
withdrawal charge, if applicable. Total returns may be shown simultaneously that
do not take into account deduction of the contingent withdrawal charge, and/or
the annual administrative charge.
Average annual total returns are calculated by determining the growth or decline
in the value of a hypothetical historical investment in the Option over certain
periods, including 1, 5, and 10 years (up to the life of the Option), and then
calculating the annually compounded percentage rate that would have produced the
same result if the rate of growth or decline in value had been constant over the
period. Investors should realize that the Option's performance is not constant
over time, but changes from year to year, and that the average annual returns
represent the averages of historical figures as opposed to the actual historical
performance of an Option during any portion of the period illustrated. Average
annual returns are calculated pursuant to the following formula: P(1+T)/n/ =
ERV, where P is a hypothetical initial payment of $1,000, T is the average
annual total return, n is the number of years, and ERV is the withdrawal value
at the end of the period.
Cumulative total returns are unaveraged and reflect the simple percentage change
in the value of a hypothetical investment in the Option over a stated period of
time. In addition to the period since inception, cumulative total returns may be
calculated on a year-to-date basis at the end of each calendar month in the
current calendar year. The last day of the period for year-to-date returns is
the last day of the most recent calendar month at the time of publication.
3
<PAGE>
Yields
Some Options may advertise yields. Yields quoted in advertising reflect the
change in value of a hypothetical investment in the Option over a stated period
of time, not taking into account capital gains or losses or the imposition of
any contingent withdrawal charge. Yields are annualized and stated as a
percentage.
Current yield and effective yield are calculated for the Money Market Option.
Current Yield is based on the change in the value of a hypothetical investment
(exclusive of capital changes) over a particular 7-day period, less a
hypothetical charge reflecting deductions from contract values during the period
(the base period), and stated as a percentage of the investment at the start of
the base period (the base period return). The base period return is then
annualized by multiplying by 365/7, with the resulting yield figure carried to
at least the nearest hundredth of one percent. Effective yield assumes that all
dividends received during an annual period have been reinvested. This
compounding effect causes effective yield to be higher than current yield.
Calculation of effective yield begins with the same base period return used in
the calculation of current yield, which is then annualized to reflect weekly
compounding pursuant to the following formula:
Effective Yield = {(Base Period Return) + 1)/365/7/} - 1
4
<PAGE>
The table below provides average annual total returns for each Option for the
One and Three Year Periods Ended December 31, 1996 and from inception through
December 31, 1996. The "contract continues" columns show returns if the contract
continues and is not terminated, and the "contract surrendered" columns show
returns if the contract is surrendered at the end of the period, in which case
contingent withdrawal charges may apply. The performance information is based on
the historical investment experience of the Options and does not indicate or
represent future experience. This table is based upon average Account Values
over $50,000 for which the annual administrative charge is $0.
Average Annual Total Returns for One and Three Year Periods Ended 12/31/96 and
Since Inception*
<TABLE>
<CAPTION>
Period Since Inception One Year Period Three Year
---------------------- --------------- ---------
Contract Contract
Contract Surrendered Contract Surrendered Contract
Option Continues 12/31/96 Continues 12/31/96 Continues
- ------ --------- ----------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C>
Dreman Value 16.58% 15.94% 22.78% 16.78% 19.98%
Zweig Asset Allocation 10.26% 9.44% 13.32% 7.32% 10.37%
Zweig Equity
(Small Cap) 10.20% 9.43% 16.87% 10.87% 11.05%
Renaissance Balanced 8.54% 7.74% 7.94% 1.94% 7.92%
Harris Bretall Sullivan &
Smith Equity Growth 10.20% 9.44% 12.42% 6.42% 14.45%
Nicholas-Applegate
Balanced 10.70% 9.95% 13.84% 7.84% 9.90%
Pinnacle Fixed Income 3.54% 2.62% 0.49% -5.51% 3.27%
Morgan Stanley Asian
Growth 1.87% -0.06% 4.13% -1.87% n/a
Morgan Stanley
Worldwide High Income 13.55% 11.90% 22.87% 16.87% n/a
</TABLE>
*The inception date for each Option is set forth in the table below.
5
<PAGE>
The table below provides cumulative total returns for each Option from inception
through December 31, 1996, and for the One and Three Year Periods ended December
31, 1996. The "contract continues" columns show returns if the contract
continues and is not terminated, and the "contract surrendered" column shows
returns if the contract is surrendered at the end of the period, in which case
contingent withdrawal charges apply. The performance information is based on the
historical investment experience of the Options and does not indicate or
represent future experience.
Cumulative Total Returns for Period Since Inception to 12/31/96, and for the One
and Three Year Periods ended 12/31/96
<TABLE>
<CAPTION>
Period Since Inception One Year Three Year
---------------------- -------- ----------
Contract
Contract Surrendered Contract Contract Inception
Option Continues 12/31/96 Continues Continues Date*
- ------ --------- ----------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Dreman Value 83.89% 79.89% 22.78% 72.72% 01/12/93
Zweig Asset
Allocation 44.52% 40.52% 13.32% 34.45% 03/26/93
Zweig Equity
(Small Cap) 46.94% 42.94% 16.87% 36.96% 01/14/93
Renaissance
Balanced 38.44% 34.44% 7.94% 25.69% 01/12/93
Harris Bretall Sullivan
& Smith Equity
Growth 47.05% 43.05% 12.42% 49.91% 01/12/93
Nicholas-Applegate
Balanced 49.73% 45.73% 13.84% 32.72% 01/12/93
Pinnacle Fixed
Income 14.83% 10.83% 0.49% 10.13% 01/12/93
Morgan Stanley
Asian Growth 4.84% -0.16% 4.13% n/a 06/16/94
Morgan Stanley
Worldwide High
Income 37.94% 32.94% 22.87% n/a 06/21/94
</TABLE>
*Inception Dates reflect date of first trade.
6
<PAGE>
Performance Comparisons
Performance information for an Option may be compared, in reports and
advertising, to: (1) Standard & Poor's Stock Index (S&P 500), Dow Jones
Industrial Averages, (DJIA), Donoghue Money Market Institutional Averages, or
other unmanaged indices generally regarded as representative of the securities
markets; (2) other variable annuity separate accounts or other investment
products tracked by Lipper Analytical Services, Inc. or the Variable Annuity
Research and Data Service, which are widely used independent research firms that
rank mutual funds and other investment companies by overall performance,
investment objectives, and assets; and (3) the Consumer Price Index (measure of
inflation) to assess the real rate of return from an investment in a contract.
Unmanaged indices may assume the reinvestment of dividends but generally do not
reflect deductions for annuity charges, investment management costs, brokerage
costs and other transaction costs that are normally paid when directly investing
in securities.
Each Option may from time to time also include the ranking of its performance
figures relative to such figures for groups of mutual funds categorized by
Lipper Analytical Services (Lipper) as having the same or similar investment
objectives or by similar services that monitor the performance of mutual funds.
Each Option may also from time to time compare its performance to average mutual
fund performance figures compiled by Lipper in Lipper Performance Analysis.
Advertisements or information furnished to present shareholders or prospective
investors may also include evaluations of an Option published by nationally
recognized ranking services and by financial publications that are nationally
recognized such as Barron's, Business Week, CDA Technologies, Inc., Changing
Times, Consumer's Digest, Dow Jones Industrial Average, Financial Planning,
Financial Times, Financial World, Forbes, Fortune, Global Investor, Hulbert's
Financial Digest, Institutional Investor, Investors Daily, Money, Morningstar
Mutual Funds, The New York Times, Personal Investor, Stanger's Investment
Adviser, Value Line, The Wall Street Journal, Wiesenberger Investment Company
Service and USA Today.
The performance figures described above may also be used to compare the
performance of an Option's shares against certain widely recognized standards or
indices for stock and bond market performance. The following are the indices
against which the Options may compare performance:
The Standard & Poor's Composite Index of 500 Stocks (the S&P 500) is a market
value-weighted and unmanaged index showing the changes in the aggregate market
value of 500 stocks relative to the base period 1941-43. The S&P 500 Index is
composed almost entirely of common stocks of companies listed on the NYSE,
although the common stocks of a few companies listed on the American Stock
Exchange or traded OTC are included. The 500 companies represented include 400
industrial, 60 transportation and 50 financial services concerns. The S&P 500
Index represents about 80% of the market value of all issues traded on the NYSE.
The Dow Jones Composite Average (or its component averages) is an unmanaged
index composed of 30 blue-chip industrial corporation stocks (Dow Jones
Industrial Average), 15 utilities company stocks and 20 transportation stocks.
Comparisons of performance assume reinvestment of dividends.
The New York Stock Exchange composite or component indices are unmanaged indices
of all industrial, utilities, transportation and finance company stocks listed
on the New York Stock Exchange.
The Wilshire 5000 Equity Index (or its component indices) represents the return
of the market value of all common equity securities for which daily pricing is
available. Comparisons of performance assume reinvestment of dividends.
The Morgan Stanley Capital International EAFE Index is an arithmetic, market
value-weighted average of the performance of over 900 securities on the stock
exchanges of countries in Europe, Australia and the Far East.
7
<PAGE>
The Morgan Stanley Capital International World Index - An arithmetic, market
value-weighted average of the performance of over 1,470 securities listed on the
stock exchanges of countries in Europe, Australia, the Far East, Canada and the
United States.
The Goldman Sachs 100 Convertible Bond Index currently includes 67 bonds and 33
preferred stocks. The original list of names was generated by screening for
convertible issues of $100 million or greater in market capitalization. The
index is priced monthly.
The Lehman Brothers Government Bond Index (the Lehman Government Index) is a
measure of the market value of all public obligations of the U.S. Treasury; all
publicly issued debt of all agencies of the U.S. Government and all quasi-
federal corporations; and all corporate debt guaranteed by the U.S. Government.
Mortgage-backed securities, flower bonds and foreign targeted issues are not
included in the Lehman Government Index.
The Lehman Brothers Government/Corporate Bond Index (the Lehman Government/
Corporate Index) is a measure of the market value of approximately 5,300 bonds
with a face value currently in excess of $1 million, which have at least one
year to maturity and are rated "Baa" or higher (investment grade) by a
nationally recognized statistical rating agency.
The Lehman Brothers Government/Corporate Intermediate Bond Index (the Lehman
Government/Corporate Intermediate Index) is composed of all bonds covered by the
Lehman Brothers Government/Corporate Bond Index with maturities between one and
9.99 years. Total return comprises price appreciation/depreciation and income as
a percentage of the original investment. Indexes are rebalanced monthly by
market capitalization.
The Lehman Brothers Intermediate Treasury Bond Index includes bonds with
maturities between one and ten years with a face value currently in excess of $1
million, that are rated investment grade or higher by a nationally recognized
statistical rating agency.
The Shearson Lehman Long-Term Treasury Bond Index is composed of all bonds
covered by the Shearson Lehman Hutton Treasury Bond Index with maturities of 10
years or greater.
The National Association of Securities Dealers Automated Quotation System
(NASDAQ) Composite Index covers 4,500 stocks traded over the counter. It
represents many small company stocks but is heavily influenced by about 100 of
the largest NASDAQ stocks. It is a value-weighted index calculated on price
change only and does not include income.
The NASDAQ Industrial Index is composed of more than 3,000 industrial issues. It
is a value-weighted index calculated on price change only and does not include
income.
The Value Line (Geometric) Index is an unweighted index of the approximately
1,700 stocks followed by the Value Line Investment Survey.
The Salomon Brothers GNMA Index includes pools of mortgages originated by
private lenders and guaranteed by the mortgage pools of the Government National
Mortgage Association.
The Salomon Brothers' World Market Index is a measure of the return of an
equally weighted basket of short-term (three month U.S. Government securities
and bank deposits) investments in eight major currencies: the U.S. dollars, UK
pounds sterling, Canadian dollars, Japanese yen, Swiss francs, French francs,
German Deutsche mark and Netherlands guilder.
The Salomon Brothers Broad Investment-Grade Bond Index contains approximately
3,800 Treasury and agency, corporate and mortgage bonds with a rating of BBB or
higher, a stated maturity of at least one
8
<PAGE>
year, and a par value outstanding of $25 million or more. The index is weighted
according to the market value of all bond issues included in the index.
The Salomon Brothers High Grade Corporate Bond Index consists of publicly
issued, non-convertible corporate bonds rated AA or AAA. It is a value-weighted,
total return index, including approximately 800 issues with maturities of 12
years or greater.
The Salomon Brothers World Bond Index measures the total return performance of
high-quality securities in major sectors of the international bond market. The
index covers approximately 600 bonds from 10 currencies: Australian dollars,
Canadian dollars, European Currency Units, French francs, Japanese yen,
Netherlands guilder, Swiss francs, UK pounds sterling, U.S. dollars, and German
deutsche marks.
The J.P. Morgan Global Government Bond Index is a total return, market
capitalization weighted index, rebalanced monthly consisting of the following
countries: Australia, Belgium, Canada, Denmark, France, Germany, Italy, Japan,
Netherlands, Spain, Sweden, United Kingdom and United States.
The 50/50 Index assumes a static mix of 50% of the S&P 500 Index and 50% of the
Lehman Government Corporate Index.
Other Composite Indices: 70% S&P 500 Index and 30% NASDAQ Industrial Index; 35%
S&P 500 Index and 65% Salomon Brothers High Grade Bond Index; and 65% S&P Index
and 35% Salomon Brothers High Grade Bond Index.
The SEI Median Balanced Fund Universe measures a group of funds with an average
annual equity commitment and an average annual bond - plus - private - placement
commitment greater than 5% each year. SEI must have at least two years of data
for a fund to be considered for the population.
The Russell 2000/Small Stock Index comprises the smallest 2000 stocks in the
Russell 3000 Index, and represents approximately 11% of the total U.S. equity
market capitalization. The Russell 3000 Index comprises the 3,000 largest U.S.
companies by market capitalization. The smallest company has a market value of
roughly $20 million.
The Russell 2500 Index is comprised of the bottom 500 stocks in the Russell 1000
Index which represents the universe of stocks from which most active money
managers typically select; and all the stocks in the Russell 2000 Index. The
largest security in the index has a market capitalization of approximately 1.3
billion.
The Consumer Price Index (or Cost of Living Index), published by the United
States Bureau of Labor Statistics is a statistical measure of change, over time,
in the price of goods and services in major expenditure groups.
Stocks, Bonds, Bills and Inflation, published by Hobson Associates, presents an
historical measure of yield, price and total return for common and small company
stocks, long-term government bonds, Treasury bills and inflation.
Savings and Loan Historical Interest Rates as published in the United States
Savings & Loan League Fact Book.
Historical data supplied by the research departments of First Boston
Corporation, the J.P. Morgan companies, Salomon Brothers, Merrill Lynch, Pierce,
Fenner & Smith, Shearson Lehman Hutton and Bloomberg L.P.
9
<PAGE>
The MSCI Combined Far East Free ex Japan Index is a market-capitalization
weighted index comprising stocks in Hong Kong, Indonesia, Korea, Malaysia,
Philippines, Singapore and Thailand. Korea is included in the MSCI Combined Far
East Free ex Japan Index at 20% of its market capitalization.
The First Boston High Yield Index generally includes over 180 issues with an
average maturity range of seven to ten years with a minimum capitalization of
$100 million. All issues are individually trader-priced monthly.
In reports or other communications to shareholders, the Fund may also describe
general economic and market conditions affecting the Options and may compare the
performance of the Options with (1) that of mutual funds included in the
rankings prepared by Lipper or similar investment services that monitor the
performance of insurance company separate accounts or mutual funds, (2)
IBC/Donoghue's Money Fund Report, (3) other appropriate indices of investment
securities and averages for peer universe of funds which are described in this
Statement of Additional Information, or (4) data developed by National Integrity
or any of the Sub-Advisers derived from such indices or averages.
Individualized Computer Generated Illustrations
National Integrity may from time to time use computer-based software available
through Morningstar, CDA/Wiesenberger and/or other firms to provide registered
representatives and existing and/or potential owners of the contracts with
individualized hypothetical performance illustrations for some or all of the
Variable Account Options. Such illustrations may include, without limitation,
graphs, bar charts and other types of formats presenting the following
information: (i) the historical results of a hypothetical investment in a single
Option; (ii) the historical fluctuation of the value of a single Option (actual
and hypothetical); (iii) the historical results of a hypothetical investment in
more than one Option; (iv) the historical performance of two or more market
indices in relation to one another and/or one or more Options; (v) the
historical performance of two or more market indices in comparison to a single
Option or a group of Options; (vi) a market risk/reward scatter chart showing
the historical risk/reward relationship of one or more mutual funds or Options
to one or more indices and a broad category of similar anonymous variable
annuity subaccounts; and (vii) Option data sheets showing various information
about one or more Options (such as information concerning total return for
various periods, fees and expenses, standard deviation, alpha and beta,
investment objective, inception date and net assets). We reserve the right to
republish figures independently provided by Morningstar or any similar agency or
service.
10
<PAGE>
PART 4 - DETERMINATION OF ANNUITY UNIT VALUES
The annuity unit value was initially fixed at $1.00 for contracts with assumed
base rates of net investment return of 5% and 3.5% a year, respectively. For
each valuation period thereafter, it is the annuity value for the preceding
valuation period multiplied by the adjusted net investment factor under the
contracts. For each valuation period, the adjusted net investment factor is
equal to the net investment factor reduced for each day in the valuation period
by:
* .00013366 for a contract with an assumed base rate of net investment return
of 5% a year; or
* .00009425 for a contract with an assumed base rate of net investment return
of 3.5% a year.
Because of this adjustment, the annuity unit value rises and falls depending on
whether the actual rate of net investment return (after charges) is higher or
lower than the assumed base rate.
All certificates have a 5% assumed base rate, except in states where that rate
is not permitted. Annuity payments under contracts with an assumed base rate of
3.5% will at first be smaller than those under contracts with a 5% assumed base
rate. Payments under the 3.5% contracts, however, will rise more rapidly when
unit values are rising, and payments will fall more slowly when unit values are
falling, than those under 5% contracts.
The amounts of variable annuity payments are determined as follows:
Payments normally start on the Annuitant's retirement date. The first three
monthly payments are the same. Each of the first three monthly payments will be
based on the amount taken from the tables in the contract or on our current
rates, whichever is more favorable to the participant. Where the Company's
current annuity rates are used, contributions in the current and five prior
participation years will qualify for the Company's current individual annuity
rates applicable to funds derived from sources outside the Company. The balance
of the proceeds will qualify for the Company's current individual annuity rates
for payment of proceeds.
The first three monthly payments depend on the assumed base rate of net
investment return and the forms of annuity chosen (and any fixed period). If the
annuity involves a life contingency, the risk class and the age of the
annuitants will affect payments.
Payments after the first three months will vary according to the investment
performance of the Variable Account Option or Options selected. After that, each
payment will be calculated by multiplying the number of annuity units credited
by the average annuity unit value for the second calendar month before the due
date of the payment. The number of annuity units credited equals the initial
periodic payment divided by the annuity unit value for the valuation period that
includes the due date of the first annuity payment. The average annuity unit
value is the average of the annuity unit values for the valuation periods ending
in that month. Each business day together with any non-business day or
consecutive non-business day immediately preceding such business day will
constitute a valuation period.
Illustration of Changes in Annuity Unit Values. To show how we determine
variable annuity payments from month to month, assume that the contract value on
a retirement date is enough to fund an annuity with a monthly payment of $363
and that the annuity unit value for the valuation period that includes the due
date of the first annuity payment is $1.05. The number of annuity units credited
under your contract would be 345.71 (363 divided by 1.05 = 345.71).
If the fourth monthly payment is due in March, and the average annuity unit
value for January was $1.10, the annuity payment for March would be the number
of units (345.71) times the average annuity unit value
11
<PAGE>
($1.10), or $380.28. If the average annuity unit value was $1.00 in February,
the annuity payment for April would be 345.71 times $1.00, or $345.71.
For period certain life annuities and life income annuities, the participant may
not surrender or redeem once annuity payments commence. For period certain life
annuities only, if the payee (or the payee and the other annuitant under a joint
and survivor annuity) dies before the period selected ends, the remaining
payments will go to another named payee who may have the right to redeem the
annuity and secure the present value of future guaranteed payments in a lump
sum. The present value of future guaranteed payments for a period certain is
based on the number of payments left, the assumed base rate of net return, the
number of annuity units and the annuity unit value for the date the Company
receives a written request for lump sum payment of remaining values. Assets held
in the Account at least equal to all statutory reserves required for such
Separate Account.
PART 5 - DEATH BENEFIT INFORMATION FOR CONTRACTS ISSUED PRIOR TO JANUARY 1, 1995
Notwithstanding anything in the prospectus to the contrary, for contracts issued
prior to January 1, 1995, the amount of the death benefit is the greatest of:
. your Account Value
. the Account Value at the beginning of the seventh contract year, plus
subsequent contributions and minus subsequent withdrawals
. your total contributions less the sum of withdrawals
. for Annuitants less than 70 years old on the birthday nearest the date
on which their contract was issued, an enhanced minimum death benefit.
"Subsequent withdrawals" for purposes of calculation of a death benefit reflect
any market value adjustments applicable to such withdrawals.
The enhanced minimum death benefit is equal to the guaranteed death benefit,
except that the guaranteed death benefit may not exceed the maximum guaranteed
death benefit. The guaranteed death benefit on your Participation Date is your
initial contribution. On a monthly basis thereafter we recalculate that portion
of your guaranteed death benefit allocated to the Separate Account by adding
interest at an annual rate of 7% until the contract anniversary on which your
nearest birthday is your 70th, subject to the maximum, and subtracting the sum
of any withdrawals or transfers from the Separate Account during the month and a
pro rata amount of the interest accumulated relative to such withdrawn or
transferred amount. Therefore, your guaranteed death benefit at any time,
subject to the maximum, is equal to the sum of (1) your Guarantee Period Values,
and (2) your Separate Account contributions and the amount of interest
calculated on your Separate Account values for purposes of determining the
guaranteed death benefit less any withdrawals or transfers and less the interest
calculated on a pro rata basis on such withdrawn or transferred amount. Your
maximum guaranteed death benefit is determined by totalling your contributions
during your first five participation years, subtracting all withdrawals
inclusive of any market value adjustments made under the contract, multiplying
the result by two, and then adding to that amount your total contributions made
after the first five participation years.
PART 6 - FINANCIAL STATEMENTS
Ernst & Young LLP, Suite 2100, 400 West Market Street, Louisville, Kentucky
40202, is our independent auditor and serves as independent auditor of the
Separate Account. Ernst & Young LLP on an annual basis will audit certain
financial statements prepared by management and express an opinion on such
financial statements based on their audits.
12
<PAGE>
The financial statements of the Separate Account as of December 31, 1996, and
for the periods indicated in the financial statements and the statutory-basis
financial statements of National Integrity as of and for the years ended
December 31, 1996 and 1995 included in this SAI have been audited by Ernst &
Young LLP, independent auditors, as set forth in their reports included herein.
The financial statements of National Integrity should be distinguished from the
financial statements of the Separate Account and should be considered only as
they relate to the ability of National Integrity to meet its obligations under
the contract. They should not be considered as relating to the investment
performance of the assets held in the Separate Account.
<PAGE>
Financial Statements
Separate Account II
of
National Integrity Life Insurance Company
December 31, 1996
With Report of Independent Auditors
<PAGE>
Separate Account II
of
National Integrity Life Insurance Company
Financial Statements
December 31, 1996
Contents
<TABLE>
<CAPTION>
<S> <C>
Report of Independent Auditors............................................. 1
Audited Financial Statements
Statement of Assets and Liabilities........................................ 2
Statement of Operations.................................................... 4
Statements of Changes in Net Assets........................................ 6
Notes to Financial Statements.............................................. 10
</TABLE>
<PAGE>
Report of Independent Auditors
Contract Holders
Separate Account II of National Integrity Life Insurance Company
We have audited the accompanying statement of assets and liabilities of Separate
Account II of National Integrity Life Insurance Company (comprising,
respectively, the Renaissance Balanced, Zweig Asset Allocation, Nicholas-
Applegate Balanced, Harris Bretall Sullivan & Smith Equity Growth, Dreman Value,
Zweig Equity (Small Cap), Pinnacle Fixed Income, ARM Capital Advisors Money
Market, Morgan Stanley Asian Growth, and Morgan Stanley Worldwide High Income
Divisions) as of December 31, 1996, the related statement of operations for the
year then ended and statements of changes in net assets for the years ended
December 31, 1996 and 1995. These financial statements 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. Our procedures included
confirmation of mutual fund shares owned in The Legends Fund, Inc. as of
December 31, 1996, by correspondence with the transfer agent of The Legends
Fund, Inc. 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
divisions constituting Separate Account II of National Integrity Life Insurance
Company at December 31, 1996, the results of their operations for the year
ended, and changes in their net assets for the years ended December 31, 1996 and
1995, in conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
Louisville, Kentucky
April 18, 1997
1
<PAGE>
Separate Account II of National Integrity Life Insurance Company
Statement of Assets and Liabilities
December 31, 1996
<TABLE>
<CAPTION>
Harris Bretall
Nicholas- Sullivan &
Renaissance Zweig Asset Applegate Smith Equity Dreman
Balanced Allocation Balanced Growth Value
Division Division Division Division Division
---------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Assets
Investments in The Legends Fund, Inc. at value
(cost of $44,079,835 in the aggregate) $8,185,762 $5,629,286 $11,656,045 $6,448,527 $5,471,962
Receivable from (payable to) the general
account of National Integrity 58 (765) 7,112 1,293 1,362
---------------------------------------------------------------------
Net assets $8,185,820 $5,628,521 $11,663,157 $6,449,820 $5,473,324
=====================================================================
Unit value $ 13.84 $ 14.45 $ 14.97 $ 14.71 $ 18.39
=====================================================================
Units outstanding 591,461 389,517 779,102 438,465 297,625
=====================================================================
</TABLE>
See accompanying notes.
2
<PAGE>
Separate Account II of National Integrity Life Insurance Company
Statement of Assets and Liabilities (continued)
December 31, 1996
<TABLE>
<CAPTION>
ARM Capital Morgan
Advisors Morgan Stanley
Zweig Equity Pinnacle Money Stanley Asian Worldwide
(Small Cap) Fixed Income Market Growth High Income
Division Division Division Division Division Total
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Assets
Investments in The Legends Fund, Inc. at value
(cost of $44,079,835 in the aggregate) $2,040,433 $1,518,177 $1,346,745 $3,478,950 $960,262 $46,736,149
Receivable from (payable to) the general
account of National Integrity (521) 432 (398) (1,613) (299) 6,661
------------------------------------------------------------------------------------
Net assets $2,039,912 $1,518,609 $1,346,347 $3,477,337 $959,963 $46,742,810
====================================================================================
Unit value $ 14.69 $ 11.48 $ 10.86 $ 10.48 $ 13.79
====================================================================
Units outstanding 138,864 132,283 123,973 331,807 69,613
====================================================================
</TABLE>
See accompanying notes.
3
<PAGE>
Separate Account II of National Integrity Life Insurance Company
Statement of Operations
Year Ended December 31, 1996
<TABLE>
<CAPTION>
Harris Bretall
Nicholas- Sullivan &
Renaissance Zweig Asset Applegate Smith Equity Dreman
Balanced Allocation Balanced Growth Value
Division Division Division Division Division
-------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Investment income
Reinvested dividends from The Legends Fund, Inc. $1,052,573 $ 685,370 $1,236,186 $ 469,289 $ 255,315
Expenses
Mortality and expense risk and
administrative charges 118,066 74,176 143,402 71,949 65,136
-------------------------------------------------------------------------
Net investment income (loss) 934,507 611,194 1,092,784 397,340 190,179
Realized and unrealized gain (loss)
on investments
Net realized gain on sales
of investments 393,940 196,615 517,897 472,123 814,248
Net unrealized appreciation (depreciation)
of investments:
Beginning of period 994,499 652,133 1,159,728 448,600 733,905
End of period 331,511 528,354 745,131 82,343 778,795
-------------------------------------------------------------------------
Change in net unrealized appreciation/
depreciation during the period (662,988) (123,779) (414,597) (366,257) 44,890
-------------------------------------------------------------------------
Net realized and unrealized gain (loss) on
investments (269,048) 72,836 103,300 105,866 859,138
-------------------------------------------------------------------------
Net increase in net assets resulting from
operations $ 665,459 $ 684,030 $1,196,084 $ 503,206 $1,049,317
=========================================================================
</TABLE>
See accompanying notes.
4
<PAGE>
Separate Account II of National Integrity Life Insurance Company
Statement of Operations (continued)
Year Ended December 31, 1996
<TABLE>
<CAPTION>
ARM Capital Morgan Morgan
Zweig Pinnacle Advisors Stanley Stanley
Equity Fixed Money Asian Worldwide
(Small Cap) Income Market Growth High Income
Division Division Division Division Division Total
--------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Investment income
Reinvested dividends from The Legends Fund, Inc. $ 188,121 $ 52,944 $136,031 $ - $ 91,052 $4,166,881
Expenses
Mortality and expense risk and administrative
charges 38,691 21,734 42,309 45,007 8,518 628,988
-------------------------------------------------------------------------
Net investment income (loss) 149,430 31,210 93,722 (45,007) 82,534 3,537,893
Realized and unrealized gain (loss) on investments
Net realized gain on sales of investments 497,943 6,428 - 26,325 49,594 2,975,113
Net unrealized appreciation (depreciation) of
investments:
Beginning of period 303,671 75,660 - 50,234 14,275 4,432,705
End of period 4,239 45,807 - 116,343 23,791 2,656,314
-------------------------------------------------------------------------
Change in net unrealized appreciation/
depreciation during the period (299,432) (29,853) - 66,109 9,516 (1,776,391)
-------------------------------------------------------------------------
Net realized and unrealized gain (loss) on investments 198,511 (23,425) - 92,434 59,110 1,198,722
-------------------------------------------------------------------------
Net increase in net assets resulting from operations $ 347,941 $ 7,785 $ 93,722 $ 47,427 $141,644 $4,736,615
=========================================================================
</TABLE>
See accompanying notes.
5
<PAGE>
Separate Account II of National Integrity Life Insurance Company
Statement of Changes in Net Assets
Year Ended December 31, 1996
<TABLE>
<CAPTION>
Zweig Nicholas- Harris Bretall
Renaissance Asset Applegate Sullivan & Smith Dreman
Balanced Allocation Balanced Equity Growth Value
Division Division Division Division Division
----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Increase (decrease) in net assets from operations
Net investment income (loss) $ 934,507 $ 611,194 $ 1,092,784 $ 397,340 $ 190,179
Net realized gain on sales of investments 393,940 196,615 517,897 472,123 814,248
Change in net unrealized appreciation/
depreciation during the period (662,988) (123,779) (414,597) (366,257) 44,890
----------------------------------------------------------------------
Net increase in net assets resulting from operations 665,459 684,030 1,196,084 503,206 1,049,317
Increase (decrease) in net assets from contract
related transactions
Contributions from contract holders 163,477 442,528 425,966 363,225 654,221
Contract terminations and benefits (505,425) (626,730) (899,360) (419,837) (512,310)
Net transfers among investment options (937,403) (244,654) 457,484 1,101,836 618,917
----------------------------------------------------------------------
Net increase (decrease) in net assets derived
from contract related transactions (1,279,351) (428,856) (15,910) 1,045,224 760,828
----------------------------------------------------------------------
Increase (decrease) in net assets (613,892) 255,174 1,180,174 1,548,430 1,810,145
Net assets, beginning of year 8,799,712 5,373,347 10,482,983 4,901,390 3,663,179
----------------------------------------------------------------------
Net assets, end of year $ 8,185,820 $5,628,521 $11,663,157 $6,449,820 $5,473,324
======================================================================
Unit transactions
Contributions 12,452 33,546 24,432 26,839 42,120
Terminations and benefits (37,773) (47,095) (67,575) (29,734) (30,046)
Net transfers (69,088) (18,373) 25,060 66,636 41,013
----------------------------------------------------------------------
Increase (decrease) in units (94,409) (31,922) (18,083) 63,741 53,087
======================================================================
</TABLE>
See accompanying notes.
6
<PAGE>
<TABLE>
<CAPTION>
Separate Account II of National Integrity Life Insurance Company
Statement of Changes in Net Assets (continued)
Year Ended December 31, 1996
ARM Capital Morgan
Advisors Morgan Stanley
Zweig Equity Pinnacle Money Stanley Asian Worldwide
(Small Cap) Fixed Income Market Growth High Income
Division Division(1) Division(2) Division Division Total
----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Increase (decrease) in net assets from operations
Net investment income (loss) $ 149,430 $ 31,210 $ 93,722 $ (45,007) $ 82,534 $ 3,537,893
Net realized gain on sales of investments 497,943 6,428 0 26,325 49,594 2,975,113
Change in net unrealized appreciation/
depreciation during the period (299,432) (29,853) 0 66,109 9,516 (1,776,391)
----------------------------------------------------------------------------
Net increase in net assets resulting from operations 347,941 7,785 93,722 47,427 141,644 4,736,615
Increase (decrease) in net assets from contract
related transactions
Contributions from contract holders 203,396 38,182 556,466 594,972 144,499 3,586,932
Contract terminations and benefits (646,821) (149,059) (2,026,755) (250,466) (37,245) (6,074,008)
Net transfers among investment options (813,891) (21,922) (821,309) 663,821 373,794 376,673
----------------------------------------------------------------------------
Net increase (decrease) in net assets derived
from contract related transactions (1,257,316) (132,799) (2,291,598) 1,008,327 481,048 (2,110,403)
----------------------------------------------------------------------------
Increase (decrease) in net assets (909,375) (125,014) (2,197,876) 1,055,754 622,692 2,626,212
Net assets, beginning of year 2,949,287 1,643,623 3,544,223 2,421,583 337,271 44,116,598
----------------------------------------------------------------------------
Net assets, end of year $ 2,039,912 $1,518,609 $1,346,347 $3,477,337 $959,963 $46,742,810
============================================================================
Unit transactions
Contributions 15,294 3,365 54,004 56,746 11,893
Terminations and benefits (48,315) (13,007) (191,155) (24,032) (2,957)
Net transfers (62,744) (1,874) (75,140) 58,618 30,644
----------------------------------------------------------------
Increase (decrease) in units (95,765) (11,516) (212,291) 91,332 39,580
================================================================
</TABLE>
(1) Effective April 1, 1996, J.P. Morgan Investment Management, Inc. replaced
Mitchell Hutchins Institutional Investors, Inc. as sub-adviser to the
portfolio.
(2) Effective April 1, 1996, ARM Capital Advisors, Inc. became the sole
investment manager of the portfolio.
See accompanying notes.
7
<PAGE>
Separate Account II of National Integrity Life Insurance Company
Statement of Changes in Net Assets
Year Ended December 31, 1995
<TABLE>
<CAPTION>
Harris Bretall
Nicholas- Sullivan &
Renaissance Zweig Asset Applegate Smith Equity Dreman
Balanced Allocation Balanced Growth Value
Division Division Division Division Division
--------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Increase (decrease) in net assets from operations
Net investment income (loss) $ 169,765 $ 57,031 $ 62,571 $ (12,353) $ 39,143
Net realized gain (loss) on sales of investments 77,487 149,185 171,724 407,573 72,280
Change in net unrealized appreciation/
depreciation during the period 1,270,669 718,111 1,298,568 372,365 801,253
--------------------------------------------------------------------------
Net increase in net assets resulting from operations 1,517,921 924,327 1,532,863 767,585 912,676
Increase (decrease) in net assets from contract
related transactions
Contributions from contract holders 541,100 357,200 1,759,155 1,253,010 244,000
Contract terminations and benefits (355,156) (296,653) (716,973) (156,906) (79,358)
Net transfers among investment options 1,326,424 (1,317,416) (464,721) 217,683 955,920
--------------------------------------------------------------------------
Net increase (decrease) in net assets derived
from contract related transactions 1,512,368 (1,256,869) 577,461 1,313,787 1,120,562
--------------------------------------------------------------------------
Increase (decrease) in net assets 3,030,289 (332,542) 2,110,324 2,081,372 2,033,238
Net assets, beginning of year 5,769,423 5,705,889 8,372,659 2,820,018 1,629,941
--------------------------------------------------------------------------
Net assets, end of year $8,799,712 $ 5,373,347 $10,482,983 $4,901,390 $3,663,179
==========================================================================
Unit transactions
Contributions 47,396 29,147 142,006 91,868 18,733
Terminations and benefits (36,045) (29,548) (62,316) (13,992) (5,987)
Net transfers 124,662 (113,936) (36,339) 16,757 75,467
--------------------------------------------------------------------------
Increase (decrease) in units 136,013 (114,337) 43,351 94,633 88,213
==========================================================================
</TABLE>
See accompanying notes.
8
<PAGE>
Separate Account II of National Integrity Life Insurance Company
Statement of Changes in Net Assets (continued)
Year Ended December 31, 1995
<TABLE>
<CAPTION>
Mitchell Morgan
Mitchell Hutchins Morgan Stanley
Zweig Equity Hutchins Money Stanley Asian Worldwide
(Small Cap) Fixed Income Market Growth High Income
Division Division Division Division Division Total
-------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Increase (decrease) in net assets from operations
Net investment income (loss) $ 1,079 $ 62,381 $ 94,402 $ (20,698) $ 30,767 $ 484,088
Net realized gain (loss) on sales of investments 21,120 (2,906) - (11,326) 2,303 887,440
Change in net unrealized appreciation/
depreciation during the period 343,729 152,741 - 233,475 32,322 5,223,233
-------------------------------------------------------------------------
Net increase in net assets resulting from operations 365,928 212,216 94,402 201,451 65,392 6,594,761
Increase (decrease) in net assets from contract
related transactions
Contributions from contract holders 399,642 31,253 332,573 403,323 33,502 5,354,758
Contract terminations and benefits (41,254) (68,196) (1,869,693) (137,527) (9,957) (3,731,673)
Net transfers among investment options 321,733 62,848 3,046,901 (268,943) (95,363) 3,785,066
-------------------------------------------------------------------------
Net increase (decrease) in net assets derived
from contract related transactions 680,121 25,905 1,509,781 (3,147) (71,818) 5,408,151
-------------------------------------------------------------------------
Increase (decrease) in net assets 1,046,049 238,121 1,604,183 198,304 (6,426) 12,002,912
Net assets, beginning of year 1,903,238 1,405,502 1,940,040 2,223,279 343,697 32,113,686
-------------------------------------------------------------------------
Net assets, end of year $2,949,287 $1,643,623 $ 3,544,223 $2,421,583 $337,271 $44,116,598
=========================================================================
Unit transactions
Contributions 32,827 2,757 34,024 41,227 3,593
Terminations and benefits (3,578) (6,336) (183,434) (13,519) (972)
Net transfers 24,419 5,341 295,168 (28,564) (9,015)
------------------------------------------------------------
Increase (decrease) in units 53,668 1,762 145,758 (856) (6,394)
============================================================
</TABLE>
See accompanying notes.
9
<PAGE>
Separate Account II
of
National Integrity Life Insurance Company
Notes to Financial Statements
December 31, 1996
1. Organization and Significant Accounting Policies
Organization and Nature of Operations
National Integrity Life Insurance Company ("National Integrity") established
Separate Account II (the "Separate Account") on May 21, 1992 under the insurance
laws of the state of New York for the purpose of issuing flexible premium
variable annuity contracts ("contracts"). The Separate Account is a unit
investment trust registered with the Securities and Exchange Commission ("SEC")
under the Investment Company Act of 1940, as amended. The operations of the
Separate Account are part of National Integrity.
National Integrity is a wholly owned subsidiary of Integrity Life Insurance
Company ("Integrity") and their ultimate parent is ARM Financial Group, Inc.
("ARM"). ARM specializes in the asset accumulation business, providing retail
and institutional customers with products and services designed to serve the
growing long-term savings and retirement markets.
Contract holders may allocate or transfer their account values to one or more
investment divisions of the Separate Account or to one or more fixed guaranteed
rate options of National Integrity's Separate Account GRO. The Separate Account
divisions invest in shares of corresponding investment portfolios of The Legends
Fund, Inc. ("Legends Fund"), a "series" type mutual fund. Integrity served as
investment adviser to the Legends Fund. Integrity had entered into a sub-
advisory agreement with a professional manager for investment of the assets of
each of the portfolios. Effective February 1, 1996 ARM Capital Advisors, Inc.
("ARM Capital Advisors"), a wholly owned subsidiary of ARM, assumed Integrity's
role as investment adviser to the Legends Fund. ARM Capital Advisors is
registered with the SEC under the Investment Advisers Act of 1940. The contract
holder's account value in a Separate Account division will vary depending on the
performance of the corresponding portfolio. The Separate Account currently has
ten investment divisions available. The investment objective of each division
and its corresponding portfolio are the same. Set forth below is a summary of
the investment objectives of the portfolios of the Legends Fund.
10
<PAGE>
Separate Account II
of
National Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. Organization and Significant Accounting Policies (continued)
Renaissance Balanced Portfolio seeks capital appreciation and income in rising
markets and the preservation of capital in declining markets. Its assets are
allocated among common stocks of issuers with large capitalizations, United
States government and high-quality corporate debt securities, and high quality
cash equivalent issues, such as commercial paper. Equity investments will
generally range from 10% to 75% of the total assets in the portfolio, and under
normal market conditions at least 25% of total assets will be invested in senior
fixed income securities. Renaissance Investment Management is the sub-adviser to
the portfolio.
Zweig Asset Allocation Portfolio seeks long-term capital appreciation. It
invests primarily in blue chip stocks, consistent with preservation of capital
and the reduction of portfolio exposure to market risk, as determined by the
sub-adviser to the portfolio. Blue chip stocks are stocks which the sub-adviser
considers comparable to the stocks included in the S&P 500 at the time of
purchase, and that have a minimum of $400 million market capitalization, average
daily trading volume of 50,000 shares or $425 million in total assets, and which
are traded on the New York Stock Exchange ("NYSE"), American Stock Exchange
("AMEX"), over-the-counter ("OTC") or on foreign exchanges. Zweig/Glaser
Advisers is the sub-adviser to the portfolio.
Nicholas-Applegate Balanced Portfolio seeks maximum total return in both the
equity and fixed income portion of its investments. Under normal market
conditions, the portfolio will have 60% to 65% of its total assets invested in
equity securities, including common stocks and securities convertible into or
exchangeable for common stocks (such as convertible preferred stocks and
convertible debentures). The remaining 35% to 40% of total assets will be
invested in U.S. government securities or cash equivalent issues. Nicholas-
Applegate Capital Management is the sub-adviser to the portfolio.
Harris Bretall Sullivan & Smith Equity Growth Portfolio seeks long-term capital
appreciation. It primarily invests in stocks of established companies with
proven records of superior and consistent growth. The portfolio may invest all
or a portion of its assets in cash and cash equivalents if the sub-adviser
considers the equity markets to be overvalued. The portfolio may invest in U.S.
government securities when this
11
<PAGE>
Separate Account II
of
National Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. Organization and Significant Accounting Policies (continued)
appears desirable in light of the portfolio's investment objective or when
market conditions warrant. Harris Bretall Sullivan & Smith, Inc. is the sub-
adviser to the portfolio.
Dreman Value Portfolio seeks primarily long-term capital appreciation with a
secondary objective of current income. It invests principally in a diversified
portfolio of securities believed by the sub-adviser to be undervalued. The sub-
adviser's philosophy centers on identifying stocks of large, well-known
companies with solid financial strength and generous dividend yields that have
low price-earnings ratios and have been generally overlooked by the market.
Dreman Value Advisors, Inc. is the sub-adviser to the portfolio.
Zweig Equity (Small Cap) Portfolio seeks long-term capital appreciation. It
invests primarily in small company stocks, consistent with preservation of
capital and reduction of portfolio exposure to market risk, as determined by the
sub-adviser. Current income is not an objective. Small Company Stocks are the
2,500 stock positions immediately after the 500 largest stocks ranked in terms
of market capitalization and/or trading volume, and which are traded on the
NYSE, AMEX, OTC or on foreign exchanges. Zweig/Glaser Advisers is the sub-
adviser to the portfolio.
Pinnacle Fixed Income Portfolio (formerly known as Mitchell Hutchins Fixed
Income Portfolio) seeks as high a level of current income as is consistent with
the preservation of capital. It invests in corporate bonds and mortgage-backed
securities (including mortgage-backed certificates issued by the Government
National Mortgage Association, the Federal National Mortgage Association and the
Federal Home Loan Mortgage Corporation), repurchase agreements with respect to
securities in which the portfolio may invest and instruments used in certain
hedging and related income strategies. The portfolio will principally invest in
securities rated at least investment grade or, if not rated, determined by the
sub-adviser to be of comparable quality. The portfolio may invest up to 15% of
its total assets in securities rated below investment grade or of equivalent
quality, including defaulted securities. Effective April 1, 1996, J. P. Morgan
Investment Management, Inc. became the sub-adviser to the portfolio.
12
<PAGE>
Separate Account II
of
National Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. Organization and Significant Accounting Policies (continued)
ARM Capital Advisors Money Market Portfolio (formerly known as Mitchell Hutchins
Money Market Portfolio) seeks maximum current income consistent with liquidity
and conservation of capital. It invests in high-grade money market instruments,
with remaining maturities of 13 months or less, and repurchase agreements
secured by such instruments, and maintains a dollar-weighted average portfolio
maturity of 90 days or less. As of April 1, 1996, ARM Capital Advisors, Inc.
became the sole investment manager of the portfolio.
Morgan Stanley Asian Growth Portfolio seeks long-term capital appreciation
through investment primarily in the common stocks of Asian issuers, excluding
Japan. Under normal market conditions, the portfolio will invest at least 65% of
the value of its total assets in common stocks that are traded on recognized
stock exchanges of Asian countries and in common stocks of companies organized
under the laws of an Asian country whose business is conducted principally in
Asia. The portfolio does not intend to invest in securities which are traded in
markets in Japan or in companies organized under the laws of Japan. The
portfolio's relatively large investment in countries with limited or developing
capital markets may involve greater risks than investments in more developed
markets and the prices of such investments may be volatile.
Morgan Stanley Worldwide High Income Portfolio seeks high current income
consistent with relative stability of principal and, secondarily, capital
appreciation through investing primarily in a portfolio of high-yielding fixed-
income securities of issuers located throughout the world. The portfolio seeks
to achieve its investment objective by allocating its assets among any or all of
three investment sectors: U.S. corporate lower-rated and unrated debt
securities, emerging country debt securities and global fixed-income securities
offering high yields. The portfolio's relatively large investment in countries
with limited or developing capital markets may involve greater risks than
investments in more developed markets and the prices of such investments may be
volatile.
Morgan Stanley Asset Management Inc. ("MSAM") serves as sub-adviser to the
Morgan Stanley Asian Growth portfolio and the Morgan Stanley Worldwide High
Income
13
<PAGE>
Separate Account II
of
National Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. Organization and Significant Accounting Policies (continued)
portfolio. MSAM is a wholly owned subsidiary of Morgan Stanley Group Inc.
("Morgan Stanley"). Approximately 91% of the shares outstanding voting stock of
ARM is owned by private equity funds sponsored by Morgan Stanley, therefore
these two entities are considered affiliates.
The assets of the Separate Account are owned by National Integrity. The portion
of the Separate Account's assets supporting the contracts may not be used to
satisfy liabilities arising out of any other business of National Integrity.
Basis of Presentation
The accompanying financial statements have been prepared in accordance with
generally accepted accounting principles for unit investment trusts.
Investments
Investments in shares of the Legends Fund are valued at the net asset values of
the respective portfolios, which approximates fair value. The difference between
cost and fair value is reflected as unrealized appreciation and depreciation of
investments.
Share transactions are recorded on the trade date. Realized gains and losses on
sales of Legends Fund shares are determined based on the identified cost basis.
Dividends from income and capital gain distributions are recorded on the ex-
dividend date. Dividends and distributions from the Legends Fund portfolios are
reinvested in the respective portfolios and are reflected in the unit value of
the divisions of the Separate Account.
Unit Value
Unit values for the Separate Account divisions are computed at the end of each
business day. The unit value is equal to the unit value for the preceding
business day multiplied by a net investment factor. This net investment factor
is determined based on the value of the
14
<PAGE>
Separate Account II
of
National Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. Organization and Significant Accounting Policies (continued)
underlying mutual fund portfolios of the Separate Account, reinvested dividends
and capital gains, new premium deposits or withdrawals, and the daily asset
charge for the mortality and expense risk and administrative charges. Unit
values are adjusted for all activity in the Separate Account.
Taxes
Operations of the Separate Account are included in the income tax return of
National Integrity which is taxed as a life insurance company under the Internal
Revenue Code. The Separate Account will not be taxed as a regulated investment
company under Subchapter M of the Internal Revenue Code. Under existing federal
income tax, no taxes are payable on the investment income or on the capital
gains of the Separate Account.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
15
<PAGE>
Separate Account II
of
National Integrity Life Insurance Company
Notes to Financial Statements (continued)
2. Investments
The aggregate cost of portfolio shares purchased and proceeds from portfolio
shares sold during the year ended December 31, 1996 and the cost of shares held
at December 31, 1996 for each division were as follows:
<TABLE>
<CAPTION>
Division Purchases Sales Cost
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Renaissance Balanced $2,645,737 $2,983,627 $ 7,854,251
Zweig Asset Allocation 1,305,640 1,123,833 5,100,932
Nicholas-Applegate Balanced 4,739,776 3,664,083 10,910,914
Harris Bretall Sullivan & Smith Equity
Growth 3,967,214 2,527,066 6,366,184
Dreman Value 3,277,395 2,326,345 4,693,167
Zweig Equity (Small Cap) 2,487,180 3,595,159 2,036,194
Pinnacle Fixed Income 151,320 252,035 1,472,370
ARM Capital Advisors Money Market 7,689,374 9,885,336 1,346,745
Morgan Stanley Asian Growth 1,940,206 975,086 3,362,607
Morgan Stanley Worldwide High Income 826,604 262,661 936,471
</TABLE>
3. Expenses
National Integrity assumes mortality and expense risks and incurs certain
administrative expenses related to the operations of the Separate Account and
deducts a charge from the assets of the Separate Account at an annual rate of
1.20% and 0.15% of net assets, respectively, to cover these risks and expenses.
In addition, an annual administrative charge of $30 per contract is assessed if
the participant's account value is less than $50,000 at the end of any
participation year prior to the participant's retirement date (as defined by the
participant's contract).
16
<PAGE>
Financial Statements
(Statutory Basis)
National Integrity Life
Insurance Company
Years Ended December 31, 1996 and 1995
with Report of Independent Auditors
<PAGE>
National Integrity Life Insurance Company
Financial Statements
(Statutory Basis)
Years Ended December 31, 1996 and 1995
<TABLE>
<CAPTION>
Contents
<S> <C>
Report of Independent Auditors..............................................1
Audited Financial Statements
Balance Sheets (Statutory Basis)............................................3
Statements of Operations (Statutory Basis)..................................5
Statements of Changes in Capital and Surplus (Statutory Basis)..............6
Statements of Cash Flows (Statutory Basis)..................................7
Notes to Financial Statements (Statutory Basis).............................9
</TABLE>
<PAGE>
Report of Independent Auditors
Board of Directors
National Integrity Life Insurance Company
We have audited the accompanying statutory basis balance sheets of National
Integrity 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 the years then ended. These financial statements 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 New York Insurance Department, which practices differ from
generally accepted accounting principles. The variances between such practices
and generally accepted accounting principles and the effects on the accompanying
financial statements are described in Note 1.
In our opinion, because of the effects of the matter 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 National Integrity Life Insurance Company at December 31, 1996 and 1995, or
the results of its operations or its cash flows for the years then ended.
1
<PAGE>
Also, in our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of National Integrity Life
Insurance Company at December 31, 1996 and 1995, and the results of its
operations and its cash flows for the years then ended in conformity with
accounting practices prescribed or permitted by the New York Insurance
Department.
/s/ Ernst & Young LLP
Louisville, Kentucky
February 12, 1997
2
<PAGE>
National Integrity Life Insurance Company
Balance Sheets (Statutory Basis)
<TABLE>
<CAPTION>
December 31,
1996 1995
------------------
(In Thousands)
<S> <C> <C>
Admitted assets
Cash and investments:
Bonds $451,439 $635,249
Preferred stocks 50,715 14,428
Mortgage loans 3,929 5,318
Policy loans 24,981 22,606
Cash and short-term investments 14,570 20,268
Other invested assets 36 8,827
------------------
Total cash and investments 545,670 706,696
Separate accounts assets 370,988 265,264
Receivable for investments sold 4,576 -
Accrued investment income 6,513 7,959
Federal income tax recoverable 438 -
Other admitted assets 1,740 -
------------------
Total admitted assets $929,925 $979,919
==================
</TABLE>
3
<PAGE>
<TABLE>
<CAPTION>
December 31,
1996 1995
------------------
(In Thousands)
<S> <C> <C>
Liabilities and capital and surplus
Liabilities:
Policy and contract liabilities:
Life and annuity reserves $513,639 $671,322
Unpaid claims 124 1,813
Deposits on policies to be issued 645 -
------------------
Total policy and contract liabilities 514,408 673,135
Separate accounts liabilities 370,988 265,264
Accounts payable and accrued expenses 213 264
Transfers to separate accounts due or accrued, net (21,247) (16,329)
Reinsurance balances payable 589 98
Federal income taxes - 1,005
Asset valuation reserve 1,773 1,969
Interest maintenance reserve 8,914 6,992
Payable for investments purchased - 6,082
Other liabilities 6,016 2,300
------------------
Total liabilities 881,654 940,780
Capital and surplus:
Common stock, $10 par value, 200,000 shares
authorized, issued, and outstanding 2,000 2,000
Paid-in surplus 59,244 59,244
Special surplus funds 750 750
Unassigned surplus (13,723) (22,855)
------------------
Total capital and surplus 48,271 39,139
------------------
Total liabilities and capital and surplus $929,925 $979,919
==================
</TABLE>
See accompanying notes.
4
<PAGE>
National Integrity Life Insurance Company
Statements of Operations (Statutory Basis)
<TABLE>
<CAPTION>
Year Ended December 31,
1996 1995
-----------------------
(In Thousands)
<S> <C> <C>
Premiums and other revenues:
Premiums and annuity considerations $ 8,640 $ 1,262
Deposit-type funds 352,899 261,378
Net investment income 53,553 46,548
Amortization of the interest maintenance reserve 1,001 823
Other revenues 5,653 3,913
-----------------------
Total premiums and other revenues 421,746 313,924
Benefits paid or provided:
Death benefits 8,260 9,098
Annuity benefits 12,106 3,581
Surrender benefits 101,241 119,789
Payments on supplementary contracts 1,879 1,869
Increase in insurance and annuity reserves 192,985 80,945
Other benefits 7,818 1,492
-----------------------
Total benefits paid or provided 324,289 216,774
Insurance and other expenses:
Commissions 5,817 4,809
General expenses 8,051 8,150
Taxes, licenses and fees 349 301
Net transfers to separate accounts 69,158 77,166
Other expenses 3,110 -
-----------------------
Total insurance and other expenses 86,485 90,426
Gain from operations before federal income taxes
and net realized capital losses 10,972 6,724
Federal income tax expense (benefit) (444) 991
-----------------------
Gain from operations before net realized capital losses 11,416 5,733
Net realized capital losses, less capital gains
tax expense (1996-$544; 1995-$1,800)
and excluding net gains (losses) transferred
to the interest maintenance reserve
(1996-$2,923; 1995-$(2,850)| (2,500) (900)
-----------------------
Net income $ 8,916 $ 4,833
=======================
</TABLE>
See accompanying notes.
5
<PAGE>
National Integrity Life Insurance Company
Statements of Changes in Capital and Surplus (Statutory Basis)
Years Ended December 31, 1996 and 1995
<TABLE>
<CAPTION>
Special Total
Common Paid-In Surplus Unassigned Capital and
Stock Surplus Funds Surplus Surplus
------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance, January 1, 1995 $2,000 $59,244 $ 750 $ (26,437) $ 35,557
Net income 4,833 4,833
Decrease in nonadmitted assets 20 20
Increase in asset valuation reserve (1,271) (1,271)
------------------------------------------------------------
Balance, December 31, 1995 2,000 59,244 750 (22,855) 39,139
Net income 8,916 8,916
Decrease in nonadmitted assets 19 19
Decrease in asset valuation reserve 197 197
------------------------------------------------------------
Balance, December 31, 1996 $2,000 $59,244 $ 750 $ (13,723) $ 48,271
============================================================
</TABLE>
See accompanying notes.
6
<PAGE>
National Integrity Life Insurance Company
Statements of Cash Flows (Statutory Basis)
<TABLE>
<CAPTION>
Year Ended December 31,
1996 1995
-----------------------
(In Thousands)
<S> <C> <C>
Operations:
Premiums, policy proceeds, and other considerations received $ 361,539 $ 262,639
Net investment income received 53,492 47,165
Commission and expense allowances received on reinsurance ceded 644 6
Benefits paid (125,238) (134,780)
Insurance expenses paid (14,170) (13,461)
Other income received net of other expenses paid 5,009 3,942
Net transfers to separate accounts (74,076) (83,932)
-----------------------
Net cash provided by operations 207,200 81,579
Investment activities:
Proceeds from sales, maturities, or repayments of investments:
Bonds 455,716 339,361
Preferred stocks 19,067 6,913
Mortgage loans 1,389 1,326
Other invested assets 8,826 -
-----------------------
Total investment proceeds 484,998 347,600
Taxes paid on capital gains (1,212) -
-----------------------
Net proceeds from sales, maturities, or repayments of investments 483,786 347,600
Cost of investments acquired:
Bonds 626,879 416,110
Preferred stocks 55,045 7,818
Other invested assets - 8,841
Miscellaneous proceeds 36 -
-----------------------
Total cost of investments acquired 681,960 432,769
Net increase in policy loans and premium notes 2,375 2,876
-----------------------
Net cash used in investment activities (200,549) (88,045)
Financing and miscellaneous activities:
Other cash provided:
Other sources 3,826 7,899
-----------------------
Total other cash provided 3,826 7,899
-----------------------
7
</TABLE>
<PAGE>
National Integrity Life Insurance Company
Statements of Cash Flows (Statutory Basis) (continued)
<TABLE>
<CAPTION>
Year Ended December 31,
1996 1995
-----------------------
(In Thousands)
<S> <C> <C>
Other cash applied:
Other applications, net 16,175 2,236
-----------------------
Total other cash applied 16,175 2,236
-----------------------
Net cash provided by (used in) financing and miscellaneous activities (12,349) 5,663
-----------------------
Net decrease in cash and short-term investments (5,698) (803)
Cash and short-term investments at beginning of year 20,268 21,071
-----------------------
Cash and short-term investments at end of year $ 14,570 $ 20,268
=======================
See accompanying notes.
8
</TABLE>
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis)
1. Organization and Accounting Policies
Organization
National Integrity Life Insurance Company ("National Integrity" or the
"Company") is a wholly owned subsidiary of Integrity Life Insurance Company
("Integrity") which is an indirect wholly owned subsidiary of ARM Financial
Group, Inc. ("ARM"). ARM acquired Integrity and the Company from The National
Mutual Life Association of Australasia Limited ("National Mutual"). The Company
is domiciled in the state of New York. The Company, currently licensed in eight
states and the District of Columbia, provides retail and institutional products
to the long-term savings and retirement marketplace.
Basis of Presentation
The accompanying financial statements of the Company have been prepared in
conformity with accounting practices prescribed or permitted by the New York
Insurance Department. Such practices vary from generally accepted accounting
principles ("GAAP"). The more significant variances from GAAP are as follows:
Investments
Investments in bonds and preferred stocks are reported at amortized cost or
market value based on the National Association of Insurance Commissioners (the
"NAIC") rating; for GAAP, such fixed maturity investments are designated at
purchase as held-to-maturity, trading or available-for-sale. Held-to-maturity
fixed investments are reported at amortized cost, and the remaining fixed
maturity investments are reported at fair value with unrealized holding gains
and losses reported in operations for those designated as trading and as a
separate component of shareholder's equity for those designated as available-
for-sale. In addition, fair values of certain investments in bonds and stock
are based on values specified by the NAIC, rather than on actual or estimated
market values used for GAAP.
Realized gains and losses are reported in income net of income tax and
transfers to the interest maintenance reserve. Changes between cost and
admitted investment asset amounts are credited or charged directly to
unassigned surplus rather than to a separate surplus account. The Asset
Valuation Reserve is determined by an NAIC prescribed formula and is reported
as a liability rather than unassigned surplus.
9
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
1. Organization and Accounting Policies (continued)
Under a formula prescribed by the NAIC, the Company defers 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 based on the individual security sold using the seriatim method.
The net deferral is reported as the Interest Maintenance Reserve in the
accompanying balance sheets. Under GAAP, realized gains and losses are
reported in the income statement on a pretax basis in the period that the
asset giving rise to the gain or loss is sold and include provisions when
there has been a decline in asset values deemed other than temporary.
Policy Acquisition Costs
Costs of acquiring and renewing business are expensed when incurred. Under
GAAP, acquisition costs related to investment-type products, to the extent
recoverable from future gross profits, are amortized generally in proportion
to the emergence of future gross profits over the estimated term of the
underlying policies.
Nonadmitted Assets
Certain assets designated as "nonadmitted," principally receivables greater
than 90 days past due, are excluded from the accompanying balance sheets and
are charged directly to unassigned surplus.
Premiums
Revenues include premiums and deposits received and benefits include death
benefits paid and the change in policy reserves. Under GAAP, such premiums
and deposits received are accounted for as a deposit liability and therefore
not recognized as premium revenue; benefits paid equal to the policy account
value are accounted for as a return of deposit instead of benefit expense.
10
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis)(continued)
1.Organization and Accounting Policies (continued)
Benefit Reserves
Certain policy reserves are calculated using statutorily prescribed interest
and mortality assumptions rather than on estimated expected experience or
actual account balances as would be required under GAAP.
Federal Income Taxes
Deferred federal income taxes are not provided for differences between the
financial statement amounts and tax bases of assets and liabilities.
The effects of the foregoing variances from GAAP on the accompanying statutory
basis financial statements are as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
1996 1995
-----------------------
(In Thousands)
<S> <C> <C>
Net income as reported in the accompanying
statutory basis financial statements $ 8,916 $ 4,833
Deferred policy acquisition costs, net of
amortization 5,187 7,614
Adjustments to customer deposits (441) (3,669)
Adjustments to invested asset carrying values
at acquisition date (160) (180)
Amortization of value of insurance in force (1,470) (2,905)
Amortization of interest maintenance reserve (1,001) (823)
Adjustments for realized investment gains (losses) 852 (747)
Adjustments for federal income tax benefit (expense) (2,185) 564
Other (200) 356
-----------------------
Net income, GAAP basis $ 9,498 $ 5,043
=======================
</TABLE>
11
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis)(continued)
1. Organization and Accounting Policies (continued)
<TABLE>
<CAPTION>
December 31,
1996 1995
-------------------
(In Thousands)
<S> <C> <C>
Capital and surplus as reported in the accompanying
statutory basis financial statements $ 48,271 $ 39,139
Adjustments to customer deposits (27,233) (26,792)
Adjustments to invested asset carrying values
at acquisition date (5,197) (5,889)
Asset valuation reserve and interest maintenance
reserve 19,369 20,567
Value of insurance in force 13,913 15,383
Deferred policy acquisition costs 23,728 18,541
Net unrealized gains on available-for-sale securities 1,416 5,577
Other (2,650) (246)
-------------------
Shareholder's equity, GAAP basis $ 71,617 $ 66,280
===================
</TABLE>
Other significant accounting practices are as follows:
Investments
Bonds, preferred stocks, common stocks, and short-term investments are stated at
values prescribed by the NAIC, as follows:
Bonds and short-term investments are reported at cost or amortized cost. The
discount or premium on bonds is amortized using the interest method. For
loan-backed bonds, anticipated prepayments are considered when determining
the amortization of discount or premium.
Prepayment assumptions for loan-backed bonds and structured securities are
obtained from broker-dealer survey values or internal estimates. These
assumptions are consistent with the current interest rate and economic
environment. The retrospective adjustment method is used to value all such
securities.
12
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
1. Organization and Accounting Policies (continued)
Preferred stocks are reported at cost.
Short-term investments include investments with maturities of less than one
year at the date of acquisition.
Mortgage loans and policy loans are reported at unpaid principal balances.
Realized capital gains and losses are determined using the specific
identification method.
Benefits
Life and annuity 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 or guaranteed policy cash values or the amounts
required by the New York Insurance Department. The Company waives deduction of
deferred fractional premiums upon the death of life and annuity policy insureds
and does not return any premium beyond the date of death. Surrender values on
policies do not exceed the corresponding benefit reserves. Policies issued
subject to multiple table substandard extra premiums are valued on the standard
reserve basis which recognizes the non-level incidence of the excess mortality
costs. Additional reserves are established when the results of cash flow testing
under various interest rate scenarios indicate the need for such reserves.
Tabular interest, tabular less actual reserve released, and tabular cost have
been determined by formula as prescribed by the NAIC.
13
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
1. Organization and Accounting Policies (continued)
Reinsurance
Reinsurance premiums, benefits and expenses are accounted for on bases
consistent with those used in accounting for the original policies issued and
the terms of the reinsurance contracts. Premiums, benefits and expenses, and the
reserves for policy and contract liabilities are reported net, rather than
gross, of reinsured amounts.
Separate Accounts
Separate account assets and liabilities reported in the accompanying financial
statements represent funds that are separately administered, principally for
variable annuity contracts. Separate account assets are reported at market
value. Surrender charges collectible by the general account in the event of
variable policy surrenders are reported as a negative liability rather than an
asset pursuant to prescribed NAIC accounting practices. The operations of the
separate accounts are not included in the accompanying financial statements,
except for separate accounts with guarantees. Fees charged on separate account
policyholder deposits are included in other revenues.
Use of Estimates
The preparation of financial statements in compliance with statutory accounting
practices requires management to make estimates and assumptions that affect
amounts reported in the financial statements and accompanying notes. Actual
results could differ from these estimates.
Reclassifications
Certain prior year amounts have been reclassified to conform with the
presentation of the 1996 financial statements. These reclassifications had no
effect on previously reported net income or surplus.
2. Permitted Statutory Accounting Practices
The Company's statutory basis financial statements are prepared in accordance
with accounting practices prescribed or permitted by the New York Insurance
Department. "Prescribed" statutory accounting practices include state laws,
regulations, and general
14
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
2. Permitted Statutory Accounting Practices (continued)
administrative rules, as well as a variety of publications of the NAIC.
"Permitted" statutory accounting practices encompass all accounting practices
that are not prescribed; such practices may differ from state to state, may
differ from company to company within a state, and may change in the future. The
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 effective for 1999, 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 financial statements. Although the
recodification project is meant to be surplus neutral, there is not enough
available information for the industry to assess the impact of such project.
3. Investments
The cost or amortized cost and the fair value of investments in bonds are
summarized as follows:
<TABLE>
<CAPTION>
Cost or Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------------------------------------------
(In Thousands)
<S> <C> <C> <C> <C>
At December 31, 1996:
U.S. Treasury securities and
obligations of U.S. government
agencies $ 16,243 $ 415 $ 110 $ 16,548
Foreign governments 12,363 643 - 13,006
Public utilities 40,882 379 644 40,617
Other corporate securities 127,264 396 6,534 121,126
Asset-backed securities 10,311 - - 10,311
Mortgage-backed securities 244,376 - - 244,376
--------------------------------------------
Total bonds $451,439 $1,833 $7,288 $445,984
============================================
</TABLE>
15
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
3. Investments (continued)
<TABLE>
<CAPTION>
Cost or Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-------------------------------------------
(In Thousands)
<S> <C> <C> <C> <C>
At December 31, 1995:
U.S. Treasury securities
and obligations of U.S.
government agencies $ 51,434 $1,381 $ 22 $ 52,793
States and political
subdivisions 5,997 43 - 6,040
Foreign governments 1,898 62 - 1,960
Public utilities 19,861 190 41 20,010
Other corporate
securities 229,776 5,366 1,653 233,489
Assets-backed securities 27,695 - - 27,695
Mortgage-backed
securities 298,588 - - 298,588
-------------------------------------------
Total bonds $635,249 $7,042 $1,716 $640,575
===========================================
</TABLE>
Fair values are based on published quotations of the Securities Valuation Office
of the NAIC. Fair values generally represent quoted market value prices for
securities traded in the public marketplace, or analytically determined values
using bid or closing prices for securities not traded in the public marketplace.
However, for certain investments for which the NAIC does not provide a value,
the Company uses the amortized cost amount as a substitute for fair value in
accordance with prescribed guidance. As of December 31, 1996 and 1995, the fair
value of investments in bonds includes $312,677,000 and $426,972,000,
respectively, of bonds that were valued at amortized cost.
16
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
3. Investments (continued)
A summary of the cost or amortized cost and fair value of the Company's
investments in bonds at December 31, 1996, by contractual maturity, is as
follows:
<TABLE>
<CAPTION>
Cost or
Amortized Fair
Cost Value
--------------------
(In Thousands)
<S> <C> <C>
Years to maturity:
After one through five $ 20,176 $ 16,110
After five through ten 32,815 31,575
After ten 143,761 143,612
Asset-backed securities 10,311 10,311
Mortgage-backed securities 244,376 244,376
-------------------
Total $451,439 $445,984
===================
</TABLE>
The expected maturities in the foregoing table may differ from the contractual
maturities because certain borrowers have the right to call or prepay
obligations with or without call or prepayment penalties and because asset-
backed and mortgage-backed securities (including floating-rate securities)
provide for periodic payments throughout their life.
Proceeds from the sales of investments in bonds during 1996 and 1995 were
$755,711,000 and $286,601,000; gross gains of $7,901,000 and $4,404,000, and
gross losses of $4,450,000 and $5,621,000 were realized on those sales,
respectively.
At December 31, 1996 and 1995, bonds with an admitted asset value of $1,234,000
and $1,235,000, respectively, were on deposit with state insurance departments
to satisfy regulatory requirements.
17
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
3. Investments (continued)
The Company has made no new investments in mortgage loans since 1988. The
maximum percentage of any one loan to the value of the security at the time of
the loan exclusive of any purchase money mortgages was 75%. Fire insurance at
least equal to the excess of the loan over the maximum loan which would be
permitted by law on the land without the buildings is required on all properties
covered by mortgage loans. As of year-end, the Company held no mortgages with
interest more than one year past due. During 1996, no interest rates of
outstanding mortgage loans were reduced. No amounts have been advanced by the
Company.
In connection with the change in control of the Company during 1993, National
Mutual agreed to indemnify the Company pursuant to a Guaranty Agreement dated
November 26, 1993, with respect to (i) principal (up to 100%) of the Company's
mortgage loans' statutory book value as of December 31, 1992 and (ii)
contractual interest payments (based on the original principal amount) of all
acquired commercial and agricultural mortgage loans. In support of its
indemnification obligations, National Mutual has placed $23.0 million into
escrow in favor of the Company and Integrity until the mortgage loans have been
repaid in full.
Major categories of the Company's net investment income are summarized as
follows:
<TABLE>
<CAPTION>
Year Ended December 31,
1996 1995
-----------------------
(In Thousands)
<S> <C> <C>
Income:
Bonds $47,487 $43,591
Preferred stocks 4,150 1,282
Mortgage loans 610 565
Policy loans 1,886 1,751
Short-term investments and cash 1,277 773
Other investment income 3 383
------------------
Total investment income 55,413 48,345
Investment expenses (1,860) (1,797)
------------------
Net investment income $53,553 $46,548
==================
</TABLE>
18
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
4. Reinsurance
Consistent with prudent business practices and the general practice of the
insurance industry, National Integrity reinsures risks under certain of its
insurance products with other insurance companies through reinsurance
agreements. Through these reinsurance agreements substantially all mortality
risks associated with single premium endowment and variable annuity deposits and
substantially all risks associated with variable life business have been
reinsured with non-affiliated insurance companies. A contingent liability exists
with respect to insurance ceded which would become a liability should the
reinsurer be unable to meet the obligations assumed under these reinsurance
agreements. Reinsurance ceded is not significant to the Company's premiums,
benefits or policy and contract liabilities. During 1995, the Company entered
into a reinsurance agreement with General American Life Insurance Company to
assume, on a 50% coinsurance basis, guaranteed investment contracts ("GICs").
Policy and contract liabilities assumed under this agreement were zero and
$117,770,000 at December 31, 1996 and 1995, respectively.
The effect of reinsurance on premiums and amounts earned is as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
1996 1995
-----------------------------------
(In Thousands)
<S> <C> <C>
Direct premiums and amounts assessed
against policyholders $115,547 $145,630
Reinsurance assumed 246,571 117,175
Reinsurance ceded (580) (165)
-----------------------------------
Net premiums and amounts earned $361,538 $262,640
===================================
</TABLE>
5. Federal Income Taxes
The Company files a consolidated return with Integrity. The method of allocation
between the companies is based on separate return calculations after
consolidated losses and credits.
19
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis)(continued)
5. Federal Income Taxes (continued)
Income before income taxes differs from taxable income principally due to value
of insurance in-force, interest maintenance reserves and differences in policy
and contract liabilities and investment income for tax and financial reporting
purposes.
The December 31, 1995 tax provision was calculated including net operating loss
carryover benefits of $4,304,000.
6. Surplus
The ability of the Company to pay dividends is limited by state insurance laws.
Under New York insurance laws, the Company may pay dividends only out of its
earnings and surplus, subject to at least thirty days prior notice to the New
York Insurance Superintendent and no disapproval from the Superintendent prior
to the date of such dividend. The Superintendent may disapprove a proposed
dividend if the Superintendent finds that the financial condition of the Company
does not warrant such distribution.
The NAIC adopted Risk-Based Capital ("RBC") requirements which became effective
December 31, 1993, that attempt to evaluate the adequacy of a life insurance
company's adjusted statutory capital and surplus in relation to investment,
insurance and other business risks. The RBC formula will be used by the states
as an early warning tool to identify possible under-capitalized companies for
the purpose of initiating regulatory action and is not designed to be a basis
for ranking the financial strength of insurance companies. In addition, the
formula defines a new minimum capital standard which supplements the previous
system of low fixed minimum capital and surplus requirements. The RBC
requirements provide for four different levels of regulatory attention depending
on the ratio of the company's adjusted capital and surplus to its RBC. As of
December 31, 1996 and 1995, the adjusted capital and surplus of the Company is
substantially in excess of the minimum level of RBC that would require
regulatory response.
20
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
7. Annuity Reserves
At December 31, 1996 and 1995, the Company's annuity reserves, including
separate accounts, and deposit fund liabilities that are subject to
discretionary withdrawal (with adjustment), subject to discretionary withdrawal
without adjustment, and not subject to discretionary withdrawal provisions are
summarized as follows:
<TABLE>
<CAPTION>
Amount Percent
-----------------------
(In Thousands)
<S> <C> <C>
At December 31, 1996:
Subject to discretionary withdrawal
(with adjustment):
With market value adjustment $ 89,668 11.5%
At book value less surrender charge
of 5% or more 23,208 3.0
At market value 257,419 33.0
-------------------
Total with adjustment or at market
value 370,295 47.5
Subject to discretionary withdrawal
(without adjustment) at book value
with minimal or no charge or
adjustment 347,883 44.7
Not subject to discretionary withdrawal 60,995 7.8
-------------------
Total annuity reserves and deposit
fund liabilities-before reinsurance 779,173 100.0%
=====
Less reinsurance ceded -
--------
Net annuity reserves and deposit fund
liabilities $779,173
========
At December 31, 1995:
Subject to discretionary withdrawal
(with adjustment):
With market value adjustment $ 67,407 8.1%
At book value less surrender charge
of 5% or more 190,629 22.7
At market value 180,991 21.6
-------------------
Total with adjustment or at market
value 439,027 52.4
Subject to discretionary withdrawal
(without adjustment) at book value
with minimal or no charge or
adjustment 337,299 40.2
Not subject to discretionary withdrawal 61,710 7.4
-------------------
Total annuity reserves and deposit
fund liabilities-before reinsurance 838,036 100.0%
=====
Less reinsurance ceded -
--------
Net annuity reserves and deposit fund
liabilities $838,036
========
</TABLE>
The Company sold $358,339,000 of guaranteed investment contracts, assumed by the
Company through a coinsurance agreement with General American Life Insurance
Company, to Integrity as of June 30, 1996.
21
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
8. Separate Accounts
Separate accounts assets and liabilities represent funds segregated for the
benefit of variable annuity and variable life policyholders who generally bear
the investment risk (mutual fund options), or for certain policyholders who are
guaranteed a fixed rate of return (guaranteed rate options). Assets held in
separate accounts are carried at estimated fair values.
Information regarding the separate accounts of the Company as of and for the
year ended December 31, 1996 is as follows:
<TABLE>
<CAPTION>
*Nonindexed
Guaranteed Nonguaranteed
More Separate
than 4% Accounts Total
------------------------------------------
(In Thousands)
<S> <C> <C> <C>
Premiums, deposits and other
considerations $32,363 $ 70,537 $102,900
==========================================
Reserves for separate accounts with
assets at fair value $90,084 $257,514 $347,598
==========================================
Reserves for separate accounts by
withdrawal characteristics:
Subject to discretionary withdrawal
(with adjustment):
With market value adjustment $89,668 $ - $ 89,668
At book value without market value
adjustment and with current
surrender charge of 5% or more 416 257,514 257,930
------------------------------------------
Total with adjustment or at market
value 90,084 257,514 347,598
Not subject to discretionary
withdrawal - - -
------------------------------------------
Total separate accounts reserves $90,084 $257,514 $347,598
==========================================
</TABLE>
*Separate accounts with guarantees.
22
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
8. Separate Accounts (continued)
A reconciliation of the amounts transferred to and from the separate accounts
for the years ended December 31, 1996 and 1995 is presented below:
<TABLE>
<CAPTION>
1996 1995
--------------------
(In Thousands)
<S> <C> <C>
Transfers as reported in the Summary of Operations
of the Separate Accounts Statement:
Transfers to separate accounts $102,901 $ 96,982
Transfers from separate accounts (37,150) (21,800)
-------------------
Net transfers to separate accounts 65,751 75,182
Reconciling adjustments:
Mortality and expense charges reported as other revenues 3,194 1,928
Other revenues 213 56
-------------------
Transfers as reported in the Summary of Operations
of the Life, Accident and Health Annual Statement $ 69,158 $ 77,166
===================
</TABLE>
9. Fair Values of Financial Instruments
Statement of Financial Accounting Standards ("SFAS") No. 107, "Disclosures About
Fair Value of Financial Instruments," requires disclosures of fair value
information about all financial instruments, including insurance liabilities
classified as investment contracts, unless specifically exempted. The fair value
of a financial instrument is the amount at which the instrument could be
exchanged in a current transaction between willing parties, other than in a
forced or liquidation sale. 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. Accordingly, the aggregate fair value amounts presented do not
necessarily represent the underlying value of such instruments. For financial
instruments not separately disclosed below, the carrying amount is a reasonable
estimate of fair value.
23
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
9. Fair Values of Financial Instruments (continued)
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
----------------------------------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
----------------------------------------------
(In Thousands)
<S> <C> <C> <C> <C>
Assets:
Bonds $451,439 $457,875 $635,249 $666,955
Preferred stocks 50,715 50,454 14,428 15,964
Mortgage loans 3,929 3,929 5,318 5,318
Liabilities:
Life and annuity reserves for
investment-type contracts $432,013 $426,516 $472,037 $474,465
Separate accounts annuity reserves 347,503 347,072 248,398 247,220
</TABLE>
Bonds and Preferred Stocks
Fair values for bonds and preferred stocks are based on quoted market prices
where available. For bonds and preferred stocks for which a quoted market price
is not available, fair values are estimated using internally calculated
estimates or quoted market prices of comparable investments.
Mortgage Loans on Real Estate
Pursuant to the terms of ARM's acquisition of the Company, payments of principal
and interest on mortgage loans acquired on November 26, 1993 are guaranteed by
National Mutual. Principal received in excess of statutory book value is to be
returned to National Mutual. Accordingly, book value is deemed to be fair value.
Life and Annuity Reserves for Investment-Type Contracts
The fair value of single premium immediate annuities is based on discounted
cash flow calculations using a market yield rate for assets with similar
durations. The fair value of the remaining annuities is based on the cash
surrender value of the underlying policies.
24
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
9. Fair Values of Financial Instruments (continued)
Separate Accounts Annuity Reserves
The fair value of separate accounts annuity reserves for investment-type
products equals the cash surrender values.
10. Related Party Transactions
Effective January 1, 1994, the Company entered into an Administrative Services
Agreement and an Investment Advisory Agreement with ARM. Under these agreements,
ARM performs certain administrative investment advisory and special services for
the Company to assist with its business operations. The services include
policyholder services; accounting, tax and auditing; underwriting; marketing and
product development; functional support services; payroll functions; personnel
functions; administrative support services; and investment functions. During
1996 and 1995, the Company was charged $6,008,000 and $5,641,000, respectively,
for these services in accordance with the requirements of applicable insurance
law and regulations.
25
<PAGE>
CROSS REFERENCE SHEET - Pinnacle(version III)
Showing Location in Part A (Prospectus) and Part B (Statement of Additional
Information) of Information required By Form N-4
PART A: INFORMATION REQUIRED IN PROSPECTUS - Pinnacle(version III)
<TABLE>
<CAPTION>
Form N-4 Item No. Location in Prospectus
<S> <C>
1. Cover Page Cover Page
2. Definitions Part 1 - Summary
3. Synopsis Part 1 - Summary; Table of Annual Fees and
Expenses; Examples
4. Condensed Financial Information Part 1 - Financial Information
5. General Description of Registrant, Part 2 - National Integrity and the Separate
Annuity Contracts Account; Part 3 - Your Investment Options
6. Deductions Part 4 - Deductions and Charges
7. General Description of Variable Part 5 - Terms of Your Variable
Annuity contracts Annuity Contract
8. Annuity Period Part 5 - Terms of Your Variable
Annuity Contract
9. Death Benefit Part 5 - Terms of Your Variable
Annuity Contract
10. Purchases and Contract Value Part 5 - Terms of Your Variable
Annuity Contract
11. Redemptions Part 5 - Terms of Your Variable
Annuity Contract
12. Taxes Part 7 - Tax Aspects of the Contracts
13. Legal Proceedings Not Applicable
14. Table of Contents of the Statement Table of Contents
of Additional Information
</TABLE>
<PAGE>
PART B: INFORMATION REQUIRED IN STATEMENT OF ADDITIONAL
INFORMATION - Pinnacle(version III)
<TABLE>
<CAPTION>
Form N-4 Item No. Location in Statement of Additional
Information
<S> <C>
15. Cover Page Cover Page
16. Table of Contents Cover Page
17. General Information and History Part 1 - National Integrity and Custodian
18. Services Part 1 - National Integrity and Custodian
19. Purchase of Securities Being Offered Part 2 - Distribution of the Contracts
20. Underwriters Part 2 - Distribution of the Contracts
21. Calculation of Performance Data Part 3 - Performance Information
22. Annuity Payments Part 4 - Determination of Annuity Unit Values
23. Financial Statements Part 5 - Financial Statements
</TABLE>
<PAGE>
Prospectus
==========
Pinnacle(version III)
Flexible Premium Variable Annuity
issued by National Integrity Life Insurance Company
This prospectus describes a flexible premium variable annuity offered by
National Integrity Life Insurance Company, an indirect wholly owned subsidiary
of ARM Financial Group, Inc. The individual contracts and group certificates
(contracts) offered by this prospectus provide several types of benefits, some
of which have tax-favored status under the Internal Revenue Code of 1986, as
amended. Contributions under the contracts may be allocated to the various
investment divisions of our Separate Account II (Variable Account Options, or
individually, Option) or to fixed rate Guaranteed Rate Options (GROs), or both.
Contributions to the Variable Account Options are invested in shares of
corresponding portfolios of The Legends Fund, Inc. (the Fund), and the values
allocated to the Options reflect the investment performance of the Fund's
portfolios. The prospectus for the Fund describes the investment objectives,
policies and risks of each of the Fund's portfolios. There are ten Variable
Account Options available:
<TABLE>
<CAPTION>
<S> <C>
Morgan Stanley Asian Growth Harris Bretall Sullivan & Smith Equity Growth
Morgan Stanley Worldwide High Income Dreman Value
Renaissance Balanced Zweig Equity (Small Cap)
Zweig Asset Allocation Pinnacle Fixed Income
Nicholas-Applegate Balanced ARM Capital Advisors Money Market
</TABLE>
Your allocation to a GRO accumulates at a fixed interest rate we declare at the
beginning of the duration you select. A market value adjustment (Market Value
Adjustment) will be made for withdrawals, surrenders, transfers and certain
other transactions before the expiration of your GRO Account, but your value
under a GRO Account may not be decreased below an amount equal to your
allocation plus interest compounded at an annual effective rate of 3% (Minimum
Value), less previous withdrawals and any applicable contingent withdrawal
charges.
This prospectus contains information about the contracts that you should know
before investing. You should read this prospectus and any supplements, and
retain them for future reference. This prospectus is not valid unless provided
with the current prospectus for the Fund, which you should also read.
For further information and assistance, you should contact our Administrative
Office at National Integrity Life Insurance Company, 200 Park Avenue, 20th
Floor, New York, New York 10166. You may also call the following toll-free
number: 1-800-433-1778.
A registration statement relating to the contracts, which includes a Statement
of Additional Information (SAI) dated May 1, 1997, has been filed with the
Securities and Exchange Commission. The SAI is incorporated by reference into
this prospectus. A copy of the SAI is available free of charge by writing to or
calling our Administrative Office. A table of contents for the SAI follows the
table of contents for this prospectus.
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.
The date of this Prospectus is May 1, 1997.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Part 1 - Summary Page
<S> <C>
Your Variable Annuity Contract......................... 1
Your Benefits.......................................... 1
How Your Contract is Taxed............................. 1
Your Contributions..................................... 1
Your Investment Options................................ 1
Variable Account Options............................... 1
Account Value, Adjusted Account Value and Cash Value... 2
Transfers.............................................. 2
Charges and Fees....................................... 2
Withdrawals............................................ 2
Your Initial Right to Revoke........................... 3
Table of Annual Fees and Expenses...................... 4
Financial Information.................................. 7
Part 2 - National Integrity And The Separate Account
National Integrity Life Insurance Company.............. 8
The Separate Account and the Variable Account Options.. 8
Assets of Our Separate Account......................... 8
Changes In How We Operate.............................. 8
Part 3 - Your Investment Options
The Legends Fund....................................... 9
The Fund's Investment Manager and Sub-Advisers..... 9
Investment Objectives of the Portfolios............ 10
Guaranteed Rate Options................................ 13
Renewals of GRO Accounts........................... 13
Market Value Adjustments........................... 14
Part 4 - Deductions and Charges
Separate Account Charges............................... 15
Annual Administrative Charge........................... 15
Fund Charges........................................... 15
State Premium Tax Deduction............................ 15
Contingent Withdrawal Charge........................... 15
Transfer Charge........................................ 16
Hardship Waiver........................................ 17
Tax Reserve............................................ 17
Part 5 - Terms of Pinnacle Variable Annuity
Contributions Under Your Contract...................... 17
Your Account Value..................................... 17
Your Purchase of Units in Our Separate Account......... 18
How We Determine Unit Value............................ 18
Transfers.............................................. 19
Withdrawals............................................ 19
Assignments............................................ 20
Death Benefits and Similar Benefit Distributions....... 20
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Page
<S> <C>
Annuity Benefits............................................... 20
Annuities...................................................... 21
Annuity Payments............................................... 21
Timing of Payment.............................................. 22
How You Make Requests and Give Instructions.................... 22
Part 6 - Voting Rights
Fund Voting Rights............................................. 22
How We Determine Your Voting Shares............................ 23
How Fund Shares Are Voted...................................... 23
Separate Account Voting Rights................................. 23
Part 7 - Tax Aspects of the Contracts
Introduction................................................... 23
Your Contract is an Annuity.................................... 24
Taxation of Annuities Generally................................ 24
Distribution-at-Death Rules.................................... 25
Diversification Standards...................................... 25
Tax-Favored Retirement Programs................................ 25
Individual Retirement Annuities............................ 26
Tax-Sheltered Annuities.................................... 26
Simplified Employee Pensions............................... 26
Corporate and Self-Employed (H.R. 10 and Keogh) Pension
and Profit Sharing Plans.................................. 26
Deferred Compensation Plans of State and Local Governments
and Tax-Exempt Organizations.............................. 27
Distributions Under Tax-Favored Retirement Programs............ 27
Federal and State Income Tax Withholding....................... 28
Impact of Taxes to National Integrity.......................... 28
Transfers Among Investment Options............................. 28
Part 8 - Additional Information
Systematic Withdrawals......................................... 28
Dollar Cost Averaging.......................................... 29
Individual Asset Rebalancing................................... 29
Systematic Contributions....................................... 29
Performance Information........................................ 29
Appendix A - Illustration of a Market Value Adjustment....... 31
</TABLE>
THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFERING IN ANY JURISDICTION IN WHICH
SUCH OFFERING MAY NOT LAWFULLY BE MADE. NO PERSON IS AUTHORIZED TO MAKE ANY
REPRESENTATIONS IN CONNECTION WITH THIS OFFERING OTHER THAN THOSE CONTAINED
IN THIS PROSPECTUS.
<PAGE>
SAI Table of Contents
Part 1 National Integrity and Custodian
Part 2 Distribution of the Contracts
Part 3 Performance Information
Part 4 Determination of Annuity Unit Values
Part 5 Financial Statements
If you would like to receive a copy of the Statement of Additional Information,
please complete the form below and send it to:
Administrative Office
National Integrity Life Insurance Company
200 Park Avenue, 20th Floor
New York, New York 10166
ATTN: Request for SAI of Separate Account II
Name:_____________________________________________________________________
Address:__________________________________________________________________
City:________________________________ State:_________ Zip:________________
<PAGE>
PART 1 -- SUMMARY
Your Variable Annuity Contract
In this prospectus, we, our and us mean National Integrity Life Insurance
Company (National Integrity), a subsidiary of Integrity Life Insurance Company
(Integrity) and an indirect wholly owned subsidiary of ARM Financial Group, Inc.
(ARM). We offer individual variable annuity contracts. In certain states, we
offer certificates under a group variable annuity contract instead of contracts.
When we use the words contract or certificate, we are referring to both the
individual contracts and the group certificates.
You can invest for retirement by purchasing a contract if you properly complete
a Customer Profile form (an application or enrollment form may be required in
some states) and make a minimum initial contribution. In this prospectus, you
and your mean the Annuitant, the person upon whose life the Annuity Benefit and
the Death Benefit are based, usually the Owner of the contract. If the Annuitant
does not own the contract, all of the rights under the contract belong to the
Owner until annuity payments begin.
Your retirement or endowment date (Retirement Date) will be no later than your
90th birthday or earlier if required by law, unless you notify us of a different
date.
Your Benefits
Your contract provides an Account Value, an annuity benefit, and a death
benefit. See "Your Account Value," "Death Benefits and Similar Benefit
Distributions" and "Annuity Benefits" in Part 5.
Your benefits may be received under a contract subject to the usual rules for
taxation of annuities, including the tax-deferral of earnings until withdrawal.
The contract also can provide your benefits under certain tax-favored retirement
programs, which are subject to special rules covering such matters as
eligibility and contribution amounts. See Part 7, "Tax Aspects of the Contracts"
for detailed information.
How Your Contract is Taxed
Under current law, any increases in the value of your contributions to your
contract are tax deferred and will not be included in your taxable income until
withdrawn. See Part 7, "Tax Aspects of the Contracts."
Your Contributions
The minimum initial contribution in most states is currently $1,000. Subsequent
contributions of at least $100 can be made. Special rules for lower minimum
initial and subsequent contributions apply for certain tax-favored retirement
plans. See "Contributions Under Your Contract" in Part 5.
Your Investment Options
You may allocate contributions to the Variable Account Options or to the GROs,
or both. The Variable Account Options and the GROs are together referred to as
the Investment Options. Contributions may be allocated to up to nine Investment
Options at any one time. See "Contributions Under Your Contract" in Part 5. To
select Investment Options most suitable for you, see Part 3, "Your Investment
Options."
Variable Account Options
The Variable Account Options (also referred to as Divisions) invest in shares of
corresponding investment portfolios of the Fund, a "series" type of mutual fund.
Each investment portfolio is referred to as a Portfolio. The investment
objective of each Variable Account Option and its corresponding Portfolio is the
same. Your value in a Variable Account Option will vary depending on the
performance of the corresponding Portfolio. For a full description of the Fund,
see the Fund's prospectus and the Fund's Statement of Additional Information.
1
<PAGE>
Account Value, Adjusted Account Value and Cash Value
The sum of your values under GROs plus your values in the Variable Account
Options is referred to as the Account Value. Your Adjusted Account Value is your
Account Value, as increased or decreased (but not below the Minimum Value) by
any Market Value Adjustments. Your Cash Value is equal to your Adjusted Account
Value, reduced by any applicable contingent withdrawal charge and will be
reduced by the pro rata portion of the annual administrative charge, if
applicable. See "Charges and Fees" below.
Transfers
You may transfer all or portions of your Account Value among the Investment
Options, subject to the conditions described under "Transfers" in Part 5.
Transfers from any Investment Option must be for at least $250. Transfers may be
arranged through our telephone transfer service. See Part 5, "Transfers."
Transfers may also be made under special services we offer to dollar cost
average or rebalance your investment in the Variable Account Options. See Part
8, "Additional Information - Dollar Cost Averaging," and "Additional
Information-Individual Asset Rebalancing."
Charges and Fees
If your Account Value is less than $50,000 as of the last day of any contract
year prior to your Retirement Date, an annual administrative expense charge of
$30 is deducted from your contract. See Part 4, "Deductions and Charges."
A charge at an effective annual rate of 1.35% of the Account Value of the assets
in each Variable Account Option is made daily. We make this charge to cover
mortality and expense risks (1.20%) and certain administrative expenses (.15%).
The charge will never be greater than an effective annual rate of 1.35% of the
Account Value of the assets in each Variable Account Option. See Part 4,
"Deductions and Charges."
Investment management fees and other expenses are deducted from amounts invested
by the Separate Account in the Fund. For providing investment management
services to the Portfolios of the Fund, ARM Capital Advisors, Inc. (ARM Capital
Advisors), the investment manager of the Fund, receives fees from the Portfolios
ranging from an annual rate of .50% to 1.05% of the average net assets of the
Portfolio. ARM Capital Advisors has entered into a sub-advisory agreement for
each Portfolio except the Money Market Portfolio, and ARM Capital Advisors pays
fees to the sub-advisers ranging from an annual rate of .50% to .90% of average
net assets of each Portfolio. The fees paid to ARM Capital Advisors and the sub-
advisers cannot be increased without the consent of Fund shareholders. See
"Table of Annual Fees and Expenses" below and "The Fund's Investment Manager and
Sub-Advisers" in Part 3.
If you frequently transfer funds from one Investment Option to another, certain
transfers may become subject to a charge. We will not, however, charge more than
$20 per transfer. See "Transfer Charge" in Part 4.
When you make withdrawals from your contract, a contingent withdrawal charge may
be deducted from your Account Value. This sales charge will be in addition to
the Market Value Adjustment applicable to early withdrawals from GRO Accounts.
Under certain circumstances, the contingent withdrawal charge and market value
adjustment may be waived. See "Withdrawals" below and "Guaranteed Rate Options"
in Part 3.
Withdrawals
You may make an unlimited number of withdrawals from your contract as frequently
as you wish. Each withdrawal must be for at least $300. A sales charge of up to
7% of the contribution amount withdrawn, in excess of any free withdrawal amount
(defined below), will be deducted from your Account Value, unless one of the
exceptions applies. This charge defrays marketing expenses. See "Contingent
Withdrawal Charge" in Part 4. Most withdrawals made by you prior to age 59-1/2
are also subject to a 10% federal
2
<PAGE>
tax penalty. In addition, some tax-favored retirement programs limit
withdrawals. See Part 7, "Tax Aspects of the Contracts." For partial
withdrawals, the amount deducted from your Account Value will include the
withdrawal amount requested, any applicable Market Value Adjustment, and any
applicable withdrawal charge, so that the net amount you receive will be the
amount requested.
The free withdrawal amount is a non-cumulative amount which you may take as a
partial withdrawal each contract year without being subject to the contingent
withdrawal charge or any Market Value Adjustment. It is equal to 10% of the
Account Value, minus cumulative prior withdrawals in the current contract year.
However, as explained above, a tax penalty still applies if you are under age
59-1/2.
Your Initial Right to Revoke
Within ten days after you receive your contract, you may cancel it by returning
it to our Administrative Office. The 10-day period may be extended if required
by state law. We will refund all your contributions with an adjustment for any
investment gain or loss on the contributions put into each Variable Account
Option from the date units were purchased until the date your contract is
received by us, including any charges deducted. If state law instead requires a
refund of your contributions without any adjustment, we will return that amount
to you. For allocations to any of the GROs, we will refund to you the amount of
your contributions.
3
<PAGE>
Table of Annual Fees and Expenses
Contract Owner Transaction Expenses
- -----------------------------------
Sales Load on Purchases........................................ $0
Deferred Sales Load (1)................................... 7% Maximum
Exchange Fee (2)............................................... $0
Annual Administrative Charge (3)............................... $30
Separate Account Annual Expenses (as a
percentage of average account value) (4)
- ----------------------------------------
Mortality and Expense Risk Fees................................ 1.20%
Administrative Expenses........................................ .15%
----
Total Separate Account Annual Expenses......................... 1.35%
====
Fund Annual Expenses After Reimbursement
(as a percentage of average net assets) (5)
- -------------------------------------------
<TABLE>
<CAPTION>
Management Other Total Annual
Portfolio Fees Expenses (5) Expenses (5)
- --------- ---- ------------ ------------
<S> <C> <C> <C>
Morgan Stanley Asian Growth.................... 1.00% 1.00% 2.00%
Morgan Stanley Worldwide High Income........... .85% 1.00% 1.85%
Renaissance Balanced........................... .65% .36% 1.01%
Zweig Asset Allocation......................... .90% .36% 1.26%
Nicholas-Applegate Balanced.................... .65% .34% .99%
Harris Bretall Sullivan & Smith Equity Growth.. .65% .40% 1.05%
Dreman Value................................... .65% .50% 1.15%
Zweig Equity (Small Cap)....................... 1.05% .50% 1.55%
Pinnacle Fixed Income.......................... .70% .50% 1.20%
ARM Capital Advisors Money Market.............. .50% .50% 1.00%
</TABLE>
- -------------------------
(1) See "Deductions and Charges - Contingent Withdrawal Charge" in Part 4. You
may make a partial withdrawal of up to 10% of the Account Value in any contract
year less withdrawals during the current contract year, without assessment of
any withdrawal charge.
(2) After the first twelve transfers during a contract year, National Integrity
has the right to impose a transfer charge of $20 per transfer. This charge would
not apply to transfers made for dollar cost averaging or individual asset
rebalancing. See "Deductions and Charges - Transfer Charge" in Part 4.
(3) The annual administrative charge is $30. This charge applies only if the
Account Value is less than $50,000 at the end of any contract year prior to your
Retirement Date. See "Deductions and Charges - Annual Administrative Charge" in
Part 4.
(4) See "Deductions and Charges - Separate Account Charges" in Part 4.
4
<PAGE>
(5) The Fund's expenses for the fiscal year ended June 30, 1996 have been
restated due to material changes in the annual expense structure. The Manager of
the Fund has agreed to reimburse each of the Portfolios for operating expenses
(excluding management fees) above an annual rate of 1.00% of average net assets
for Morgan Stanley Asian Growth Portfolio and Morgan Stanley Worldwide High
Income Portfolio, and above an annual rate of .50% of average net assets for all
other Portfolios. Without reimbursements, total annual restated expenses for the
Funds's fiscal year ended June 30, 1996 would have been 2.77% for the Morgan
Stanley Asian Growth Portfolio, 2.17% for the Morgan Stanley Worldwide High
Income Portfolio, 1.19% for the Dreman Value Portfolio, 1.88% for the Zweig
Equity (Small Cap) Portfolio, 1.48% for the Pinnacle Fixed Income Portfolio, and
1.39% for the ARM Capital Advisors Money Market Portfolio. The Manager has
reserved the right to withdraw or modify its policy of expense reimbursement for
the Portfolios, but has no current intention to do so during 1997. In the Fund's
prospectus, see "Management of the Fund."
Examples
The examples below show the expenses that would be borne by the Annuitant per
$1,000 investment, assuming a $60,000 average contract value and a 5% annual
rate of return on assets.
Expenses per $1,000 investment if you surrender your contract at the end of the
- -------------------------------------------------------------------------------
applicable period:
- ------------------
<TABLE>
<CAPTION>
Option 1 year 3 years 5 years 10 years
- ------- ------- ------- ------- --------
<S> <C> <C> <C> <C>
Morgan Stanley Asian Growth.................... $114.83 $165.96 $219.12 $371.28
Morgan Stanley Worldwide High Income........... $113.29 $161.44 $211.75 $357.40
Renaissance Balanced........................... $104.68 $135.86 $169.54 $275.61
Zweig Asset Allocation......................... $107.24 $143.52 $182.26 $300.69
Nicholas-Applegate Balanced.................... $104.48 $135.24 $168.52 $273.57
Harris Bretall Sullivan & Smith Equity Growth.. $105.09 $137.08 $171.59 $279.66
Dreman Value................................... $106.12 $140.15 $176.68 $289.73
Zweig Equity (Small Cap)....................... $110.22 $152.36 $196.85 $328.99
Pinnacle Fixed Income.......................... $106.63 $141.68 $179.22 $294.73
ARM Capital Advisors Money Market.............. $104.58 $135.55 $169.03 $274.59
</TABLE>
5
<PAGE>
Expenses per $1,000 investment if you do not surrender your contract at the end
- -------------------------------------------------------------------------------
of the applicable period:
- -------------------------
<TABLE>
<CAPTION>
Option 1 year 3 years 5 years 10 years
- ------ ------ ------- ------- --------
<S> <C> <C> <C> <C>
Morgan Stanley Asian Growth.................... $34.83 $105.96 $179.12 $371.28
Morgan Stanley Worldwide High Income........... $33.29 $101.44 $171.75 $357.40
Renaissance Balanced........................... $24.68 $ 75.86 $129.54 $275.61
Zweig Asset Allocation......................... $27.24 $ 83.52 $142.26 $300.69
Nicholas-Applegate Balanced.................... $24.48 $ 75.24 $128.52 $273.57
Harris Bretall Sullivan & Smith Equity Growth.. $25.09 $ 77.08 $131.59 $279.66
Dreman Value................................... $26.12 $ 80.15 $136.68 $289.73
Zweig Equity (Small Cap)....................... $30.22 $ 92.36 $156.85 $328.99
Pinnacle Fixed Income.......................... $26.63 $ 81.68 $139.22 $294.73
ARM Capital Advisors Money Market.............. $24.58 $ 75.55 $129.03 $274.59
</TABLE>
Expenses per $1,000 investment if you elect the normal form of annuity at the
end of the applicable period:
Same expenses per $1,000 investment as shown in table above.
These examples assume the current level of fixed charges that are borne by the
Separate Account and the investment management fees and other expenses of the
Fund as they were for the fiscal year ended June 30, 1996. Actual Fund expenses
may be greater or less than those on which these examples were based. The annual
rate of return assumed in the examples is not an estimate or guarantee of future
investment performance. The table also assumes an estimated $60,000 average
contract value, so that the administrative charge per $1,000 of net asset value
in the Separate Account is $0.50. Such per $1,000 charge would be higher for
smaller Account Values and lower for higher values.
The above table and examples are intended to assist your understanding of the
various costs and expenses that apply to your contract, directly or indirectly.
These tables reflect expenses of the Separate Account as well as those of the
Portfolios. Premium taxes upon annuitization also may be applicable.
6
<PAGE>
Financial Information
The table below shows the unit value for each Variable Account Option at
inception, the number of units outstanding at December 31 of each year since
inception, and the unit value at the beginning and end of each period.
<TABLE>
<CAPTION>
Year Ended December 31
1996 1995 1994 1993 Inception*
-------- -------- -------- -------- ----------
<S> <C> <C> <C> <C> <C>
Morgan Stanley Asian Growth Division
Unit value at beginning of period..................... $10.07 $9.21 - - $10.00
Unit value at end of period........................... $10.48 $10.07 $9.21 -
Number of units outstanding at end of period.......... 331,807 240,475 241,331 -
Morgan Stanley Worldwide High Income Division
Unit value at beginning of period..................... $11.23 $9.44 - - $10.00
Unit value at end of period........................... $13.79 $11.23 $9.44 -
Number of units outstanding at end of period.......... 69,613 30,033 36,427 -
Renaissance Balanced Division
Unit value at beginning of period..................... $12.83 $10.49 $11.01 - $10.00
Unit value at end of period........................... 13.84 $12.83 $10.49 $11.01
Number of units outstanding at end of period.......... 591,461 685,870 549,857 197,669
Zweig Asset Allocation Division
Unit value at beginning of period..................... $12.75 $10.65 $10.75 - $10.00
Unit value at end of period........................... $14.45 $12.75 $10.65 $10.75
Number of units outstanding at end of period.......... 389,517 421,439 535,776 205,268
Nicholas-Applegate Balanced Division
Unit value at beginning of period..................... $13.15 $11.11 $11.28 - $10.00
Unit value at end of period........................... $14.97 $13.15 $11.11 $11.28
Number of units outstanding at end of period.......... 779,102 797,185 753,834 341,488
Harris Bretall Sullivan & Smith Equity Growth Division
Unit value at beginning of period..................... $13.08 $10.07 $9.81 - $10.00
Unit value at end of period........................... $14.71 $13.08 $10.07 $9.81
Number of units outstanding at end of period.......... 438,465 374,724 280,091 83,619
Dreman Value Division
Unit value at beginning of period..................... $14.98 $10.43 $10.65 - $10.00
Unit value at end of period........................... $18.39 $14.98 $10.43 $10.65
Number of units outstanding at end of period.......... 297,625 244,538 156,325 80,112
Zweig Equity (Small Cap) Division
Unit value at beginning of period..................... $12.57 $10.52 $10.73 - $10.00
Unit value at end of period........................... $14.69 $12.57 $10.52 $10.73
Number of units outstanding at end of period.......... 138,864 234,629 180,961 68,249
Pinnacle Fixed Income Division
Unit value at beginning of period..................... $11.43 $ 9.90 $10.43 - $10.00
Unit value at end of period........................... $11.48 $11.43 $9.90 $10.43
Number of units outstanding at end of period.......... 132,283 143,799 142,037 84,916
ARM Capital Advisors Money Market Division
Unit value at beginning of period..................... $10.54 $10.18 $10.02 - $10.00
Unit value at end of period........................... $10.86 $10.54 $10.18 $10.02
Number of units outstanding at end of period.......... 123,973 336,264 190,506 97,936
</TABLE>
* Inception Dates for the Variable Account Options were January 13, 1993 for all
Options except for the Morgan Stanley Asian Growth and Morgan Stanley Worldwide
High Income Options, which were June 15, 1994.
7
<PAGE>
PART 2 - NATIONAL INTEGRITY AND THE SEPARATE ACCOUNT
National Integrity Life Insurance Company
National Integrity is a stock life insurance company organized under the laws of
New York. Our home office is in New York, New York. We are authorized to sell
life insurance and annuities in eight states plus the District of Columbia. In
addition to the contracts, we sell flexible premium annuity contracts with an
underlying investment medium other than the Fund, and fixed single premium
annuity contracts. We are currently licensed to sell variable contracts in five
states. In addition to issuing annuity products, we have entered into agreements
with other insurance companies to provide administrative and investment support
for products to be designed, underwritten and sold by these companies.
National Integrity is an indirect wholly owned subsidiary of ARM. ARM
specializes in the asset accumulation business, providing retail and
institutional customers with products and services designed to serve the growing
long-term savings and retirement markets. At December 31, 1996, ARM had $4.8
billion of assets under management.
The Separate Account and the Variable Account Options
The Separate Account is established and maintained under the insurance laws of
the State of New York. It is a unit investment trust registered with the
Securities and Exchange Commission (the SEC) under the Investment Company Act of
1940 (1940 Act). A unit investment trust is a type of investment company. SEC
registration does not involve any supervision by the SEC of the management or
investment policies of the Separate Account. Each Variable Account Option
invests in shares of a corresponding Portfolio of the Fund. We may establish
additional Options, some of which may not be available for your allocations. The
Variable Account Options currently available to you are listed on the cover page
of this prospectus.
Assets of Our Separate Account
Under New York law, we own the assets of our Separate Account and use them to
support the variable portion of your contract and other variable annuity
contracts. Annuitants under other variable annuity contracts will participate in
the Separate Account in proportion to the amounts relating to their contracts.
The Separate Account's assets supporting the variable portion of these variable
contracts may not be used to satisfy liabilities arising out of any other
business of ours. Under certain unlikely circumstances, one Variable Account
Option may be liable for claims relating to the operations of another Option.
Income, gains and losses, whether or not realized, from assets allocated to the
Separate Account are credited to or charged against the Separate Account without
regard to our other income, gains or losses. We may permit charges owed to us to
stay in the Separate Account, and thus may participate proportionately in the
Separate Account. Amounts in the Separate Account in excess of reserves and
other liabilities belong to us, and we may transfer them to our general account
(General Account).
Changes In How We Operate
We may modify how we or our Separate Account operate, subject to your approval
when required by the 1940 Act or other applicable law or regulation. You will be
notified if any changes result in a material change in the underlying
investments of a Variable Account Option. We may:
- - add Options to, or remove Options from, our Separate Account, combine two or
more Options within our Separate Account, or withdraw assets relating to
your contract from one Option and put them into another;
- - register or end the registration of the Separate Account under the
1940 Act;
- - operate our Separate Account under the direction of a committee or discharge
such a committee at any time (the committee may be composed of a majority of
persons who are "interested persons" of National Integrity under the 1940
Act);
8
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- - restrict or eliminate any voting rights of Owners or others who have voting
rights that affect our Separate Account;
- - cause one or more Options to invest in a mutual fund other than or in
addition to the Fund;
- - operate our Separate Account or one or more of the Options in any other
form the law allows, including a form that allows us to make direct
investments. We may make any legal investments we wish. In choosing these
investments, we will rely on our own or outside counsel for advice.
PART 3 - YOUR INVESTMENT OPTIONS
The Legends Fund
The Legends Fund, Inc., a Maryland corporation (the Fund), is an open-end
diversified management investment company registered under the 1940 Act. Such
registration does not involve supervision by the SEC of the investments or
investment policies of the Fund. The Fund is a "series" type of investment
company with diversified portfolios. The Fund does not impose a sales charge or
"load" for buying and selling its shares. The shares of the Portfolios of the
Funds are bought and sold by the Separate Account at their respective net asset
values.
The Fund is designed to serve as an investment vehicle for variable annuity and
variable life contracts of insurance companies. Shares of the Portfolios of the
Fund currently are available to the separate accounts of National Integrity and
Integrity, the parent of National Integrity.
Shares of Portfolios of the Fund are made available to the Separate Account
under a Participation Agreement (Participation Agreement). The Participation
Agreement is among the Fund, ARM Securities Corporation (ARM Securities), a
wholly owned subsidiary of ARM which is the principal underwriter for Fund
shares, and National Integrity. If state or federal law precludes the sale of
the Fund's or any Portfolio's shares to the Separate Account, or in certain
other circumstances, sales of shares to the Separate Account may be suspended
and/or the Participation Agreement may be terminated as to the Fund or the
affected Portfolio. Also, the Participation Agreement may be terminated by any
party thereto with one year's written notice.
Notwithstanding termination of the Participation Agreement, the Fund and ARM
Securities are obligated to continue to make the Fund's shares available for
contracts outstanding on the date the Participation Agreement terminates, unless
the Participation Agreement was terminated due to an irreconcilable conflict
among contract owners of different separate accounts. If for any reason the
shares of any Portfolio are no longer available for purchase by the Separate
Account for outstanding contracts, the parties to the Participation Agreement
have agreed to cooperate to comply with the 1940 Act in arranging for the
substitution of another funding medium as soon as reasonably practicable and
without disruption of sales of shares to the Separate Account or any Variable
Account Option.
The Fund's Investment Manager and Sub-Advisers. ARM Capital Advisors became the
investment adviser to the Fund on February 1, 1996. ARM Capital Advisors is a
wholly owned subsidiary of ARM registered as an investment adviser under the
Investment Advisers Act of 1940. Its offices are located at 200 Park Avenue,
20th Floor, New York, New York 10166. It is the intention of ARM Capital
Advisors to change its name to Integrity Capital Advisors, Inc., during the
calendar year 1997.
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<PAGE>
ARM Capital Advisors has entered into a sub-advisory agreement with a
professional manager for investment of the assets of each of the Portfolios,
except for the Money Market Portfolio. The sub-adviser for each Portfolio is
listed under "Investment Objectives of the Portfolios" below. The Portfolios pay
monthly investment management fees to ARM Capital Advisors, and ARM Capital
Advisors pays the sub-advisers for their services to the Portfolios. ARM Capital
Advisors retains a management fee at an annual rate between .15% and .20% of
Portfolio net assets (depending upon Portfolio) as compensation for providing
certain services to the Portfolios (except that ARM Capital Advisors retains the
full management fee for the ARM Capital Advisors Money Market Portfolio which it
manages directly without a sub-adviser.) The management fees paid by each
Portfolio to ARM Capital Advisors as a percentage of net assets are set forth
below:
Portfolio Management Fee
--------- --------------
Morgan Stanley Asian Growth......................... 1.00%
Morgan Stanley Worldwide High Income. . ............ .85%
Renaissance Balanced................................ .65%
Zweig Asset Allocation.............................. .90%
Nicholas-Applegate Balanced......................... .65%
Harris Bretall Sullivan & Smith Equity Growth....... .65%
Dreman Value........................................ .65%
Zweig Equity (Small Cap)............................ 1.05%
Pinnacle Fixed Income............................... .70%
ARM Capital Advisors Money Market................... .50%
Investment Objectives of the Portfolios. Set forth below is a summary of the
investment objectives of the Portfolios of the Fund. There can be no assurance
that these objectives will be achieved. You should read the Fund's prospectus
carefully before investing.
Morgan Stanley Asian Growth Portfolio
-------------------------------------
Morgan Stanley Asian Growth Portfolio seeks long-term capital appreciation
through investment primarily in the common stocks of Asian issuers, excluding
Japan. The production of any current income is incidental to this objective.
Under normal market conditions, the Portfolio will invest at least 65% of the
value of its total assets in common stocks that are traded on recognized stock
exchanges of Asian countries and in common stocks of companies organized under
the laws of an Asian country whose business is conducted principally in Asia.
The remaining portion of the Portfolio will be kept in any combination of debt
instruments, bills and bonds of governmental entities in Asia and the United
States, in notes, debentures and bonds of companies in Asia and in money market
instruments of the United States. The Portfolio does not intend to invest in
securities which are traded in markets in Japan or in companies organized under
the laws of Japan. Morgan Stanley Asset Management Inc. is the sub-adviser to
the Portfolio.
Morgan Stanley Worldwide High Income Portfolio
----------------------------------------------
Morgan Stanley Worldwide High Income Portfolio seeks high current income
consistent with relative stability of principal and, secondarily, capital
appreciation through investing primarily in a portfolio of high-yielding fixed-
income securities of issuers located throughout the world. The Portfolio seeks
to achieve its investment objective by allocating its assets among any or all
of three investment sectors: U.S. corporate lower-rated and unrated debt
securities, emerging country debt securities and global fixed-income securities
offering high real yields. Under normal conditions, the Portfolio will invest
between 80% and 100% of its total assets in some or all of these three
categories of higher yielding securities, some of which may entail increased
credit and market risk. The Portfolio may invest a portion of its assets, which
may be up to 100% of its total assets, in lower-rated and unrated bonds ("junk
bonds") considered to be speculative with regard to the payment of interest and
return of principal, and purchasers should carefully assess the risks
associated with an investment in this Portfolio. Additional
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<PAGE>
information concerning the investment objectives and policies of the Morgan
Stanley Worldwide High Income Portfolio can be found in the Fund's prospectus,
which should be read carefully before making any allocation to this Portfolio.
Morgan Stanley Asset Management Inc. is the sub-adviser to the Portfolio.
Renaissance Balanced Portfolio
------------------------------
Renaissance Balanced Portfolio seeks capital appreciation and income in rising
markets and the preservation of capital in declining markets. Its assets are
allocated among common stocks of issuers with large capitalizations, United
States government and high-quality corporate debt securities, and high quality
cash equivalent issues, such as commercial paper. Equity investments will
generally range from 10% to 75% of the total assets in the Portfolio, and under
normal market conditions at least 25% of total assets will be invested in
senior fixed income securities. Renaissance Investment Management is the sub-
adviser to the Portfolio.
Zweig Asset Allocation Portfolio
--------------------------------
Zweig Asset Allocation Portfolio seeks long-term capital appreciation. It
invests primarily in Blue Chip Stocks, consistent with preservation of capital
and the reduction of portfolio exposure to market risk, as determined by the
sub-adviser to the Portfolio. Blue Chip Stocks are stocks which the sub-adviser
considers comparable to the stocks included in the S&P 500 at the time of
purchase, and that have a minimum of $400 million market capitalization,
average daily trading volume of 50,000 shares or $425 million in total assets,
and which are traded on the New York Stock Exchange (NYSE), American Stock
Exchange (AMEX), over-the-counter (OTC) or on foreign exchanges. Zweig/Glaser
Advisers is the sub-adviser to the Portfolio.
Nicholas-Applegate Balanced Portfolio
-------------------------------------
Nicholas-Applegate Balanced Portfolio seeks maximum total return in both the
equity and fixed income portion of its investments. Under normal market
conditions, the Portfolio will have 60% to 65% of its total assets invested in
equity securities, including common stocks and securities convertible into or
exchangeable for common stocks (such as convertible preferred stocks and
convertible debentures). The remaining 35% to 40% of total assets will be
invested in United States government securities or cash equivalent issues.
Nicholas-Applegate Capital Management is the sub-adviser to the Portfolio.
Harris Bretall Sullivan & Smith Equity Growth Portfolio
-------------------------------------------------------
Harris Bretall Sullivan & Smith Equity Growth Portfolio seeks long-term capital
appreciation. It primarily invests in stocks of established companies with
proven records of superior and consistent growth. The Portfolio may invest all
or a portion of its assets in cash and cash equivalents if the sub-adviser
considers the equity markets to be overvalued. The Portfolio may invest in U.S.
government securities when this appears desirable in light of the Portfolio's
investment objective or when market conditions warrant. Harris Bretall Sullivan
& Smith, Inc. is the sub-adviser to the Portfolio.
Dreman Value Portfolio
----------------------
Dreman Value Portfolio seeks primarily long-term capital appreciation with a
secondary objective of current income. It invests principally in a diversified
portfolio of securities believed by the sub-adviser to be undervalued. The sub-
adviser's philosophy centers on identifying stocks of large, well-known
companies with solid financial strength and generous dividend yields that have
low price-earnings ratios and have been generally overlooked by the market.
Dreman Value Advisors, Inc. is the sub-adviser to the Portfolio.
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<PAGE>
Zweig Equity (Small Cap) Portfolio
----------------------------------
Zweig Equity (Small Cap) Portfolio seeks long-term capital appreciation. It
invests primarily in Small Company Stocks, consistent with preservation of
capital and reduction of portfolio exposure to market risk, as determined by
the sub-adviser. Current income is not an objective. Small Company Stocks are
the 2,500 stock positions immediately after the 500 largest stocks ranked in
terms of market capitalization and/or trading volume, and which are traded on
the NYSE, AMEX, OTC or on foreign exchanges. Zweig/Glaser Advisers is the sub-
adviser to the Portfolio.
Pinnacle Fixed Income Portfolio
-------------------------------
Pinnacle Fixed Income Portfolio seeks as high a level of current income as is
consistent with the preservation of capital. It invests primarily in corporate
debt securities; U.S. Government securities (including mortgage-backed
securities issued by the Government National Mortgage Association, the Federal
National Mortgage Association, and the Federal Home Loan Mortgage Corporation);
obligations of other governmental issuers such as the Federal Farm Credit
System and the Federal Home Loan Banks; asset-backed securities; repurchase
agreements with respect to securities in which the Portfolio may invest; and
instruments used in certain hedging and related income strategies. The
Portfolio may also invest in certain private placements and in debt securities
of foreign governments and governmental entities. The Portfolio will
principally invest in securities rated at least investment grade, or, if not
rated, determined by the sub-adviser to be of comparable quality. However, the
Portfolio may invest up to 15% of its total assets in securities rated below
investment grade or of equivalent quality, if not rated, including defaulted
securities. J.P. Morgan Investment Management Inc. is the sub-adviser to the
Portfolio.
ARM Capital Advisors Money Market Portfolio
-------------------------------------------
ARM Capital Advisors Money Market Portfolio seeks maximum current income
consistent with liquidity and conservation of capital. It invests in high grade
money market instruments, with remaining maturities of 13 months or less, and
repurchase agreements secured by such instruments, and maintains a dollar-
weighted average portfolio maturity of 90 days or less. ARM Capital Advisors is
the adviser to the Portfolio.
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<PAGE>
Guaranteed Rate Options
Because of applicable exemptive and exclusionary provisions, interests in
contracts attributable to GROs have not been registered under the Securities Act
of 1933 ("1933 Act"), nor under the Investment Company Act of 1940 ("1940 Act").
Thus, neither such contracts nor our General Account, which guarantees the
values and benefits under those contracts, are generally subject to regulation
under the provisions of the 1933 Act or the 1940 Act. Accordingly, we have been
advised that the staff of the Securities and Exchange Commission has not
reviewed the disclosure in this prospectus relating to the GROs or the General
Account. Disclosures regarding the GROs or the General Account may, however, be
subject to certain generally applicable provisions of the Federal securities
laws relating to the accuracy and completeness of statements made in
prospectuses.
We offer GROs with durations of three, five, seven and ten years. We may from
time to time change the durations available. Each allocation to a GRO locks in a
fixed effective annual interest rate declared by us (Guaranteed Interest Rate)
for the duration you select (your GRO Account). The duration of your GRO Account
is the Guarantee Period. Each contribution or transfer to a GRO establishes a
new GRO Account at the then-current Guaranteed Interest Rate declared by us. We
will not declare an interest rate less than 3%. Each GRO Account expires at the
end of the duration you have selected. See "Renewals of GRO Accounts" below.
Values and benefits under your contract attributable to GRO are guaranteed by
the reserves in our GRO separate account as well as by our General Account.
The value of each of your GRO Accounts is referred to as a GRO Value. The GRO
Value at the expiration of the GRO Account, assuming you have not transferred or
withdrawn any amounts, will be the amount allocated plus interest at the
Guaranteed Interest Rate. We credit interest daily at an effective annual rate
equal to the Guaranteed Interest Rate. We allocate interest at the end of each
contract year and at the time of any transfer, full or partial withdrawal,
payment of a death benefit or purchase of any annuity benefit.
We may declare a higher rate of interest in the first year for any Contribution
allocated to a GRO which will exceed the Guaranteed Interest Rate credited
during the remaining years of the Guarantee Period (Enhanced Rate). This
Enhanced Rate will be guaranteed for the Guaranteed Period's first year and
declared at the time of purchase. We reserve the right to declare and credit
additional interest based on Contribution, Account Value, withdrawal dates,
economic conditions or on any other lawful, nondiscriminatory basis (Additional
Interest). Any Enhanced Rate and Additional Interest credited to your GRO
Account will be separate from the Guaranteed Interest Rate and not used in the
Market Value Adjustment formula. The Enhanced Rate or Additional Interest may
not be made applicable under contracts issued in certain states.
Each group of GRO Accounts of the same duration is considered one GRO, (i.e. all
of your three-year GRO Accounts are one GRO while all of your five-year GRO
Accounts are another GRO).
You may obtain information about our current Guaranteed Interest Rates by
calling our Administrative Office.
Allocations to GROs may not be made under contracts issued in certain
states.
Renewals of GRO Accounts. When a GRO Account expires, a new GRO Account of the
same duration, at the then-current Guaranteed Interest Rate, will be established
unless you withdraw your GRO Value or transfer it to another Investment Option.
We will notify you in writing before the expiration of your GRO Accounts. You
must notify us prior to the expiration of your GRO Accounts of any changes you
desire to make. See "Transfers" in Part 5.
Any renewal of a GRO Account will be implemented on the expiration date of the
GRO Account. You will receive the current Guaranteed Interest Rate applicable on
the expiration date. If a GRO Account expires and it cannot be renewed for the
same duration, it will be renewed for the next shortest
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<PAGE>
available duration, unless you instruct us otherwise within 30 days prior to
expiration of the GRO Account. You may not choose, and we will not renew, a GRO
Account that expires after your Retirement Date.
Market Value Adjustments. A Market Value Adjustment is an adjustment, either up
or down, in your GRO Value prior to the expiration of your GRO Account. A Market
Value Adjustment will be made for each transfer, partial withdrawal in excess of
the free withdrawal amount, surrender, or purchase of an annuity benefit from a
GRO Account that occurs other than within 30 days prior to the expiration of the
GRO Account. There will be no Market Value Adjustment made for a death benefit.
The market adjusted value may be higher or lower than the GRO Value. In no
event, however, may the market adjusted value in each GRO Account be less than
the Minimum Value, an amount equal to your allocation to such GRO Account plus
3% interest, compounded annually, less previous withdrawals from such GRO
Account and less any applicable contingent withdrawal charges. The Minimum Value
for partial withdrawals or transfers will be calculated on a pro-rata basis.
The Market Value Adjustment applicable to a GRO Account prior to its expiration
reflects the relationship between the Guaranteed Interest Rate for such GRO
Account and the then-current Guaranteed Interest Rate applicable to a newly
elected GRO Account of a duration equal to the time remaining in your GRO
Account. The Market Value Adjustment will reduce the GRO Value (but not below
the Minimum Value) if the current Guaranteed Interest Rate is higher than the
Guaranteed Interest Rate being credited to amounts under your GRO Account.
Conversely, the Market Value Adjustment will increase the GRO Value if the
current Guaranteed Interest Rate is lower than the Guaranteed Interest Rate
being credited to amounts under your GRO Account.
The Market Value Adjustment (MVA) for a GRO Account is determined under the
following formula:
MVA = GRO Value x [(1 + A)/N/12/ / (1 + B + .0025)/N/12/ - 1], where
A is the Guaranteed Interest Rate being credited to the GRO Account
subject to the Market Value Adjustment,
B is the current Guaranteed Interest Rate, as of the effective date of the
application of the Market Value Adjustment, for current allocations to a
GRO Account, the length of which is equal to the number of whole months
remaining in your GRO Account. Subject to certain adjustments, if such
remaining period is not equal to an exact period for which we have declared
a new Guaranteed Interest Rate, B will be determined by interpolating
between the Guaranteed Interest Rates for GRO Accounts of durations closest
to (next higher and next lower) the remaining period described above.
N is the number of whole months remaining in your GRO Account.
For contracts issued in certain states, the formula above will be adjusted to
comply with applicable state requirements.
If the remaining term of your GRO Account is 30 days or less, the Market Value
Adjustment for your GRO Account shall be zero. If for any reason we are no
longer declaring current Guaranteed Interest Rates, then for purposes of
determining B we will use the yield to maturity of United States Treasury Notes
with the same remaining term as your GRO Account, interpolating when necessary,
in place of the current Guaranteed Interest Rate or Rates.
For illustrations of the application of the Market Value Adjustment formula, see
Appendix A.
14
<PAGE>
PART 4 DEDUCTIONS AND CHARGES
Separate Account Charges
National Integrity deducts from the unit value every calendar day an amount
equal to an effective annual rate of 1.35% of the Account Value in the Variable
Account Options. This daily expense rate cannot be increased without your
consent. Various portions of this total charge, as described below, pay for
certain services to the Separate Account and the contracts.
A daily charge equal to an effective annual rate of .15% of the value of each
Variable Account Option is deducted for administrative expenses not covered by
the annual administrative charge described below. The daily administrative
charge, like the annual administrative charge, is designed to reimburse National
Integrity for expenses actually incurred, without profit.
A daily charge equal to an effective annual rate of 1.20% of the value of each
Variable Account Option is deducted for National Integrity's assuming the
expense risk (.85%) and the mortality risk (.35%) under the contract. The
expense risk is the risk that our actual expenses of administering the contracts
will exceed the annual administrative expense charge. In this context, mortality
risk refers to the cost of insuring the risk National Integrity takes that
annuitants, as a class of persons, will live longer than estimated and therefore
require National Integrity to pay out more annuity benefits than anticipated.
The relative proportion of the mortality and expense risk charges may be
modified, but the total effective annual risk charge of 1.20% of the value of
the Variable Account Options may not be increased on your Contract.
National Integrity may realize a gain from these daily charges to the extent
they are not needed to meet the actual expenses incurred.
Annual Administrative Charge
If your Account Value is less than $50,000 on the last day of any contract year
prior to the your Retirement Date, National Integrity charges an annual
administrative charge of $30. This charge is deducted from your Account Value in
each Investment Option on a pro-rata basis. The portion of the charge applicable
to the Variable Account Options will reduce the number of units credited to you.
The portion of the charge applicable to the GROs is withdrawn in dollars. The
annual administrative charge will be pro-rated based on the number of days that
have elapsed in the contract year in the event of the Annuitant's retirement,
death, or termination of a contract during a contract year.
Fund Charges
Our Separate Account purchases shares of the Fund at net asset value. That price
reflects investment management fees and other direct expenses that have already
been deducted from the assets of the Fund. The amount charged for investment
management may not be increased without the prior approval of the Fund's
shareholders. See "The Legends Fund" in Part 3.
State Premium Tax Deduction
National Integrity will not deduct state premium taxes from your contributions
before applying the contributions to the Investment Options, unless required to
pay such taxes under applicable state law. If the Annuitant elects an annuity
benefit, National Integrity will deduct any applicable state premium taxes from
the amount otherwise available for an annuity benefit. State premium taxes, if
applicable, currently range up to 4%.
Contingent Withdrawal Charge
No sales charges are applied when you make a contribution to the contract.
Contributions withdrawn will be subject to a withdrawal charge of up to 7%. As
shown below, the percentage charge varies, depending upon the "age" of the
contributions included in the withdrawal-that is, the contract year in
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<PAGE>
which each contribution was made. The maximum percentage of 7% would apply if
the entire amount of the withdrawal consisted of contributions made during your
current contract year. No withdrawal charge applies when you withdraw
contributions made earlier than your sixth prior contract year. For purposes of
calculating the withdrawal charge, (1) the oldest contributions will be treated
as the first withdrawn and more recent contributions next, and (2) partial
withdrawals up to the free withdrawal amount will not be considered a withdrawal
of any contributions. For partial withdrawals, the total amount deducted from
your Account Value will include the withdrawal amount requested, any applicable
Market Value Adjustment and any applicable withdrawal charge, so that the net
amount you receive will be the amount requested.
During any contract year, no charge will be applied to your partial withdrawals
that do not exceed the free withdrawal amount. On any Business Day, the free
withdrawal amount is 10% of your Account Value less withdrawals during the
current contract year. If any partial withdrawal exceeds the free withdrawal
amount, we will deduct the applicable contingent withdrawal charge with respect
to such excess amount. The contingent withdrawal charge is a sales charge to
defray our costs of selling and promoting the contracts. We do not expect that
revenues from contingent withdrawal charges will cover all of such costs. Any
shortfall will be made up from our General Account assets, including any profits
from other charges under the contracts.
<TABLE>
<CAPTION>
Contract Year in Which Charge as a % of the
Withdrawn Contribution Was Made Contribution Withdrawn
------------------------------- ----------------------
<S> <C>
Current........................ 7%
First Prior.................... 6
Second Prior................... 5
Third Prior.................... 4
Fourth Prior................... 3
Fifth Prior.................... 2
Sixth Prior.................... 1
Seventh Prior and Earlier...... 0
</TABLE>
No contingent withdrawal charge will be applied to any amount withdrawn if the
Annuitant uses the withdrawal either to purchase from National Integrity an
immediate annuity benefit with life contingencies or an immediate annuity
without life contingencies which provides for level payments over five or more
years, with a restricted prepayment option. Similarly, no charge will be applied
if the Annuitant dies and the withdrawal is made by the Annuitant's beneficiary.
See "Death Benefits and Similar Benefit Distributions" in Part 5.
Unless specifically instructed otherwise, National Integrity will make
withdrawals (including any applicable charges) from the Investment Options in
the same ratio the Annuitant's Account Value in each Investment Option bears to
the Annuitant's total Account Value. The minimum withdrawal permitted is $300.
Transfer Charge
No charge is made for your first twelve transfers among the Variable Account
Options or the GROs during a contract year. We are, however, permitted to charge
up to $20 for each additional transfer during that contract year. (No transfer
charge will apply to transfers under our dollar cost averaging or individual
asset rebalancing programs, nor will such transfers count towards the twelve
transfers you may make in a contract year before we may impose a transfer
charge.) See "Transfers" in Part 5. Transfers from a GROs may be subject to a
Market Value Adjustment. See "Guaranteed Rate Options" in Part 3.
16
<PAGE>
Hardship Waiver
Withdrawal Charges may also be waived on full or partial withdrawal requests of
$1,000 or more under a Hardship circumstance. The Market Value Adjustment may
also be waived on any amounts withdrawn from the GRO Accounts. Such Hardship
circumstances include the Owner's (1) confinement to a nursing home, hospital
and long term care facility, (2) diagnosis of terminal illness with any medical
condition which would result in death or total disability, and (3) unemployment.
We reserve the right to obtain reasonable notice and documentation including,
but not limited to, a physician's certification and Determination Letter from a
State Department of Labor. Some of the hardship circumstances listed above may
not be applicable in some states and, in other states, may not be available at
all.
Tax Reserve
We have the right to make a charge in the future for taxes or for reserves set
aside for taxes, which will reduce the investment experience of the Variable
Account Options.
PART 5 TERMS OF YOUR VARIABLE ANNUITY
Contributions Under Your Contract
You can make contributions of at least $100 at any time up to the Annuitant's
Retirement Date. Your first contribution, however, cannot be less than $1,000.
We will accept contributions of at least $50 for salary allotment programs. We
have special rules for minimum contribution amounts for tax-favored retirement
programs. See "Special Rules for Tax-Favored Retirement Programs" in Part 7.
We may limit the total contributions under one contract to $1,000,000 if you are
under age 76 or to $250,000 if you are over age 76. Once you reach eight years
before your Retirement Date, we may refuse to accept any contribution made for
you. Contributions may also be limited by various laws or prohibited by National
Integrity for all Annuitants under the contract. If your contributions are made
under a tax-favored retirement program, we will not measure them against the
maximum limits set by law.
Contributions are applied to the various Investment Options selected by you and
are used to pay annuity and death benefits.
Each contribution is credited as of the date we have received (as defined below)
at our Administrative Office both the contribution and instructions for
allocation among the Investment Options, provided that at any time you may have
amounts in not more than nine Investment Options. For purposes of calculating
the nine Investment Options, each of your GRO Accounts counts as one Investment
Option. Wire transfers of federal funds are deemed received on the day of
transmittal if credited to our account by 3 p.m. Eastern Time, otherwise they
are deemed received on the next Business Day. Contributions by check or mail are
deemed received not later than the second Business Day after they are delivered
to our Administrative Office. A Business Day is any day other than a weekend or
a national bank holiday.
You can change your choice of Investment Options at any time by writing to the
Administrative Office. The request should indicate your contract number and the
specific change, and you should sign the request. When it is received by the
Administrative Office, the change will be effective for any contribution which
accompanies it and for all future contributions.
Your Account Value
Your Account Value reflects various charges. See Part 4, "Deductions and
Charges." Annual deductions are made as of the last day of each contract year.
Withdrawal charges and Market Value Adjustments, if applicable, are made as of
the effective date of the transaction. Charges against our Separate Account
17
<PAGE>
are reflected daily. Any amount allocated to a Variable Account Option will go
up or down in value depending on the investment experience of that Option. For
contributions allocated to the Variable Account Options, there are no guaranteed
values. The value of your contributions allocated to the GROs is guaranteed,
subject to any applicable Market Value Adjustments. See "Guaranteed Rate
Options" in Part 3.
Your Purchase of Units in Our Separate Account
Allocations to the Variable Account Options are used to purchase units. On any
given day, the value you have in a Variable Account Option is the unit value
multiplied by the number of units credited to you in that Option. The units of
each Variable Account Option have different unit values.
The number of units purchased or redeemed (sold) in any Variable Account Option
is calculated by dividing the dollar amount of the transaction by the Option's
unit value, calculated after the close of business that day. The number of
units for a Variable Account Option at any time is the number of units
purchased less the number of units redeemed. The value of units fluctuates with
the investment performance of the corresponding Portfolios of the Fund which in
turn reflects the investment income and realized and unrealized capital gains
and losses of the Portfolios, as well as the Fund's expenses. The unit values
also change because of deductions and charges we make to our Separate Account.
The number of units credited to you, however, will not vary because of changes
in unit values. Units of a Variable Account Option are purchased when you
allocate new contributions or transfer prior contributions to that Option.
Units are redeemed when you make withdrawals or transfer amounts from a
Variable Account Option. We also redeem units to pay the death benefit when the
Annuitant dies and to pay the annual administrative charge.
How We Determine Unit Value
We determine unit values for each Variable Account Option on the Valuation
Date. The Valuation Date for purposes of determining unit values is 4 p.m.
Eastern Time on each day the New York Stock Exchange is open for business.
The unit value of each Variable Account Option for any day on which we
determine unit values is equal to the unit value for the last day on which a
unit value was determined multiplied by the net investment factor for that
Option on the current day. We determine a net investment factor for each Option
as follows:
- First, we take the value of the shares belonging to the Option in the
corresponding Portfolio at the close of business that day (before giving
effect to any transactions for that day, such as contributions or
withdrawals). For this purpose, we use the share value reported to us by the
Funds.
- Next, we add any dividends or capital gains distributions by the Fund on
that day.
- Then, we charge or credit for any taxes or amounts set aside as a reserve
for taxes.
- Then, we divide this amount by the value of the amounts in the Option at the
close of business on the last day on which a unit value was determined
(after giving effect to any transactions on that day).
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- Finally, we subtract a daily asset charge for each calendar day since the
last day on which a unit value was determined (for example, a Monday
calculation will include charges for Saturday and Sunday). The daily charge
is .00003721, which is an effective annual rate of 1.35%. This charge is for
the mortality risk, administrative expenses and expense risk assumed by us
under the contract.
Generally, this means that we adjust unit values to reflect what happens to the
Fund, and also for the mortality and expense risk charge and any charge for
administrative expenses or taxes.
Transfers
You may transfer your Account Value among the Variable Account Options and the
GROs, subject to National Integrity's then current transfer restrictions.
Transfers to a GRO must be to a newly elected GRO (i.e. to a GRO that you have
not elected before) at the then-current Guaranteed Interest Rate, unless
National Integrity otherwise consents. Transfers from a GRO other than within
30 days prior to the expiration date of a GRO Account are subject to a Market
Value Adjustment. See "Guaranteed Rate Options" in Part 3. For amounts in GROs,
transfers will be made according to the order in which monies were originally
allocated to any GRO.
The amount transferred must be at least $250 or, if less, the entire amount in
the Investment Option. After twelve transfers have been made by you during a
contract year, a charge of up to $20 may apply to each additional transfer
during that contract year, except that no charge will be made for transfers
under our dollar cost averaging or individual asset rebalancing programs,
described in Part 8. Once annuity payments begin, transfers are no longer
permitted.
Written transfer requests must be sent directly to the Administrative Office.
Each Annuitant's request for a transfer must specify the contract number, the
amounts to be transferred and the Investment Options to and from which the
amounts are to be transferred. Transfers may also be arranged through our
telephone transfer service provided you have established a Personal
Identification Number (PIN Code). We will honor telephone transfer instructions
from any person who provides correct identifying information, and we are not
responsible in the event of a fraudulent telephone transfer which is believed
to be genuine in accordance with these procedures. Accordingly, you bear the
risk of loss if unauthorized persons make transfers on your behalf.
A transfer request will be effective as of the Business Day it is received by
our Administrative Office. A transfer request does not change the allocation of
current or future contributions among the Investment Options. Telephone
transfers may be requested from 8:30 a.m. - 5:00 p.m., Eastern Time, on any day
we are open for business. You will receive the Variable Account Options' unit
values as of the close of business on the day you call. Accordingly, transfer
requests received after 4:00 p.m. Eastern Time will be processed using unit
values as of the close of business on the next Business Day after the day you
call. All transfers will be confirmed in writing.
Withdrawals
You may make an unlimited number of withdrawals from your contract as
frequently as you wish. Each withdrawal must be for at least $300. A
withdrawal charge of up to 7% of the contribution amount withdrawn, as adjusted
for any applicable Market Value Adjustment and the withdrawal charge itself
will be deducted from your Account Value, unless one of the exceptions applies.
See "Guaranteed Rate Options" in Part 3 and "Contingent Withdrawal Charge" in
Part 4. Most withdrawals made by you prior to age 59-1/2 are also subject to a
10% federal tax penalty. In addition, some tax-favored retirement programs
limit withdrawals. See Part 7, "Tax Aspects of the Contracts" for further
information regarding various tax consequences associated with the contracts.
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Assignments
You may not assign the contract as collateral or security for a loan, but an
Owner whose contract is not related to a tax-favored program may otherwise
assign the contract before the Annuitant's Retirement Date. An assignment of the
contract as a gift may, however, have adverse tax consequences. See Part 7, "Tax
Aspects of the Contracts." National Integrity will not be bound by an assignment
unless it is in writing, and we have received it at the Administrative Office.
Death Benefits and Similar Benefit Distributions
A death benefit is available to a beneficiary if the Annuitant dies prior to
the Retirement Date.
If the Annuitant is under the age of 80 at the time of death, the amount of the
death benefit is the greatest of:
. your Account Value
. the highest Account Value at the beginning of any contract year, plus
subsequent contributions and minus subsequent withdrawals.
. your total contributions less the sum of withdrawals
"Subsequent withdrawals" for purposes of calculation of a death benefit reflect
any market value adjustments applicable to such withdrawals.
If the Annuitant is 80 or older at the time of death, the amount of the death
benefit will be your Account Value.
The death benefit amount is determined as of the date proof of death and
instructions for payment of proceeds are received by the Administrative Office.
Death benefits (and benefit distributions required because of a separate
Owner's death) can be paid in a lump sum or as an annuity. If no benefit option
is selected for the beneficiary at the Annuitant's death, the beneficiary can
select an option.
The beneficiary of the death benefit under a contract is selected by the Owner.
An Owner may change beneficiaries by submitting the appropriate form to the
Administrative Office. If no Annuitant's beneficiary survives the Annuitant,
then the death benefit is generally paid to the Annuitant's estate. No death
benefit will be paid after the Annuitant's death if there is a contingent
Annuitant. In that case, the contingent Annuitant becomes the new Annuitant
under the contract.
Generally, the Owner also may select his or her own beneficiary. If the Owner
dies before the Annuitant's Retirement Date, an Owner's beneficiary will become
the Owner of the contract and may be required to receive benefit distributions.
Annuity Benefits
All annuity benefits under your contract are calculated as of the Retirement
Date selected by you. The Retirement Date can be changed by written notice to
the Administrative Office any time prior to the Retirement Date. The Retirement
Date may be no later than your 90th birthday or earlier, if required by law.
The terms of the contracts applicable to the various retirement programs, along
with the federal tax laws, establish certain minimum and maximum retirement
ages.
Annuity benefits may take the form of a lump sum payment or an annuity. A lump
sum payment will provide the Annuitant with the Cash Value under the contract,
shortly after the Retirement Date. The amount applied for the purchase of an
annuity benefit will be the Adjusted Account Value, except that the Cash Value
will be the amount applied if the annuity benefit does not have a life
contingency and either the term is less than five years or the annuity can be
commuted to a lump sum payment without a withdrawal charge applying.
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Annuities
Alternate forms of annuity benefits can provide for fixed or variable payments
which may be made monthly, quarterly, semi-annually or annually. Variable
payments will be funded through one or more Separate Account Divisions. For any
annuity, the minimum amount applied to the annuity must be $2,000 and the
minimum initial payment must be at least $20.
If you have not already selected a form of annuity, we will send you, within
six months prior to your Retirement Date, an appropriate notice form on which
you may indicate the type of annuity you desire or confirm to us that the
normal form of annuity, as defined below, is to be provided. However, if we do
not receive a completed form from you on or before your Retirement Date, we
will deem the Retirement Date to have been extended until we receive your
written instructions at our Administrative Office. During such extension, the
values under your contract in the various Investment Options will remain
invested in such options and amounts remaining in Variable Account Options will
continue to be subject to the investment risks associated with those Options.
However, your Retirement Date cannot be extended beyond your 90th birthday or
earlier if required by law. You will receive a lump sum benefit if you do not
make an election by such date.
We currently offer the following types of annuities:
A period certain annuity provides for fixed or variable payments, or both, to
the Annuitant or the Annuitant's beneficiary (the payee) for a fixed period.
The amount is determined by the period selected. The Annuitant, or if the payee
dies before the end of the period selected, the payee's beneficiary, may elect
to receive the total present value of future payments in cash.
A period certain life annuity provides for fixed or variable payments, or both,
for at least the period selected and thereafter for the life of the payee or
the payee and another annuitant under a joint and survivor annuity. You may not
change or redeem the annuity once payments have begun. If the payee (or the
payee and the other annuitant under a joint and survivor annuity) dies before
the period selected ends, the remaining payments will go to another named payee
who may have the right to redeem the annuity and secure the present value of
future guaranteed payments in a lump sum. The normal form of annuity is a fixed
life income annuity with 10 years of payments guaranteed, funded through our
General Account.
A life income annuity provides fixed payments for the life of the payee or the
payee and another annuitant under a joint and survivor annuity. Once a life
income annuity is selected, the form of annuity cannot be changed or redeemed
for a lump sum payment by the Annuitant or any payee.
Annuity Payments
Fixed annuity payments will not change and are based upon annuity rates
provided in your contract. The size of payments will depend on the form of
annuity that was chosen and, in the case of a life income annuity, on the
payee's age (or payee and a joint annuitant in the case of a joint and survivor
annuity) and sex (except under most tax-favored retirement programs). If
National Integrity's current annuity rates then in effect would yield a larger
payment, those current rates will apply instead of the tables.
Variable annuity payments are funded only in the Separate Account Divisions
through the purchase of annuity units. The Variable Account Option or Options
selected cannot be changed after annuity payments begin. The SAI provides
further information concerning the determination of annuity payments. The
number of units purchased is equal to the amount of the first annuity payment
divided by the new annuity unit value for the valuation period which includes
the due date of the first annuity payment. The amount of the first annuity
payment is determined in the same manner for a variable annuity as it is for a
fixed annuity. The number of annuity units stays the same for the annuity
payment period but the new annuity unit value changes to reflect the investment
income and the realized and unrealized capital gains and losses of the Variable
Account Option or Options selected, after charges
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made against it. Annuity unit values assume a base rate of net investment return
of 5%, except in states which require a lower rate in which case 3.5% will be
used. The annuity unit value will rise or fall depending on whether the actual
rate of net investment return is higher or lower than the assumed base rate. In
the SAI, see "Determination of Annuity Unit Values."
If the age or sex of an annuitant has been misstated, any benefits will be those
which would have been purchased at the correct age and sex. Any overpayments or
underpayments made by us will be charged or credited with interest at the rate
of 6% per year. If we have made overpayments because of incorrect information
about age or sex, we will deduct the overpayment from the next payment or
payments due. We add underpayments to the next payment.
Timing of Payment
We normally make payments from the Variable Account Options, or apply your
Adjusted Account Value to the purchase of an annuity within seven days after
receipt of the required form at our Administrative Office. Our action can be
deferred, however, for any period during which (1) the New York Stock Exchange
has been closed or trading on it is restricted; (2) sales of securities or
determination of the fair value of Separate Account assets is not reasonably
practicable because of an emergency; or (3) the SEC, by order, permits National
Integrity to defer action in order to protect persons with interests in the
Separate Account. National Integrity can defer payment of your GRO Values for up
to six months, and interest will be paid on any such payment delayed for 30 days
or more.
How You Make Requests and Give Instructions
When you communicate in writing with our Administrative Office, use the address
on the first page of this prospectus. Your request or instruction cannot be
honored unless it is in proper and complete form. Whenever possible, use one of
our printed forms, which may be obtained from our Administrative Office.
PART 6 - VOTING RIGHTS
Fund Voting Rights
National Integrity is the legal owner of the shares of the Fund held by the
Separate Account and, as such, has the right to vote on certain matters. Among
other things, we may vote to elect the Fund's Board of Directors, to ratify the
selection of independent auditors for the Fund, and on any other matters
described in the Fund's current prospectus or requiring a vote by shareholders
under the 1940 Act.
Whenever a shareholder vote is taken, we give you the opportunity to tell us how
to vote the number of shares purchased as a result of contributions to your
contract. We will send you Fund proxy materials and a form for giving us voting
instructions.
If we do not receive instructions in time from all Owners, we will vote shares
in a Portfolio for which no instructions have been received in the same
proportion as we vote shares for which we have received instructions. Under
eligible deferred compensation plans and certain Qualified Plans, your voting
instructions must be communicated to us indirectly, through your employer, but
we are not responsible for any failure by your employer to solicit your
instructions or to communicate your instructions to us. We will vote any Fund
shares that we are entitled to vote directly, because of amounts we have
accumulated in our Separate Account, in the same proportions that other Owners
vote. If the federal securities laws or regulations or interpretations of them
change so that we are permitted to vote shares of the Fund in our own right or
to restrict Owner voting, we may do so.
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How We Determine Your Voting Shares
You may participate in voting only on matters concerning the Portfolios in which
your contributions have been invested. We determine the number of Fund shares in
each Variable Account Option that are attributable to your contract by dividing
the amount of your Account Value allocated to that Option by the net asset value
of one share of the corresponding Portfolio as of the record date set by the
Fund's Board for the Fund's shareholders' meeting. The record date for this
purpose must be no more than 60 days before the meeting of the Fund. We count
fractional shares. After annuity payments have commenced, voting rights are
calculated in a similar manner based on the actuarially determined value of your
interest in each Variable Account Option.
How Fund Shares Are Voted
All Fund shares are entitled to one vote; fractional shares have fractional
votes. Voting is on a Portfolio-by-Portfolio basis, except for certain matters
(for example, election of Directors) which require collective approval. On
matters on which the interests of the individual Portfolios differ, the approval
of the shareholders in one Portfolio is not needed in order to make a decision
in another Portfolio. To the extent shares of the Fund are sold to separate
accounts of other insurance companies, the shares voted by such companies in
accordance with instructions received from their contract holders will dilute
the effect of voting instructions received by National Integrity from its
Owners.
Separate Account Voting Rights
Under the 1940 Act, certain actions (such as some of those described under
"Changes in How We Operate" in Part 2) may require Owner approval. In that case,
you will be entitled to a number of votes based on the value you have in the
Variable Account Options, as described above under "How We Determine Your Voting
Shares." We will cast votes attributable to amounts we have in the Variable
Account Options in the same proportions as votes cast by Owners.
PART 7 - TAX ASPECTS OF THE CONTRACTS
Introduction
The effect of federal income taxes on the amounts held under a contract, on
annuity payments, and on the economic benefits to the Owner, Annuitant, and the
beneficiary or other payee may depend on National Integrity's tax status, on the
type of retirement plan, if any, for which the contract is purchased, and upon
the tax and employment status of the individuals concerned.
The following discussion of the federal income tax treatment of the contract is
not exhaustive, does not purport to cover all situations and is not intended to
be tax advice. It is based upon understanding of the present federal income tax
laws as currently interpreted by the Internal Revenue Service (IRS). No
representation is made regarding the likelihood of continuation of the present
federal income tax laws or of the current interpretations by the IRS or the
courts. Future legislation may affect annuity contracts adversely. Moreover, no
attempt has been made to consider any applicable state or other laws. Because of
the inherent complexity of such laws and the fact that tax results will vary
according to the particular circumstances of the individual involved and, if
applicable, the qualified plan, any person contemplating the purchase of a
contract, contemplating selection of annuity payments under the contract, or
receiving annuity payments under a contract should consult a qualified tax
adviser. NATIONAL INTEGRITY DOES NOT MAKE ANY GUARANTEE REGARDING THE TAX
STATUS, FEDERAL, STATE, OR LOCAL, OF ANY CONTRACT OR ANY TRANSACTION INVOLVING
THE CONTRACTS.
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Your Contract is an Annuity
Under the federal tax law, any individual can purchase an annuity with after-tax
dollars and exclude any annuity earnings in taxable income until an actual
distribution is taken from the annuity. Alternatively, the individual (or
employer) may purchase the annuity to fund a tax-favored retirement program
(contributions are with pre-tax dollars), such as an IRA or qualified plan.
This prospectus covers the basic tax rules that apply to an annuity purchased
directly with after-tax dollars, (nonqualified annuity), and some of the special
tax rules which apply to an annuity purchased to fund a tax-favored retirement
program, (qualified annuity). A qualified annuity may restrict your rights and
benefits in order to qualify for its special treatment under the federal tax
law.
Taxation of Annuities Generally
Section 72 of the Internal Revenue Code of 1986, as amended (the Code), governs
the taxation of annuities. In general, an Owner is not taxed on increases in
value under a contract until some form of withdrawal or distribution is made
under the contract. However, under certain circumstances, the increase in value
may be subject to current federal income tax. For example, corporations,
partnerships, trusts and other non-natural persons cannot defer the taxation of
current income credited to the contract unless an exception applies. In
addition, if an Owner transfers an annuity as a gift to someone other than a
spouse (or divorced spouse), any increase in its value will be taxed at the time
of transfer. The assignment or pledge of any portion of the value of a contract
will be treated as a distribution of that portion of the value of the contract.
Section 72 provides that the proceeds of a full or partial withdrawal from a
contract prior to the date on which annuity payments begin are treated first as
taxable income to the extent that the Account Value exceeds the "investment" or
"basis" in the contract and then as non-taxable recovery of the investment or
basis in the contract. Generally, the investment or basis in the contract equals
the contributions made by or on your behalf, less any amounts previously
withdrawn which were not treated as taxable income. Special rules may apply if
the contract includes contributions made prior to August 14, 1982 which were
rolled over to the contract in a tax-free exchange.
Once annuity payments begin, the Annuitant recovers a portion of the investment
tax-free from each payment. The non-taxable portion of each payment is based on
the ratio of the Annuitant's investment to his or her expected return under the
contract (exclusion Ratio). The remainder of each payment will be ordinary
income.
After you have recovered your total investment, future payments are fully
included in income. If the Annuitant dies prior to recovering the total
investment, a deduction for the remaining basis will generally be allowed on the
Annuitant's final federal income tax return.
Withholding of federal income taxes on all distributions may be required unless
the recipient who is eligible elects not to have any amounts withheld and
properly notifies National Integrity of that election.
The taxable portion of a distribution is treated as ordinary income and is taxed
at ordinary income tax rates. In addition, a tax penalty of 10% applies to the
taxable portion of a distribution unless the distribution is: (1) on or after
the date on which the taxpayer attains age 59-1/2; (2) as a result of the death
of the Owner; (3) attributable to the taxpayer becoming disabled within the
meaning of Code Section 72(m)(7); (4) from certain qualified plans (note,
however, other penalties may apply); (5) under a qualified funding asset (as
defined in Section 130(d) of the Code); (6) purchased by an employer on
termination of certain types of qualified plans and held by the employer until
the employee separates from service; or (7) under an immediate annuity as
defined in Code Section 72(u)(4).
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All annuity contracts issued by National Integrity or its affiliates to one
Annuitant during any calendar year are treated as a single contract in measuring
the taxable income that results from surrenders and withdrawals under any one of
the contracts.
Distribution-at-Death Rules
Under section 72(s) of the Code, in order to be treated as an annuity, a
contract must provide the following distribution rules: (a) if any Owner dies on
or after the Retirement Date and before the entire interest in the contract has
been distributed, then the remaining portion of such interest must be
distributed at least as quickly as the method in effect on the date of the
Owner's death; and (b) if any Owner dies before the Retirement Date, the entire
interest in the contract must be distributed within five years after the date of
the Owner's death. To the extent such interest is payable to a beneficiary,
however, such interest may be annuitized over the life of that beneficiary or
over a period not extending beyond the life expectancy of that beneficiary, so
long as distributions commence within one year after the Owner's death. If the
beneficiary is the spouse of the Owner, the contract (along with the deferred
tax status) may be continued in the name of the spouse as the Owner.
If the Owner is not an individual, the "primary annuitant," as defined in the
Code, is considered the Owner. The primary annuitant is the individual who is of
primary importance in affecting the timing of the amount of payout under a
contract. In addition, when the Owner is not an individual, a change in the
primary annuitant is treated as the death of the Owner. Finally, in the case of
joint owners, the distribution-at-death rules will be applied at the death of
the first Owner.
Diversification Standards
Each Portfolio of the Fund will be required to adhere to regulations adopted by
the Treasury Department pursuant to Section 817(h) of the Code prescribing asset
diversification requirements for investment companies whose shares are sold to
insurance company separate accounts funding variable contracts. The investment
manager for the Fund monitors the investments in order to comply with the
regulations to assure that the contracts continue to be treated as annuities for
federal income tax purposes.
The IRS has stated in published rulings that a variable contract owner will be
considered the owner of separate account assets if the contract owner possesses
incidents of ownership in those assets, such as the ability to exercise
investment control over the assets. In those circumstances, income and gains
from the separate account assets would be includable in the variable contract
owner's gross income. The Treasury Department also announced, in connection with
the issuance of regulations concerning 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 (i.e.,
the Owner), 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 the underlying assets." As of the date of this prospectus, no such
guidance has been issued.
Tax-Favored Retirement Programs
The contract is designed for use in connection with certain types of retirement
plans which receive favorable treatment under the Code. Numerous special tax
rules apply to the participants in such qualified plans and to the contracts
used in connection with such qualified plans. These tax rules vary according to
the type of plan and the terms and conditions of the plan itself. Owners,
Annuitants, and beneficiaries are cautioned that the rights of any person to any
benefits under qualified plans may be subject to the terms and conditions of the
plans themselves, regardless of the terms and conditions of the contract. In
addition, loans from qualified contracts, where allowed, are subject to a
variety of limitations, including restrictions as to the amount that may be
borrowed, the duration of the loan, and the manner in which the loans must be
repaid. (Owners should always consult their tax advisors and
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retirement plan fiduciaries prior to exercising their loan privileges.) Also,
special rules apply to the time at which distributions must commence and the
form in which the distributions must be paid. Therefore, no attempt is made to
provide more than general information about the use of contracts with the
various types of qualified plans.
National Integrity reserves the right to change its administrative rules, such
as minimum contribution amounts, as needed to comply with the Code as to tax-
favored retirement programs.
Following are brief descriptions of various types of qualified plans in
connection with which National Integrity may issue a contract.
Individual Retirement Annuities
- -------------------------------
Code Section 408 permits eligible individuals to contribute to an individual
retirement program known as an IRA. An individual who receives compensation and
who has not reached age 70-1/2 by the end of the tax year may establish an IRA
and make contributions up to the deadline for filing his or her federal income
tax return for that year (without extensions). IRAs are subject to limitations
on the amount that may be contributed, the persons who may be eligible, and on
the time when distributions may commence. An individual may also rollover
amounts distributed from another IRA or another tax-favored retirement program
to an IRA contract. Your IRA contract will be issued with a rider outlining the
special terms of your contract which apply to IRAs.
Tax Sheltered Annuities
- -----------------------
Section 403(b) of the Code permits the purchase of tax-sheltered annuities (TSA)
by public schools and certain charitable, educational and scientific
organizations described in Section 501(c)(3) of the Code. The contract is not
intended to accept other than employee contributions. Such contributions are not
includible in the gross income of the employee until the employee receives
distributions from the contract. The amount of contributions to the TSA is
limited to certain maximums imposed by Code sections 403(b), 415 and 402(g).
Furthermore, the Code sets forth additional restrictions governing such items as
transferability, distributions and withdrawals. Any employee should obtain
competent tax advice as to the tax treatment and suitability of such an
investment. Your contract will be issued with a rider outlining the special
terms which apply to a TSA.
Simplified Employee Pensions
- ----------------------------
Section 408(k) of the Code allows employers to establish simplified employee
pension plans (SEP-IRAs) for their employees, using the employees' IRAs for such
purposes, if certain criteria are met. Under these plans the employer may,
within specified limits, make deductible contributions on behalf of the
employees to IRAs. Employers intending to use the contract in connection with
such plans should seek competent advice. The SEP-IRA will be issued with a rider
outlining the special terms of the contract.
Corporate and Self-Employed (H.R. 10 and Keogh) Pension and Profit Sharing
- --------------------------------------------------------------------------
Plans
- -----
Sections 401(a) and 403(a) of the Code permit corporate employers to establish
various types of tax-favored retirement plans for employees. The Self-Employed
Individuals' Tax Retirement Act of 1962, as amended, commonly referred to as
"H.R. 10" or "Keogh," permits self-employed individuals also to establish such
tax-favored retirement plans for themselves and their employees. Such retirement
plans may permit the purchase of the contract in order to provide benefits under
the plans. Employers intending to use the contract in connection with such plans
should seek competent advice. The Company reserves the right to request
documentation to substantiate that a qualified plan exists and is being properly
administered. National Integrity does not administer such plans.
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Deferred Compensation Plans of State and Local Governments and Tax-Exempt
- -------------------------------------------------------------------------
Organizations
- -------------
Section 457 of the Code permits employees of state and local governments and
tax-exempt organizations to defer a portion of their compensation without paying
current taxes. The employees must be participants in an eligible deferred
compensation plan. To the extent the contracts are used in connection with an
eligible plan, employees are considered general creditors of the employer and
the employer as Owner of the contract has the sole right to the proceeds of the
contract. However, Section 457(g), as added by the Small Business and Jobs
Protection Act (SBJPA) of 1996, provides that on and after August 20, 1996, a
plan maintained by an eligible governmental employer must hold all assets and
income of the plan in a trust, custodial account, or annuity contract for the
exclusive benefit of participants and their beneficiaries. If the plan is in
existence on August 20, 1996, the employer need not establish a trust, custodial
account, or annuity contract until January 1, 1999. Loans to employees may be
permitted under such plans; however, a Section 457 plan is not required to allow
loans. Contributions to a contract in connection with an eligible government
plan are subject to limitations. Those who intend to use the contracts in
connection with such plans should seek competent advice. The Company reserves
the right to request documentation to substantiate that a qualified plan exists
and is being properly administered. National Integrity does not administer such
plans.
Distributions Under Tax-Favored Retirement Programs
Distributions from tax-favored plans are subject to certain restrictions. Prior
to the enactment of the 1996 SBJPA, distributions of minimum amounts specified
by the Code must have commenced by April 1 of the calendar year following the
calendar year in which the participant reaches age 70-1/2. The SBJPA provides
participants in qualified plans, with the exception of five-percent owners and
IRA holders, to begin receiving distributions by April 1 of the calendar year
following the later of either (i) the calendar year in which the employee
reaches age 70-1/2, or (ii) the calendar year in which the employee retires.
Additional distribution rules apply after the participant's death. Failure to
make mandatory distributions may result in the imposition of a 50% penalty tax
on any difference between the required distribution amount and the amount
distributed. Distributions to a participant from all plans (other than 457
plans) in a calendar year that exceed a specific limit under the Code are
generally subject to a 15% penalty tax (in addition to any ordinary income tax)
on the excess portion of the distributions. However, the SBJPA of 1996 has
suspended the excise tax on excess distributions. The provision relating to the
excise tax on excess distributions is effective with respect to distributions
received in 1997, 1998 and 1999.
Distributions from a tax-favored plan (not including an IRA subject to Code
Section 408) to an employee, surviving spouse, or former spouse who is an
alternate payee under a qualified domestic relations order, in the form of a
lump sum settlement or periodic annuity payments for a fixed period of fewer
than 10 years are subject to mandatory income tax withholding of 20% of the
taxable amount of the distribution, unless (1) the distributee directs the
transfer of such amounts in cash to another plan or an IRA; or (2) the payment
is a minimum distribution required under the Code. The taxable amount is the
amount of the distribution less the amount allocable to after-tax contributions.
All other types of taxable distributions are subject to withholding unless the
distributee elects not to have withholding apply.
We are not permitted to make distributions from a contract unless a request has
been made. It is therefore your responsibility to comply with the minimum
distribution rules. You should consult your tax adviser regarding these rules
and their proper application.
The above description of the federal income tax consequences of the different
types of tax-favored retirement plans which may be funded by the contract is
only a brief summary and is not intended as tax advice. The rules governing the
provisions of plans are extremely complex and often difficult to comprehend.
Anything less than full compliance with all applicable rules, all of which are
subject to change, may have adverse tax consequences. A prospective Owner
considering adoption of a plan and purchase of a contract in connection
therewith should first consult a qualified and competent tax adviser, with
regard to the suitability of the contract as an investment vehicle for the plan.
27
<PAGE>
Federal and State Income Tax Withholding
National Integrity will withhold and remit to the U.S. government a part of the
taxable portion of each distribution made under a contract unless the
distributee notifies National Integrity at or before the time of the
distribution of an election not to have any amounts withheld. In certain
circumstances, National Integrity may be required to withhold tax, as explained
above. The withholding rates applicable to the taxable portion of periodic
annuity payments (other than eligible rollover distributions) are the same as
the withholding rates generally applicable to payments of wages. In addition,
the withholding rate applicable to the taxable portion of non-periodic payments
(including withdrawals prior to the maturity date) is 10%. As discussed above,
the withholding rate applicable to eligible rollover distributions is 20%.
Certain states have indicated that pension and annuity withholding will apply to
payments made to residents. Generally, an election out of federal withholding
will also be considered an election out of state withholding. For more
information concerning a particular state, call our Administrative Office at the
toll-free number.
Impact of Taxes to National Integrity
The contracts provide that National Integrity may charge the Separate Account
for taxes. National Integrity can also set up reserves for taxes.
Transfers Among Investment Options
There will not be any tax liability if you transfer any part of the Account
Value among the Investment Options of your contract.
PART 8 - ADDITIONAL INFORMATION
Systematic Withdrawals
We offer a program for systematic withdrawals that allows you to pre-authorize
periodic withdrawals from your contract prior to your Retirement Date. You may
choose to have withdrawals made monthly, quarterly, semi-annually or annually
and may specify the day of the month (other than the 29th, 30th or 31st) on
which the withdrawal is to be made. You may specify a dollar amount for each
withdrawal or an annual percentage to be withdrawn. The minimum systematic
withdrawal currently is $100. You may also specify an account for direct deposit
of your systematic withdrawals. To enroll under our systematic withdrawal
program, you must deliver the appropriate administrative form to our
Administrative Office. Withdrawals may begin not less than one business day
after our receipt of the form. You or we may terminate your participation in the
program upon one day's prior written notice, and we may terminate or amend the
systematic withdrawal program at any time. If on any withdrawal date you do not
have sufficient values to make all of the withdrawals you have specified, no
withdrawals will be made and your enrollment in the program will be ended.
Amounts withdrawn by you under the systematic withdrawal program may be within
the free withdrawal amount in which case neither a contingent withdrawal charge
nor a Market Value Adjustment will be made. See "Contingent Withdrawal Charge"
in Part 4. Amounts withdrawn under the systematic withdrawal program in excess
of the free withdrawal amount will be subject to a contingent withdrawal charge
and a Market Value Adjustment if applicable. Withdrawals also may be subject to
the 10% federal tax penalty for early withdrawals under the contracts and to
income taxation. See Part 7, "Tax Aspects of the Contracts."
28
<PAGE>
Dollar Cost Averaging
We offer a dollar cost averaging program under which allocations to the ARM
Capital Advisors Money Market Option are automatically transferred on a monthly,
quarterly, semi-annual or annual basis to one or more other Variable Account
Options. You must specify a dollar amount to be transferred into each Variable
Account Option, and the current minimum transfer to each Option is $250. No
transfer charge will apply to transfers under our dollar cost averaging program,
and such transfers will not count towards the twelve transfers you may make in a
contract year before we may impose a transfer charge.
To enroll under our dollar cost averaging program, you must deliver the
appropriate administrative form to our Administrative Office. You or we may
terminate your participation in the program upon one day's prior written notice,
and we may terminate or amend the dollar cost averaging program at any time. If
you do not have sufficient funds in the ARM Capital Advisors Money Market Option
to transfer to each Variable Account Option specified, no transfer will be made
and your enrollment in the program will be ended.
Individual Asset Rebalancing
We offer an individual asset rebalancing program whereby you can select the
frequency for rebalancing. Frequencies available include rebalancing monthly,
quarterly, semi-annually or annually. The value in the Variable Account Options
will be automatically rebalanced by transfers among such Variable Account
Options, and you will receive a confirmation notice after each rebalancing.
Transfers will occur only to and from those Variable Account Options where you
have current contribution allocations. No transfer charge will apply to
transfers under our individual asset rebalancing program, and such transfers
will not count towards the twelve transfers you may make in a contract year
before we may impose a transfer charge.
GROs are not eligible for the individual asset rebalancing program.
To enroll under our individual asset rebalancing program, you must deliver the
appropriate administrative form to our Administrative Office. You should be
aware that other allocation programs, such as dollar cost averaging, as well as
transfers and withdrawals that you make, may not work in concert with the
individual asset rebalancing program. You should, therefore, monitor your use of
such other programs, transfers, and withdrawals while the individual asset
rebalancing program is in effect. You or we may terminate your participation in
the program upon one day's prior written notice, and we may terminate or amend
the individual asset rebalancing program at any time.
Systematic Contributions
We offer a program for systematic contributions that allows you to pre-authorize
monthly withdrawals from your checking account for payment to us. To enroll
under our program, you must deliver the appropriate administrative form to our
Administrative Office. You or we may terminate your participation in the program
upon 30 days' prior written notice. Your participation may be terminated by us
if your bank declines to make any payment. The minimum amount for systematic
contributions is $1,000 per month.
Performance Information
Performance data for the Variable Account Options, including the yield and
effective yield of the ARM Capital Advisors Money Market Option, the yield of
the other Options, and the total return of all of the Options may appear in
advertisements or sales literature. Performance data for any Option reflects
only the performance of a hypothetical investment in the Option during the
particular time period on which the calculations are based. Performance
information should be considered in light of the investment objectives and
policies of the Portfolio in which the Option invests and the market conditions
during the
29
<PAGE>
given time period, and it should not be considered as a representation of
performance to be achieved in the future.
Total returns are based on the overall dollar or percentage change in value of a
hypothetical investment in an Option. Total return quotations reflect changes in
Fund share price, the automatic reinvestment by the Option of all distributions
and the deduction of applicable contract charges and expenses, including any
contingent withdrawal charge that would apply if an Owner surrendered the
contract at the end of the period indicated. Total returns also may be shown
that do not take into account the contingent withdrawal charge or the annual
administrative charge applicable where the Account Value is less than $50,000 at
the end of a contract year.
A cumulative total return reflects an Option's performance over a stated period
of time. An average annual total return reflects the hypothetical annually
compounded return that would have produced the same cumulative total return if
the Option's performance had been constant over the entire period. Because
average annual total returns tend to smooth out variations in an Option's
returns, you should recognize that they are not the same as actual year-by-year
results.
Some Options may also advertise yield. These measures reflect the income
generated by an investment in the Option over a specified period of time. This
income is annualized and shown as a percentage. Yields do not take into account
capital gains or losses or the contingent withdrawal charge.
The ARM Capital Advisors Money Market Option may advertise its current and
effective yield. Current yield reflects the income generated by an investment in
the Option over a specified 7-day period. Effective yield is calculated in a
similar manner except that income earned is assumed to be reinvested. The
Pinnacle Fixed Income Option may advertise a 30-day yield which reflects the
income generated by an investment in such Option over a specified 30-day period.
For a detailed description of the methods used to determine yield and total
return for the Variable Account Options, see the SAI.
30
<PAGE>
APPENDIX A
ILLUSTRATION OF A MARKET VALUE ADJUSTMENT
Contribution:................. $50,000.00
GRO Account duration:......... 7 Years
Guaranteed Interest Rate:..... 5% Annual Effective Rate
The following examples illustrate how the Market Value Adjustment and the
contingent withdrawal charge may affect the values of a contract upon a
withdrawal. The 5% assumed Guaranteed Interest Rate is the same rate used in the
Example under "Table of Annual Fees and Expenses" in this Prospectus. In these
examples, the withdrawal occurs three years after the initial contribution. The
Market Value Adjustment operates in a similar manner for transfers. No
contingent withdrawal charge applies to transfers.
The GRO Value for this $50,000 contribution is $70,355.02 at the expiration of
the GRO Account. After three years, the GRO Value is $57,881.25. It is also
assumed, for the purposes of these examples, that no prior partial withdrawals
or transfers have occurred.
The Market Value Adjustment will be based on the rate we are then crediting (at
the time of the withdrawal) on new contributions to GRO Accounts of the same
duration as the time remaining in your GRO Account, rounded to the next higher
number of complete months. If we do not declare a rate for the exact time
remaining, we will interpolate between the Guaranteed Interest Rates for GRO
Accounts of durations closest to (next higher and next lower) the remaining
period described above. Three years after the initial contribution, there would
have been four years remaining in your GRO Account. These examples also show the
withdrawal charge which would be calculated separately.
Example of a Downward Market Value Adjustment:
A downward Market Value Adjustment results from a full or partial withdrawal
that occurs when interest rates have increased. Assume interest rates have
increased three years after the initial contribution and we are then crediting
6.25% for a four-year GRO Account. Upon a full withdrawal, the Market Value
Adjustment, applying the above formula would be:
-0.0551589 = [(1 + .05)/48/12/ / (1 + .0625 + .0025)/48/12/] - 1
The Market Value Adjustment is a reduction of $3,192.67 from the GRO Value:
-$3,192.67 = -0.0551589 X $57,881.25
The Market Adjusted Value would be:
$54,688.58 = $57,881.25 - $3,192.67
A withdrawal charge of 5% would be assessed against the $50,000 original
contribution:
$2,500.00 = $50,000.00 X .05
Thus, the amount payable on a full withdrawal would be:
$52,188.58 = $57,881.25 - $3,192.67 - $2,500.00
31
<PAGE>
If instead of a full withdrawal, $20,000 was requested, we would first determine
the free withdrawal amount:
$5,788.13 = $57,881.25 X .10
Free Amount = $5,788.13
The non-free amount would be:
$14,211.87 = $20,000.00 - $5,788.13
The Market Value Adjustment, which is only applicable to the non-free amount,
would be
- $783.91 = -0.0551589 X $14,211.87
The withdrawal charge would be:
$789.25 = [($14,211.87 + $783.91)/(1 - .05)] - ($14,211.87 + 783.91)
Thus, the total amount needed to provide $20,000 after the Market Value
Adjustment and withdrawal charge would be:
$21,573.16 = $20,000.00 + $783.91 + $789.25
The ending Account Value would be:
$36,308.09 = $57,881.25 - $21,573.16
Example of an Upward Market Value Adjustment:
An upward Market Value Adjustment results from a full or partial withdrawal that
occurs when interest rates have decreased. Assume interest rates have decreased
three years after the initial contribution and we are then crediting 4% for a
four-year GRO Account. Upon a full withdrawal, the Market Value Adjustment,
applying the formula set forth in the prospectus, would be:
.0290890 = [(1 + .05)/48/12/ / (1 + .04 + .0025)/48/12/] - 1
The Market Value Adjustment is an increase of $1,683.71 to the GRO Value:
$1,683.71 = .0290890 X $57,881.25
The Market Adjusted Value would be:
$59,564.96 = $57,881.25 + $1,683.71
A withdrawal charge of 5% would be assessed against the $50,000 original
contribution:
$2,500.00 = $50,000.00 X .05
Thus, the amount payable on a full withdrawal would be:
$57,064.96 = $57,881.25 + $1,683.71 - $2,500.00
32
<PAGE>
If instead of a full withdrawal, $20,000 was requested, the free withdrawal
amount and non-free amount would first be determined as above:
Free Amount = $ 5,788.13
Non-Free Amount = $14,211.87
The Market Value Adjustment would be:
$413.41 = .0290890 X $14,211.87
The withdrawal charge would be:
$726.23 = [($14,211.87 - $413.41)/(1 - .05)] - ($14,211.87 - $413.41)
Thus, the total amount needed to provide $20,000 after the Market Value
Adjustment and withdrawal charge would be:
$20,312.82 = $20,000.00 - $413.41 + $726.23
The ending Account Value would be:
$37,568.43 = $57,881.25 - $20,312.82
Actual Market Value Adjustments may have a greater or lesser impact than shown
in the examples, depending on the actual change in interest crediting rate and
the timing of the withdrawal or transfer in relation to the time remaining in
the GRO Account. Also, the Market Value Adjustment can never decrease the
Account Value below premium plus 3% interest, before any applicable charges.
Account values less than $50,000 will be subject to a $30 annual charge.
33
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
May 1, 1997
FOR
PINNACLE(version III)
FLEXIBLE PREMIUM VARIABLE ANNUITY
ISSUED BY
NATIONAL INTEGRITY LIFE INSURANCE COMPANY
AND
FUNDED THROUGH ITS SEPARATE ACCOUNT II
<TABLE>
<CAPTION>
Table of Contents
Page
<S> <C>
Part 1 - National Integrity and Custodian......................................2
Part 2 - Distribution of the Contracts.........................................2
Part 3 - Performance Information...............................................3
Part 4 - Determination of Annuity Unit Values.................................11
Part 5 - Financial Statements.................................................12
</TABLE>
This Statement of Additional Information (SAI) is not a prospectus. It should be
read in conjunction with the prospectus for the contracts, dated May 1, 1997.
For definitions of special terms used in the SAI, please refer to the
prospectus.
A copy of the prospectus to which this SAI relates is available at no charge by
writing the Administrative Office at National Integrity Life Insurance Company
("National Integrity"), 200 Park Avenue, 20th Floor, New York, New York 10166,
or by calling 1-800-325-8583.
<PAGE>
PART 1 - NATIONAL INTEGRITY AND CUSTODIAN
National Integrity is a New York stock life insurance company that sells life
insurance and annuities. Its offices are located at 200 Park Avenue, 20th Floor,
New York, New York 10166. National Integrity, the depositor of Separate Account
II, is a wholly owned subsidiary of Integrity Life Insurance Company. Integrity
Life Insurance Company is a wholly owned subsidiary of Integrity Holdings, Inc.,
a Delaware corporation which is a holding company engaged in no active business.
All outstanding shares of Integrity Holdings, Inc. are owned by ARM Financial
Group, Inc. (ARM), a Delaware corporation which is a financial services company
focusing on the long-term savings and retirement marketplace by providing retail
and institutional products and services throughout the United States. ARM owns
100% of the stock of (i) ARM Securities Corporation (ARM Securities), a
Minnesota corporation registered with the SEC as a broker-dealer and a member of
the National Association of Securities Dealers, Inc., (ii) ARM Capital Advisors,
Inc., a New York corporation registered with the SEC as an investment adviser,
(iii) SBM Certificate Company, a Minnesota corporation registered with the SEC
as an issuer of face-amount certificates, and (iv) ARM Transfer Agency, Inc., a
Delaware corporation registered with the SEC as a transfer and dividend
disbursing agency. Approximately 91% of the outstanding voting stock of ARM is
owned by The Morgan Stanley Leveraged Equity Fund II, L.P., Morgan Stanley
Capital Partners III, L.P., Morgan Stanley Capital Investors, L.P., and MSCP III
892 Investors, L.P., each of which is a Delaware limited partnership
(collectively, the MSCP Funds). The MSCP Funds are private equity funds
sponsored by Morgan Stanley Group, Inc., a Delaware corporation that, through
its subsidiaries, provides a wide range of financial services on a global basis
(Morgan Stanley). The general partner of each of the MSCP Funds is a wholly
owned subsidiary of Morgan Stanley. Oldarm Limited Partnership, a Kentucky
limited partnership, New ARM, LLC, a Kentucky limited liability company, and
certain current and former employees and management of ARM own in the aggregate
approximately 9% of the voting stock of ARM.
No person has the direct or indirect power to control Morgan Stanley except
insofar as he or she may have such power by virtue of his or her capacity as a
director or executive officer thereof. Morgan Stanley is publicly held; no
individual beneficially owns more than 5% of the common shares; however,
approximately 31% of such shares are subject to a stockholders' agreement or
voting agreement among certain current and former principals and employees of
Morgan Stanley and its predecessor.
Beginning in 1994, ARM provided substantially all of the services required to be
performed on behalf of the Separate Account. Total fees paid to ARM by National
Integrity for management services in 1995 and 1996, including services
applicable to the Registrant, were $5,640,827 and $6,007,766, respectively.
National Integrity is the custodian for the shares of The Legends Fund, Inc.
owned by the Separate Account. The Fund's shares are held in book-entry form.
Reports and marketing materials, from time to time, may include information
concerning the rating of National Integrity, as determined by A.M. Best Company,
Moody's Investor Service, Standard & Poor's Corporation, Duff & Phelps
Corporation, or other recognized rating services. National Integrity is
currently rated "A" (Excellent) by A.M. Best Company, and has received claims
paying ability ratings of "A" (Good) from Standard & Poor's Corporation, "Baa1"
from Moody's Investors Service, Inc., and "A+" (High) from Duff and Phelps
Credit Rating Company. However, National Integrity does not guarantee the
investment performance of the portfolios, and these ratings do not reflect
protection against investment risk.
PART 2 - DISTRIBUTION OF THE CONTRACTS
ARM Securities, a wholly owned subsidiary of ARM, is the principal underwriter
of the contracts. ARM Securities is registered with the SEC as a broker-dealer
and is a member in good standing of the National Association of Securities
Dealers, Inc. ARM Securities' address is 515 West Market Street, Louisville,
Kentucky 40202. The contracts are offered through ARM Securities on a continuous
basis.
2
<PAGE>
We generally pay a maximum distribution allowance of 6.5% of initial
contributions. The amount of distribution allowances paid was $51,204, $123,719,
and $684,838 for the years ended December 31, 1996, 1995 and 1994, respectively.
No distribution allowances were retained by ARM Securities during these years.
National Integrity may from time to time pay or allow additional promotional
incentives, in the form of cash or other compensation, to broker-dealers that
sell contracts. In some instances, such other incentives may be offered only to
certain broker-dealers that sell or are expected to sell during specified time
periods certain minimum amounts of the contracts.
PART 3 - PERFORMANCE INFORMATION
Each Variable Account Option may from time to time include the Average Annual
Total Return, the Cumulative Total Return, and Yield of its shares in
advertisements or in information furnished to shareholders. The ARM Capital
Advisors Money Market Option may also from time to time include the Yield and
Effective Yield of its shares in information furnished to shareholders.
Performance information is computed separately for each Option in accordance
with the formulas described below. At any time in the future, total return and
yields may be higher or lower than in the past and there can be no assurance
that any historical results will continue.
Total Returns
Total returns reflect all aspects of an Option's return, including the automatic
reinvestment by the Option of all distributions and the deduction of all
applicable charges to the Option on an annual basis, including mortality risk
and expense charges, the annual administrative charge and other charges against
contract values. Quotations also will assume a termination (surrender) at the
end of the particular period and reflect the deductions of the contingent
withdrawal charge, if applicable. Total returns may be shown simultaneously that
do not take into account deduction of the contingent withdrawal charge, and/or
the annual administrative charge.
Average annual total returns are calculated by determining the growth or decline
in the value of a hypothetical historical investment in the Option over certain
periods, including 1, 5, and 10 years (up to the life of the Option), and then
calculating the annually compounded percentage rate that would have produced the
same result if the rate of growth or decline in value had been constant over the
period. Investors should realize that the Option's performance is not constant
over time, but changes from year to year, and that the average annual returns
represent the averages of historical figures as opposed to the actual historical
performance of an Option during any portion of the period illustrated. Average
annual returns are calculated pursuant to the following formula: P(1+T)/n/ =
ERV, where P is a hypothetical initial payment of $1,000, T is the average
annual total return, n is the number of years, and ERV is the withdrawal value
at the end of the period.
Cumulative total returns are unaveraged and reflect the simple percentage change
in the value of a hypothetical investment in the Option over a stated period of
time. In addition to the period since inception, cumulative total returns may be
calculated on a year-to-date basis at the end of each calendar month in the
current calendar year. The last day of the period for year-to-date returns is
the last day of the most recent calendar month at the time of publication.
3
<PAGE>
Yields
Some Options may advertise yields. Yields quoted in advertising reflect the
change in value of a hypothetical investment in the Option over a stated period
of time, not taking into account capital gains or losses or the imposition of
any contingent withdrawal charge. Yields are annualized and stated as a
percentage.
Current yield and effective yield are calculated for the Money Market Option.
Current Yield is based on the change in the value of a hypothetical investment
(exclusive of capital changes) over a particular 7-day period, less a
hypothetical charge reflecting deductions from contract values during the period
(the base period), and stated as a percentage of the investment at the start of
the base period (the base period return). The base period return is then
annualized by multiplying by 365/7, with the resulting yield figure carried to
at least the nearest hundredth of one percent. Effective yield assumes that all
dividends received during an annual period have been reinvested. This
compounding effect causes effective yield to be higher than current yield.
Calculation of effective yield begins with the same base period return used in
the calculation of current yield, which is then annualized to reflect weekly
compounding pursuant to the following formula:
Effective Yield = {(Base Period Return) + 1)/365/7/} - 1
4
<PAGE>
The table below provides average annual total returns for each Option for the
One and Three Year Periods Ended December 31, 1996 and from inception through
December 31, 1996. The "contract continues" columns show returns if the contract
continues and is not terminated, and the "contract surrendered" columns show
returns if the contract is surrendered at the end of the period, in which case
contingent withdrawal charges may apply. The performance information is based on
the historical investment experience of the Options and does not indicate or
represent future experience. This table is based upon average Account Values
over $50,000 for which the annual administrative charge is $0.
Average Annual Total Returns for One and Three Year Periods Ended 12/31/96 and
Since Inception*
<TABLE>
<CAPTION>
Period Since Inception One Year Period Three Year
------------------------ ------------------------ ----------
Contract Contract
Contract Surrendered Contract Surrendered Contract
Option Continues 12/31/96 Continues 12/31/96 Continues
- ------ --------- ----------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C>
Dreman Value 16.58% 15.78% 22.78% 15.78% 19.98%
Zweig Asset Allocation 10.26% 9.24% 13.32% 6.32% 10.37%
Zweig Equity (Small Cap) 10.20% 9.24% 16.87% 9.87% 11.05%
Renaissance Balanced 8.54% 7.54% 7.94% 0.94% 7.92%
Harris Bretall Sullivan & Smith Equity Growth 10.20% 9.25% 12.42% 5.42% 14.45%
Nicholas-Applegate Balanced 10.70% 9.76% 13.84% 6.84% 9.90%
Pinnacle Fixed Income 3.54% 2.39% 0.49% -6.51% 3.27%
Morgan Stanley Asian Growth 1.87% -0.46% 4.13% -2.87% n/a
Morgan Stanley Worldwide High Income 13.55% 11.57% 22.87% 15.87% n/a
</TABLE>
*The inception date for each Option is set forth in the table below.
5
<PAGE>
The table below provides cumulative total returns for each Option from inception
through December 31, 1996, and for the One and Three Year Periods ended December
31, 1996. The "contract continues" columns show returns if the contract
continues and is not terminated, and the "contract surrendered" column shows
returns if the contract is surrendered at the end of the period, in which case
contingent withdrawal charges apply. The performance information is based on the
historical investment experience of the Options and does not indicate or
represent future experience.
Cumulative Total Returns for Period Since Inception to 12/31/96, and for the One
and Three Year Periods ended 12/31/96
<TABLE>
<CAPTION>
Period Since Inception One Year Three Year
------------------------ --------- ----------
Contract
Contract Surrendered Contract Contract Inception
Option Continues 12/31/96 Continues Continues Date*
- ------ --------- ----------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Dreman Value 83.89% 78.89% 22.78% 72.72% 01/12/93
Zweig Asset Allocation 44.52% 39.52% 13.32% 34.45% 03/26/93
Zweig Equity (Small Cap) 46.94% 41.94% 16.87% 36.96% 01/14/93
Renaissance Balanced 38.44% 33.44% 7.94% 25.69% 01/12/93
Harris Bretall Sullivan & Smith Equity Growth 47.05% 42.05% 12.42% 49.91% 01/12/93
Nicholas-Applegate Balanced 49.73% 44.73% 13.84% 32.72% 01/12/93
Pinnacle Fixed Income 14.83% 9.83% 0.49% 10.13% 01/12/93
Morgan Stanley Asian Growth 4.84% -1.16% 4.13% n/a 06/16/94
Morgan Stanley Worldwide High Income 37.94% 31.94% 22.87% n/a 06/21/94
</TABLE>
*Inception Dates reflect date of first trade.
6
<PAGE>
Performance Comparisons
Performance information for an Option may be compared, in reports and
advertising, to: (1) Standard & Poor's Stock Index (S&P 500), Dow Jones
Industrial Averages, (DJIA), Donoghue Money Market Institutional Averages, or
other unmanaged indices generally regarded as representative of the securities
markets; (2) other variable annuity separate accounts or other investment
products tracked by Lipper Analytical Services, Inc. or the Variable Annuity
Research and Data Service, which are widely used independent research firms that
rank mutual funds and other investment companies by overall performance,
investment objectives, and assets; and (3) the Consumer Price Index (measure of
inflation) to assess the real rate of return from an investment in a contract.
Unmanaged indices may assume the reinvestment of dividends but generally do not
reflect deductions for annuity charges, investment management costs, brokerage
costs and other transaction costs that are normally paid when directly investing
in securities.
Each Option may from time to time also include the ranking of its performance
figures relative to such figures for groups of mutual funds categorized by
Lipper Analytical Services (Lipper) as having the same or similar investment
objectives or by similar services that monitor the performance of mutual funds.
Each Option may also from time to time compare its performance to average mutual
fund performance figures compiled by Lipper in Lipper Performance Analysis.
Advertisements or information furnished to present shareholders or prospective
investors may also include evaluations of an Option published by nationally
recognized ranking services and by financial publications that are nationally
recognized such as Barron's, Business Week, CDA Technologies, Inc., Changing
Times, Consumer's Digest, Dow Jones Industrial Average, Financial Planning,
Financial Times, Financial World, Forbes, Fortune, Global Investor, Hulbert's
Financial Digest, Institutional Investor, Investors Daily, Money, Morningstar
Mutual Funds, The New York Times, Personal Investor, Stanger's Investment
Adviser, Value Line, The Wall Street Journal, Wiesenberger Investment Company
Service and USA Today.
The performance figures described above may also be used to compare the
performance of an Option's shares against certain widely recognized standards or
indices for stock and bond market performance. The following are the indices
against which the Options may compare performance:
The S&P 500 is a market value-weighted and unmanaged index showing the changes
in the aggregate market value of 500 stocks relative to the base period 1941-43.
The S&P 500 Index is composed almost entirely of common stocks of companies
listed on the NYSE, although the common stocks of a few companies listed on the
American Stock Exchange or traded OTC are included. The 500 companies
represented include 400 industrial, 60 transportation and 50 financial services
concerns. The S&P 500 Index represents about 80% of the market value of all
issues traded on the NYSE.
The DJIA (or its component averages) is an unmanaged index composed of 30 blue-
chip industrial corporation stocks, 15 utilities company stocks and 20
transportation stocks. Comparisons of performance assume reinvestment of
dividends.
The New York Stock Exchange composite or component indices are unmanaged indices
of all industrial, utilities, transportation and finance company stocks listed
on the New York Stock Exchange.
The Wilshire 5000 Equity Index (or its component indices) represents the return
of the market value of all common equity securities for which daily pricing is
available. Comparisons of performance assume reinvestment of dividends.
The Morgan Stanley Capital International EAFE Index is an arithmetic, market
value-weighted average of the performance of over 900 securities on the stock
exchanges of countries in Europe, Australia and the Far East.
7
<PAGE>
The Morgan Stanley Capital International World Index - An arithmetic, market
value-weighted average of the performance of over 1,470 securities listed on the
stock exchanges of countries in Europe, Australia, the Far East, Canada and the
United States.
The Goldman Sachs 100 Convertible Bond Index currently includes 67 bonds and 33
preferred stocks. The original list of names was generated by screening for
convertible issues of $100 million or greater in market capitalization. The
index is priced monthly.
The Lehman Brothers Government Bond Index (the Lehman Government Index) is a
measure of the market value of all public obligations of the U.S. Treasury; all
publicly issued debt of all agencies of the U.S. Government and all quasi-
federal corporations; and all corporate debt guaranteed by the U.S. Government.
Mortgage-backed securities, flower bonds and foreign targeted issues are not
included in the Lehman Government Index.
The Lehman Brothers Government/Corporate Bond Index (the Lehman Government/
Corporate Index) is a measure of the market value of approximately 5,300 bonds
with a face value currently in excess of $1 million, which have at least one
year to maturity and are rated "Baa" or higher (investment grade) by a
nationally recognized statistical rating agency.
The Lehman Brothers Government/Corporate Intermediate Bond Index (the Lehman
Government/Corporate Intermediate Index) is composed of all bonds covered by the
Lehman Brothers Government/Corporate Bond Index with maturities between one and
9.99 years. Total return comprises price appreciation/depreciation and income as
a percentage of the original investment. Indexes are rebalanced monthly by
market capitalization.
The Lehman Brothers Intermediate Treasury Bond Index includes bonds with
maturities between one and ten years with a face value currently in excess of $1
million, that are rated investment grade or higher by a nationally recognized
statistical rating agency.
The Shearson Lehman Long-Term Treasury Bond Index is composed of all bonds
covered by the Shearson Lehman Hutton Treasury Bond Index with maturities of 10
years or greater.
The National Association of Securities Dealers Automated Quotation System
(NASDAQ) Composite Index covers 4,500 stocks traded over the counter. It
represents many small company stocks but is heavily influenced by about 100 of
the largest NASDAQ stocks. It is a value-weighted index calculated on price
change only and does not include income.
The NASDAQ Industrial Index is composed of more than 3,000 industrial issues. It
is a value-weighted index calculated on price change only and does not include
income.
The Value Line (Geometric) Index is an unweighted index of the approximately
1,700 stocks followed by the Value Line Investment Survey.
The Salomon Brothers GNMA Index includes pools of mortgages originated by
private lenders and guaranteed by the mortgage pools of the Government National
Mortgage Association.
The Salomon Brothers' World Market Index is a measure of the return of an
equally weighted basket of short-term (three month U.S. Government securities
and bank deposits) investments in eight major currencies: the U.S. dollars, UK
pounds sterling, Canadian dollars, Japanese yen, Swiss francs, French francs,
German Deutsche mark and Netherlands guilder.
The Salomon Brothers Broad Investment-Grade Bond Index contains approximately
3,800 Treasury and agency, corporate and mortgage bonds with a rating of BBB or
higher, a stated maturity of at least one
8
<PAGE>
year, and a par value outstanding of $25 million or more. The index is weighted
according to the market value of all bond issues included in the index.
The Salomon Brothers High Grade Corporate Bond Index consists of publicly
issued, non-convertible corporate bonds rated AA or AAA. It is a value-weighted,
total return index, including approximately 800 issues with maturities of 12
years or greater.
The Salomon Brothers World Bond Index measures the total return performance of
high-quality securities in major sectors of the international bond market. The
index covers approximately 600 bonds from 10 currencies: Australian dollars,
Canadian dollars, European Currency Units, French francs, Japanese yen,
Netherlands guilder, Swiss francs, UK pounds sterling, U.S. dollars, and German
deutsche marks.
The J.P. Morgan Global Government Bond Index is a total return, market
capitalization weighted index, rebalanced monthly consisting of the following
countries: Australia, Belgium, Canada, Denmark, France, Germany, Italy, Japan,
Netherlands, Spain, Sweden, United Kingdom and United States.
The 50/50 Index assumes a static mix of 50% of the S&P 500 Index and 50% of the
Lehman Government Corporate Index.
Other Composite Indices: 70% S&P 500 Index and 30% NASDAQ Industrial Index; 35%
S&P 500 Index and 65% Salomon Brothers High Grade Bond Index; and 65% S&P Index
and 35% Salomon Brothers High Grade Bond Index.
The SEI Median Balanced Fund Universe measures a group of funds with an average
annual equity commitment and an average annual bond - plus - private - placement
commitment greater than 5% each year. SEI must have at least two years of data
for a fund to be considered for the population.
The Russell 2000/Small Stock Index comprises the smallest 2000 stocks in the
Russell 3000 Index, and represents approximately 11% of the total U.S. equity
market capitalization. The Russell 3000 Index comprises the 3,000 largest U.S.
companies by market capitalization. The smallest company has a market value of
roughly $20 million.
The Russell 2500 Index is comprised of the bottom 500 stocks in the Russell 1000
Index which represents the universe of stocks from which most active money
managers typically select; and all the stocks in the Russell 2000 Index. The
largest security in the index has a market capitalization of approximately 1.3
billion.
The Consumer Price Index (or Cost of Living Index), published by the United
States Bureau of Labor Statistics is a statistical measure of change, over time,
in the price of goods and services in major expenditure groups.
Stocks, Bonds, Bills and Inflation, published by Hobson Associates, presents an
historical measure of yield, price and total return for common and small company
stocks, long-term government bonds, Treasury bills and inflation.
Savings and Loan Historical Interest Rates as published in the United States
Savings & Loan League Fact Book.
Historical data supplied by the research departments of First Boston
Corporation, the J.P. Morgan companies, Salomon Brothers, Merrill Lynch, Pierce,
Fenner & Smith, Shearson Lehman Hutton and Bloomberg L.P.
9
<PAGE>
The MSCI Combined Far East Free ex Japan Index is a market-capitalization
weighted index comprising stocks in Hong Kong, Indonesia, Korea, Malaysia,
Philippines, Singapore and Thailand. Korea is included in the MSCI Combined Far
East Free ex Japan Index at 20% of its market capitalization.
The First Boston High Yield Index generally includes over 180 issues with an
average maturity range of seven to ten years with a minimum capitalization of
$100 million. All issues are individually trader-priced monthly.
In reports or other communications to shareholders, the Fund may also describe
general economic and market conditions affecting the Options and may compare the
performance of the Options with (1) that of mutual funds included in the
rankings prepared by Lipper or similar investment services that monitor the
performance of insurance company separate accounts or mutual funds, (2)
IBC/Donoghue's Money Fund Report, (3) other appropriate indices of investment
securities and averages for peer universe of funds which are described in this
Statement of Additional Information, or (4) data developed by National Integrity
or any of the Sub-Advisers derived from such indices or averages.
Individualized Computer Generated Illustrations
National Integrity may from time to time use computer-based software available
through Morningstar, CDA/Wiesenberger and/or other firms to provide registered
representatives and existing and/or potential owners of the contracts with
individualized hypothetical performance illustrations for some or all of the
Variable Account Options. Such illustrations may include, without limitation,
graphs, bar charts and other types of formats presenting the following
information: (i) the historical results of a hypothetical investment in a single
Option; (ii) the historical fluctuation of the value of a single Option (actual
and hypothetical); (iii) the historical results of a hypothetical investment in
more than one Option; (iv) the historical performance of two or more market
indices in relation to one another and/or one or more Options; (v) the
historical performance of two or more market indices in comparison to a single
Option or a group of Options; (vi) a market risk/reward scatter chart showing
the historical risk/reward relationship of one or more mutual funds or Options
to one or more indices and a broad category of similar anonymous variable
annuity subaccounts; and (vii) Option data sheets showing various information
about one or more Options (such as information concerning total return for
various periods, fees and expenses, standard deviation, alpha and beta,
investment objective, inception date and net assets). We reserve the right to
republish figures independently provided by Morningstar or any similar agency or
service.
10
<PAGE>
PART 4 - DETERMINATION OF ANNUITY UNIT VALUES
The annuity unit value was initially fixed at $1.00 for contracts with assumed
base rates of net investment return of 5% and 3.5% a year, respectively. For
each valuation period thereafter, it is the annuity value for the preceding
valuation period multiplied by the adjusted net investment factor under the
contracts. For each valuation period, the adjusted net investment factor is
equal to the net investment factor reduced for each day in the valuation period
by:
* .00013366 for a contract with an assumed base rate of net investment return
of 5% a year; or
* .00009425 for a contract with an assumed base rate of net investment return
of 3.5% a year.
Because of this adjustment, the annuity unit value rises and falls depending on
whether the actual rate of net investment return (after charges) is higher or
lower than the assumed base rate.
All certificates have a 5% assumed base rate, except in states where that rate
is not permitted. Annuity payments under contracts with an assumed base rate of
3.5% will at first be smaller than those under contracts with a 5% assumed base
rate. Payments under the 3.5% contracts, however, will rise more rapidly when
unit values are rising, and payments will fall more slowly when unit values are
falling, than those under 5% contracts.
The amounts of variable annuity payments are determined as follows:
Payments normally start on the Annuitant's retirement date. The first three
monthly payments are the same. Each of the first three monthly payments will be
based on the amount taken from the tables in the contract or on our current
rates, whichever is more favorable to the participant. Where the Company's
current annuity rates are used, contributions in the current and five prior
participation years will qualify for the Company's current individual annuity
rates applicable to funds derived from sources outside the Company. The balance
of the proceeds will qualify for the Company's current individual annuity rates
for payment of proceeds.
The first three monthly payments depend on the assumed base rate of net
investment return and the forms of annuity chosen (and any fixed period). If the
annuity involves a life contingency, the risk class and the age of the
annuitants will affect payments.
Payments after the first three months will vary according to the investment
performance of the Variable Account Option or Options selected. After that, each
payment will be calculated by multiplying the number of annuity units credited
by the average annuity unit value for the second calendar month before the due
date of the payment. The number of annuity units credited equals the initial
periodic payment divided by the annuity unit value for the valuation period that
includes the due date of the first annuity payment. The average annuity unit
value is the average of the annuity unit values for the valuation periods ending
in that month. Each business day together with any non-business day or
consecutive non-business day immediately preceding such business day will
constitute a valuation period.
Illustration of Changes in Annuity Unit Values. To show how we determine
variable annuity payments from month to month, assume that the contract value on
a retirement date is enough to fund an annuity with a monthly payment of $363
and that the annuity unit value for the valuation period that includes the due
date of the first annuity payment is $1.05. The number of annuity units credited
under your contract would be 345.71 (363 divided by 1.05 = 345.71).
If the fourth monthly payment is due in March, and the average annuity unit
value for January was $1.10, the annuity payment for March would be the number
of units (345.71) times the average annuity unit value
11
<PAGE>
($1.10), or $380.28. If the average annuity unit value was $1.00 in February,
the annuity payment for April would be 345.71 times $1.00, or $345.71.
For period certain life annuities and life income annuities, the participant may
not surrender or redeem once annuity payments commence. For period certain life
annuities only, if the payee (or the payee and the other annuitant under a joint
and survivor annuity) dies before the period selected ends, the remaining
payments will go to another named payee who may have the right to redeem the
annuity and secure the present value of future guaranteed payments in a lump
sum. The present value of future guaranteed payments for a period certain is
based on the number of payments left, the assumed base rate of net return, the
number of annuity units and the annuity unit value for the date the Company
receives a written request for lump sum payment of remaining values. Assets held
in the Account at least equal to all statutory reserves required for such
Separate Account.
PART 5 - FINANCIAL STATEMENTS
Ernst & Young LLP, Suite 2100, 400 West Market Street, Louisville, Kentucky
40202, is our independent auditor and serves as independent auditor of the
Separate Account. Ernst & Young LLP on an annual basis will audit certain
financial statements prepared by management and express an opinion on such
financial statements based on their audits.
The financial statements of the Separate Account as of December 31, 1996, and
for the periods indicated in the financial statements and the statutory-basis
financial statements of National Integrity as of and for the years ended
December 31, 1996 and 1995 included in this SAI have been audited by Ernst &
Young LLP, independent auditors, as set forth in their reports included herein.
The financial statements of National Integrity should be distinguished from the
financial statements of the Separate Account and should be considered only as
they relate to the ability of National Integrity to meet its obligations under
the contract. They should not be considered as relating to the investment
performance of the assets held in the Separate Account.
12
<PAGE>
Financial Statements
Separate Account II
of
National Integrity Life Insurance Company
December 31, 1996
With Report of Independent Auditors
<PAGE>
Separate Account II
of
National Integrity Life Insurance Company
Financial Statements
December 31, 1996
Contents
<TABLE>
<CAPTION>
<S> <C>
Report of Independent Auditors............................................. 1
Audited Financial Statements
Statement of Assets and Liabilities........................................ 2
Statement of Operations.................................................... 4
Statements of Changes in Net Assets........................................ 6
Notes to Financial Statements.............................................. 10
</TABLE>
<PAGE>
Report of Independent Auditors
Contract Holders
Separate Account II of National Integrity Life Insurance Company
We have audited the accompanying statement of assets and liabilities of Separate
Account II of National Integrity Life Insurance Company (comprising,
respectively, the Renaissance Balanced, Zweig Asset Allocation, Nicholas-
Applegate Balanced, Harris Bretall Sullivan & Smith Equity Growth, Dreman Value,
Zweig Equity (Small Cap), Pinnacle Fixed Income, ARM Capital Advisors Money
Market, Morgan Stanley Asian Growth, and Morgan Stanley Worldwide High Income
Divisions) as of December 31, 1996, the related statement of operations for the
year then ended and statements of changes in net assets for the years ended
December 31, 1996 and 1995. These financial statements 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. Our procedures included
confirmation of mutual fund shares owned in The Legends Fund, Inc. as of
December 31, 1996, by correspondence with the transfer agent of The Legends
Fund, Inc. 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
divisions constituting Separate Account II of National Integrity Life Insurance
Company at December 31, 1996, the results of their operations for the year
ended, and changes in their net assets for the years ended December 31, 1996 and
1995, in conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
Louisville, Kentucky
April 18, 1997
1
<PAGE>
Separate Account II of National Integrity Life Insurance Company
Statement of Assets and Liabilities
December 31, 1996
<TABLE>
<CAPTION>
Harris Bretall
Nicholas- Sullivan &
Renaissance Zweig Asset Applegate Smith Equity Dreman
Balanced Allocation Balanced Growth Value
Division Division Division Division Division
---------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Assets
Investments in The Legends Fund, Inc. at value
(cost of $44,079,835 in the aggregate) $8,185,762 $5,629,286 $11,656,045 $6,448,527 $5,471,962
Receivable from (payable to) the general
account of National Integrity 58 (765) 7,112 1,293 1,362
---------------------------------------------------------------------
Net assets $8,185,820 $5,628,521 $11,663,157 $6,449,820 $5,473,324
=====================================================================
Unit value $ 13.84 $ 14.45 $ 14.97 $ 14.71 $ 18.39
=====================================================================
Units outstanding 591,461 389,517 779,102 438,465 297,625
=====================================================================
</TABLE>
See accompanying notes.
2
<PAGE>
Separate Account II of National Integrity Life Insurance Company
Statement of Assets and Liabilities (continued)
December 31, 1996
<TABLE>
<CAPTION>
ARM Capital Morgan
Advisors Morgan Stanley
Zweig Equity Pinnacle Money Stanley Asian Worldwide
(Small Cap) Fixed Income Market Growth High Income
Division Division Division Division Division Total
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Assets
Investments in The Legends Fund, Inc. at value
(cost of $44,079,835 in the aggregate) $2,040,433 $1,518,177 $1,346,745 $3,478,950 $960,262 $46,736,149
Receivable from (payable to) the general
account of National Integrity (521) 432 (398) (1,613) (299) 6,661
------------------------------------------------------------------------------------
Net assets $2,039,912 $1,518,609 $1,346,347 $3,477,337 $959,963 $46,742,810
====================================================================================
Unit value $ 14.69 $ 11.48 $ 10.86 $ 10.48 $ 13.79
====================================================================
Units outstanding 138,864 132,283 123,973 331,807 69,613
====================================================================
</TABLE>
See accompanying notes.
3
<PAGE>
Separate Account II of National Integrity Life Insurance Company
Statement of Operations
Year Ended December 31, 1996
<TABLE>
<CAPTION>
Harris Bretall
Nicholas- Sullivan &
Renaissance Zweig Asset Applegate Smith Equity Dreman
Balanced Allocation Balanced Growth Value
Division Division Division Division Division
-------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Investment income
Reinvested dividends from The Legends Fund, Inc. $1,052,573 $ 685,370 $1,236,186 $ 469,289 $ 255,315
Expenses
Mortality and expense risk and
administrative charges 118,066 74,176 143,402 71,949 65,136
-------------------------------------------------------------------------
Net investment income (loss) 934,507 611,194 1,092,784 397,340 190,179
Realized and unrealized gain (loss)
on investments
Net realized gain on sales
of investments 393,940 196,615 517,897 472,123 814,248
Net unrealized appreciation (depreciation)
of investments:
Beginning of period 994,499 652,133 1,159,728 448,600 733,905
End of period 331,511 528,354 745,131 82,343 778,795
-------------------------------------------------------------------------
Change in net unrealized appreciation/
depreciation during the period (662,988) (123,779) (414,597) (366,257) 44,890
-------------------------------------------------------------------------
Net realized and unrealized gain (loss) on
investments (269,048) 72,836 103,300 105,866 859,138
-------------------------------------------------------------------------
Net increase in net assets resulting from
operations $ 665,459 $ 684,030 $1,196,084 $ 503,206 $1,049,317
=========================================================================
</TABLE>
See accompanying notes.
4
<PAGE>
Separate Account II of National Integrity Life Insurance Company
Statement of Operations (continued)
Year Ended December 31, 1996
<TABLE>
<CAPTION>
ARM Capital Morgan Morgan
Zweig Pinnacle Advisors Stanley Stanley
Equity Fixed Money Asian Worldwide
(Small Cap) Income Market Growth High Income
Division Division Division Division Division Total
--------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Investment income
Reinvested dividends from The Legends Fund, Inc. $ 188,121 $ 52,944 $136,031 $ - $ 91,052 $4,166,881
Expenses
Mortality and expense risk and administrative
charges 38,691 21,734 42,309 45,007 8,518 628,988
-------------------------------------------------------------------------
Net investment income (loss) 149,430 31,210 93,722 (45,007) 82,534 3,537,893
Realized and unrealized gain (loss) on investments
Net realized gain on sales of investments 497,943 6,428 - 26,325 49,594 2,975,113
Net unrealized appreciation (depreciation) of
investments:
Beginning of period 303,671 75,660 - 50,234 14,275 4,432,705
End of period 4,239 45,807 - 116,343 23,791 2,656,314
-------------------------------------------------------------------------
Change in net unrealized appreciation/
depreciation during the period (299,432) (29,853) - 66,109 9,516 (1,776,391)
-------------------------------------------------------------------------
Net realized and unrealized gain (loss) on investments 198,511 (23,425) - 92,434 59,110 1,198,722
-------------------------------------------------------------------------
Net increase in net assets resulting from operations $ 347,941 $ 7,785 $ 93,722 $ 47,427 $141,644 $4,736,615
=========================================================================
</TABLE>
See accompanying notes.
5
<PAGE>
Separate Account II of National Integrity Life Insurance Company
Statement of Changes in Net Assets
Year Ended December 31, 1996
<TABLE>
<CAPTION>
Zweig Nicholas- Harris Bretall
Renaissance Asset Applegate Sullivan & Smith Dreman
Balanced Allocation Balanced Equity Growth Value
Division Division Division Division Division
----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Increase (decrease) in net assets from operations
Net investment income (loss) $ 934,507 $ 611,194 $ 1,092,784 $ 397,340 $ 190,179
Net realized gain on sales of investments 393,940 196,615 517,897 472,123 814,248
Change in net unrealized appreciation/
depreciation during the period (662,988) (123,779) (414,597) (366,257) 44,890
----------------------------------------------------------------------
Net increase in net assets resulting from operations 665,459 684,030 1,196,084 503,206 1,049,317
Increase (decrease) in net assets from contract
related transactions
Contributions from contract holders 163,477 442,528 425,966 363,225 654,221
Contract terminations and benefits (505,425) (626,730) (899,360) (419,837) (512,310)
Net transfers among investment options (937,403) (244,654) 457,484 1,101,836 618,917
----------------------------------------------------------------------
Net increase (decrease) in net assets derived
from contract related transactions (1,279,351) (428,856) (15,910) 1,045,224 760,828
----------------------------------------------------------------------
Increase (decrease) in net assets (613,892) 255,174 1,180,174 1,548,430 1,810,145
Net assets, beginning of year 8,799,712 5,373,347 10,482,983 4,901,390 3,663,179
----------------------------------------------------------------------
Net assets, end of year $ 8,185,820 $5,628,521 $11,663,157 $6,449,820 $5,473,324
======================================================================
Unit transactions
Contributions 12,452 33,546 24,432 26,839 42,120
Terminations and benefits (37,773) (47,095) (67,575) (29,734) (30,046)
Net transfers (69,088) (18,373) 25,060 66,636 41,013
----------------------------------------------------------------------
Increase (decrease) in units (94,409) (31,922) (18,083) 63,741 53,087
======================================================================
</TABLE>
See accompanying notes.
6
<PAGE>
<TABLE>
<CAPTION>
Separate Account II of National Integrity Life Insurance Company
Statement of Changes in Net Assets (continued)
Year Ended December 31, 1996
ARM Capital Morgan
Advisors Morgan Stanley
Zweig Equity Pinnacle Money Stanley Asian Worldwide
(Small Cap) Fixed Income Market Growth High Income
Division Division(1) Division(2) Division Division Total
----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Increase (decrease) in net assets from operations
Net investment income (loss) $ 149,430 $ 31,210 $ 93,722 $ (45,007) $ 82,534 $ 3,537,893
Net realized gain on sales of investments 497,943 6,428 0 26,325 49,594 2,975,113
Change in net unrealized appreciation/
depreciation during the period (299,432) (29,853) 0 66,109 9,516 (1,776,391)
----------------------------------------------------------------------------
Net increase in net assets resulting from operations 347,941 7,785 93,722 47,427 141,644 4,736,615
Increase (decrease) in net assets from contract
related transactions
Contributions from contract holders 203,396 38,182 556,466 594,972 144,499 3,586,932
Contract terminations and benefits (646,821) (149,059) (2,026,755) (250,466) (37,245) (6,074,008)
Net transfers among investment options (813,891) (21,922) (821,309) 663,821 373,794 376,673
----------------------------------------------------------------------------
Net increase (decrease) in net assets derived
from contract related transactions (1,257,316) (132,799) (2,291,598) 1,008,327 481,048 (2,110,403)
----------------------------------------------------------------------------
Increase (decrease) in net assets (909,375) (125,014) (2,197,876) 1,055,754 622,692 2,626,212
Net assets, beginning of year 2,949,287 1,643,623 3,544,223 2,421,583 337,271 44,116,598
----------------------------------------------------------------------------
Net assets, end of year $ 2,039,912 $1,518,609 $1,346,347 $3,477,337 $959,963 $46,742,810
============================================================================
Unit transactions
Contributions 15,294 3,365 54,004 56,746 11,893
Terminations and benefits (48,315) (13,007) (191,155) (24,032) (2,957)
Net transfers (62,744) (1,874) (75,140) 58,618 30,644
----------------------------------------------------------------
Increase (decrease) in units (95,765) (11,516) (212,291) 91,332 39,580
================================================================
</TABLE>
(1) Effective April 1, 1996, J.P. Morgan Investment Management, Inc. replaced
Mitchell Hutchins Institutional Investors, Inc. as sub-adviser to the
portfolio.
(2) Effective April 1, 1996, ARM Capital Advisors, Inc. became the sole
investment manager of the portfolio.
See accompanying notes.
7
<PAGE>
Separate Account II of National Integrity Life Insurance Company
Statement of Changes in Net Assets
Year Ended December 31, 1995
<TABLE>
<CAPTION>
Harris Bretall
Nicholas- Sullivan &
Renaissance Zweig Asset Applegate Smith Equity Dreman
Balanced Allocation Balanced Growth Value
Division Division Division Division Division
--------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Increase (decrease) in net assets from operations
Net investment income (loss) $ 169,765 $ 57,031 $ 62,571 $ (12,353) $ 39,143
Net realized gain (loss) on sales of investments 77,487 149,185 171,724 407,573 72,280
Change in net unrealized appreciation/
depreciation during the period 1,270,669 718,111 1,298,568 372,365 801,253
--------------------------------------------------------------------------
Net increase in net assets resulting from operations 1,517,921 924,327 1,532,863 767,585 912,676
Increase (decrease) in net assets from contract
related transactions
Contributions from contract holders 541,100 357,200 1,759,155 1,253,010 244,000
Contract terminations and benefits (355,156) (296,653) (716,973) (156,906) (79,358)
Net transfers among investment options 1,326,424 (1,317,416) (464,721) 217,683 955,920
--------------------------------------------------------------------------
Net increase (decrease) in net assets derived
from contract related transactions 1,512,368 (1,256,869) 577,461 1,313,787 1,120,562
--------------------------------------------------------------------------
Increase (decrease) in net assets 3,030,289 (332,542) 2,110,324 2,081,372 2,033,238
Net assets, beginning of year 5,769,423 5,705,889 8,372,659 2,820,018 1,629,941
--------------------------------------------------------------------------
Net assets, end of year $8,799,712 $ 5,373,347 $10,482,983 $4,901,390 $3,663,179
==========================================================================
Unit transactions
Contributions 47,396 29,147 142,006 91,868 18,733
Terminations and benefits (36,045) (29,548) (62,316) (13,992) (5,987)
Net transfers 124,662 (113,936) (36,339) 16,757 75,467
--------------------------------------------------------------------------
Increase (decrease) in units 136,013 (114,337) 43,351 94,633 88,213
==========================================================================
</TABLE>
See accompanying notes.
8
<PAGE>
Separate Account II of National Integrity Life Insurance Company
Statement of Changes in Net Assets (continued)
Year Ended December 31, 1995
<TABLE>
<CAPTION>
Mitchell Morgan
Mitchell Hutchins Morgan Stanley
Zweig Equity Hutchins Money Stanley Asian Worldwide
(Small Cap) Fixed Income Market Growth High Income
Division Division Division Division Division Total
-------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Increase (decrease) in net assets from operations
Net investment income (loss) $ 1,079 $ 62,381 $ 94,402 $ (20,698) $ 30,767 $ 484,088
Net realized gain (loss) on sales of investments 21,120 (2,906) - (11,326) 2,303 887,440
Change in net unrealized appreciation/
depreciation during the period 343,729 152,741 - 233,475 32,322 5,223,233
-------------------------------------------------------------------------
Net increase in net assets resulting from operations 365,928 212,216 94,402 201,451 65,392 6,594,761
Increase (decrease) in net assets from contract
related transactions
Contributions from contract holders 399,642 31,253 332,573 403,323 33,502 5,354,758
Contract terminations and benefits (41,254) (68,196) (1,869,693) (137,527) (9,957) (3,731,673)
Net transfers among investment options 321,733 62,848 3,046,901 (268,943) (95,363) 3,785,066
-------------------------------------------------------------------------
Net increase (decrease) in net assets derived
from contract related transactions 680,121 25,905 1,509,781 (3,147) (71,818) 5,408,151
-------------------------------------------------------------------------
Increase (decrease) in net assets 1,046,049 238,121 1,604,183 198,304 (6,426) 12,002,912
Net assets, beginning of year 1,903,238 1,405,502 1,940,040 2,223,279 343,697 32,113,686
-------------------------------------------------------------------------
Net assets, end of year $2,949,287 $1,643,623 $ 3,544,223 $2,421,583 $337,271 $44,116,598
=========================================================================
Unit transactions
Contributions 32,827 2,757 34,024 41,227 3,593
Terminations and benefits (3,578) (6,336) (183,434) (13,519) (972)
Net transfers 24,419 5,341 295,168 (28,564) (9,015)
------------------------------------------------------------
Increase (decrease) in units 53,668 1,762 145,758 (856) (6,394)
============================================================
</TABLE>
See accompanying notes.
9
<PAGE>
Separate Account II
of
National Integrity Life Insurance Company
Notes to Financial Statements
December 31, 1996
1. Organization and Significant Accounting Policies
Organization and Nature of Operations
National Integrity Life Insurance Company ("National Integrity") established
Separate Account II (the "Separate Account") on May 21, 1992 under the insurance
laws of the state of New York for the purpose of issuing flexible premium
variable annuity contracts ("contracts"). The Separate Account is a unit
investment trust registered with the Securities and Exchange Commission ("SEC")
under the Investment Company Act of 1940, as amended. The operations of the
Separate Account are part of National Integrity.
National Integrity is a wholly owned subsidiary of Integrity Life Insurance
Company ("Integrity") and their ultimate parent is ARM Financial Group, Inc.
("ARM"). ARM specializes in the asset accumulation business, providing retail
and institutional customers with products and services designed to serve the
growing long-term savings and retirement markets.
Contract holders may allocate or transfer their account values to one or more
investment divisions of the Separate Account or to one or more fixed guaranteed
rate options of National Integrity's Separate Account GRO. The Separate Account
divisions invest in shares of corresponding investment portfolios of The Legends
Fund, Inc. ("Legends Fund"), a "series" type mutual fund. Integrity served as
investment adviser to the Legends Fund. Integrity had entered into a sub-
advisory agreement with a professional manager for investment of the assets of
each of the portfolios. Effective February 1, 1996 ARM Capital Advisors, Inc.
("ARM Capital Advisors"), a wholly owned subsidiary of ARM, assumed Integrity's
role as investment adviser to the Legends Fund. ARM Capital Advisors is
registered with the SEC under the Investment Advisers Act of 1940. The contract
holder's account value in a Separate Account division will vary depending on the
performance of the corresponding portfolio. The Separate Account currently has
ten investment divisions available. The investment objective of each division
and its corresponding portfolio are the same. Set forth below is a summary of
the investment objectives of the portfolios of the Legends Fund.
10
<PAGE>
Separate Account II
of
National Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. Organization and Significant Accounting Policies (continued)
Renaissance Balanced Portfolio seeks capital appreciation and income in rising
markets and the preservation of capital in declining markets. Its assets are
allocated among common stocks of issuers with large capitalizations, United
States government and high-quality corporate debt securities, and high quality
cash equivalent issues, such as commercial paper. Equity investments will
generally range from 10% to 75% of the total assets in the portfolio, and under
normal market conditions at least 25% of total assets will be invested in senior
fixed income securities. Renaissance Investment Management is the sub-adviser to
the portfolio.
Zweig Asset Allocation Portfolio seeks long-term capital appreciation. It
invests primarily in blue chip stocks, consistent with preservation of capital
and the reduction of portfolio exposure to market risk, as determined by the
sub-adviser to the portfolio. Blue chip stocks are stocks which the sub-adviser
considers comparable to the stocks included in the S&P 500 at the time of
purchase, and that have a minimum of $400 million market capitalization, average
daily trading volume of 50,000 shares or $425 million in total assets, and which
are traded on the New York Stock Exchange ("NYSE"), American Stock Exchange
("AMEX"), over-the-counter ("OTC") or on foreign exchanges. Zweig/Glaser
Advisers is the sub-adviser to the portfolio.
Nicholas-Applegate Balanced Portfolio seeks maximum total return in both the
equity and fixed income portion of its investments. Under normal market
conditions, the portfolio will have 60% to 65% of its total assets invested in
equity securities, including common stocks and securities convertible into or
exchangeable for common stocks (such as convertible preferred stocks and
convertible debentures). The remaining 35% to 40% of total assets will be
invested in U.S. government securities or cash equivalent issues. Nicholas-
Applegate Capital Management is the sub-adviser to the portfolio.
Harris Bretall Sullivan & Smith Equity Growth Portfolio seeks long-term capital
appreciation. It primarily invests in stocks of established companies with
proven records of superior and consistent growth. The portfolio may invest all
or a portion of its assets in cash and cash equivalents if the sub-adviser
considers the equity markets to be overvalued. The portfolio may invest in U.S.
government securities when this
11
<PAGE>
Separate Account II
of
National Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. Organization and Significant Accounting Policies (continued)
appears desirable in light of the portfolio's investment objective or when
market conditions warrant. Harris Bretall Sullivan & Smith, Inc. is the sub-
adviser to the portfolio.
Dreman Value Portfolio seeks primarily long-term capital appreciation with a
secondary objective of current income. It invests principally in a diversified
portfolio of securities believed by the sub-adviser to be undervalued. The sub-
adviser's philosophy centers on identifying stocks of large, well-known
companies with solid financial strength and generous dividend yields that have
low price-earnings ratios and have been generally overlooked by the market.
Dreman Value Advisors, Inc. is the sub-adviser to the portfolio.
Zweig Equity (Small Cap) Portfolio seeks long-term capital appreciation. It
invests primarily in small company stocks, consistent with preservation of
capital and reduction of portfolio exposure to market risk, as determined by the
sub-adviser. Current income is not an objective. Small Company Stocks are the
2,500 stock positions immediately after the 500 largest stocks ranked in terms
of market capitalization and/or trading volume, and which are traded on the
NYSE, AMEX, OTC or on foreign exchanges. Zweig/Glaser Advisers is the sub-
adviser to the portfolio.
Pinnacle Fixed Income Portfolio (formerly known as Mitchell Hutchins Fixed
Income Portfolio) seeks as high a level of current income as is consistent with
the preservation of capital. It invests in corporate bonds and mortgage-backed
securities (including mortgage-backed certificates issued by the Government
National Mortgage Association, the Federal National Mortgage Association and the
Federal Home Loan Mortgage Corporation), repurchase agreements with respect to
securities in which the portfolio may invest and instruments used in certain
hedging and related income strategies. The portfolio will principally invest in
securities rated at least investment grade or, if not rated, determined by the
sub-adviser to be of comparable quality. The portfolio may invest up to 15% of
its total assets in securities rated below investment grade or of equivalent
quality, including defaulted securities. Effective April 1, 1996, J. P. Morgan
Investment Management, Inc. became the sub-adviser to the portfolio.
12
<PAGE>
Separate Account II
of
National Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. Organization and Significant Accounting Policies (continued)
ARM Capital Advisors Money Market Portfolio (formerly known as Mitchell Hutchins
Money Market Portfolio) seeks maximum current income consistent with liquidity
and conservation of capital. It invests in high-grade money market instruments,
with remaining maturities of 13 months or less, and repurchase agreements
secured by such instruments, and maintains a dollar-weighted average portfolio
maturity of 90 days or less. As of April 1, 1996, ARM Capital Advisors, Inc.
became the sole investment manager of the portfolio.
Morgan Stanley Asian Growth Portfolio seeks long-term capital appreciation
through investment primarily in the common stocks of Asian issuers, excluding
Japan. Under normal market conditions, the portfolio will invest at least 65% of
the value of its total assets in common stocks that are traded on recognized
stock exchanges of Asian countries and in common stocks of companies organized
under the laws of an Asian country whose business is conducted principally in
Asia. The portfolio does not intend to invest in securities which are traded in
markets in Japan or in companies organized under the laws of Japan. The
portfolio's relatively large investment in countries with limited or developing
capital markets may involve greater risks than investments in more developed
markets and the prices of such investments may be volatile.
Morgan Stanley Worldwide High Income Portfolio seeks high current income
consistent with relative stability of principal and, secondarily, capital
appreciation through investing primarily in a portfolio of high-yielding fixed-
income securities of issuers located throughout the world. The portfolio seeks
to achieve its investment objective by allocating its assets among any or all of
three investment sectors: U.S. corporate lower-rated and unrated debt
securities, emerging country debt securities and global fixed-income securities
offering high yields. The portfolio's relatively large investment in countries
with limited or developing capital markets may involve greater risks than
investments in more developed markets and the prices of such investments may be
volatile.
Morgan Stanley Asset Management Inc. ("MSAM") serves as sub-adviser to the
Morgan Stanley Asian Growth portfolio and the Morgan Stanley Worldwide High
Income
13
<PAGE>
Separate Account II
of
National Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. Organization and Significant Accounting Policies (continued)
portfolio. MSAM is a wholly owned subsidiary of Morgan Stanley Group Inc.
("Morgan Stanley"). Approximately 91% of the shares outstanding voting stock of
ARM is owned by private equity funds sponsored by Morgan Stanley, therefore
these two entities are considered affiliates.
The assets of the Separate Account are owned by National Integrity. The portion
of the Separate Account's assets supporting the contracts may not be used to
satisfy liabilities arising out of any other business of National Integrity.
Basis of Presentation
The accompanying financial statements have been prepared in accordance with
generally accepted accounting principles for unit investment trusts.
Investments
Investments in shares of the Legends Fund are valued at the net asset values of
the respective portfolios, which approximates fair value. The difference between
cost and fair value is reflected as unrealized appreciation and depreciation of
investments.
Share transactions are recorded on the trade date. Realized gains and losses on
sales of Legends Fund shares are determined based on the identified cost basis.
Dividends from income and capital gain distributions are recorded on the ex-
dividend date. Dividends and distributions from the Legends Fund portfolios are
reinvested in the respective portfolios and are reflected in the unit value of
the divisions of the Separate Account.
Unit Value
Unit values for the Separate Account divisions are computed at the end of each
business day. The unit value is equal to the unit value for the preceding
business day multiplied by a net investment factor. This net investment factor
is determined based on the value of the
14
<PAGE>
Separate Account II
of
National Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. Organization and Significant Accounting Policies (continued)
underlying mutual fund portfolios of the Separate Account, reinvested dividends
and capital gains, new premium deposits or withdrawals, and the daily asset
charge for the mortality and expense risk and administrative charges. Unit
values are adjusted for all activity in the Separate Account.
Taxes
Operations of the Separate Account are included in the income tax return of
National Integrity which is taxed as a life insurance company under the Internal
Revenue Code. The Separate Account will not be taxed as a regulated investment
company under Subchapter M of the Internal Revenue Code. Under existing federal
income tax, no taxes are payable on the investment income or on the capital
gains of the Separate Account.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
15
<PAGE>
Separate Account II
of
National Integrity Life Insurance Company
Notes to Financial Statements (continued)
2. Investments
The aggregate cost of portfolio shares purchased and proceeds from portfolio
shares sold during the year ended December 31, 1996 and the cost of shares held
at December 31, 1996 for each division were as follows:
<TABLE>
<CAPTION>
Division Purchases Sales Cost
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Renaissance Balanced $2,645,737 $2,983,627 $ 7,854,251
Zweig Asset Allocation 1,305,640 1,123,833 5,100,932
Nicholas-Applegate Balanced 4,739,776 3,664,083 10,910,914
Harris Bretall Sullivan & Smith Equity
Growth 3,967,214 2,527,066 6,366,184
Dreman Value 3,277,395 2,326,345 4,693,167
Zweig Equity (Small Cap) 2,487,180 3,595,159 2,036,194
Pinnacle Fixed Income 151,320 252,035 1,472,370
ARM Capital Advisors Money Market 7,689,374 9,885,336 1,346,745
Morgan Stanley Asian Growth 1,940,206 975,086 3,362,607
Morgan Stanley Worldwide High Income 826,604 262,661 936,471
</TABLE>
3. Expenses
National Integrity assumes mortality and expense risks and incurs certain
administrative expenses related to the operations of the Separate Account and
deducts a charge from the assets of the Separate Account at an annual rate of
1.20% and 0.15% of net assets, respectively, to cover these risks and expenses.
In addition, an annual administrative charge of $30 per contract is assessed if
the participant's account value is less than $50,000 at the end of any
participation year prior to the participant's retirement date (as defined by the
participant's contract).
16
<PAGE>
Financial Statements
(Statutory Basis)
National Integrity Life
Insurance Company
Years Ended December 31, 1996 and 1995
with Report of Independent Auditors
<PAGE>
National Integrity Life Insurance Company
Financial Statements
(Statutory Basis)
Years Ended December 31, 1996 and 1995
<TABLE>
<CAPTION>
Contents
<S> <C>
Report of Independent Auditors..............................................1
Audited Financial Statements
Balance Sheets (Statutory Basis)............................................3
Statements of Operations (Statutory Basis)..................................5
Statements of Changes in Capital and Surplus (Statutory Basis)..............6
Statements of Cash Flows (Statutory Basis)..................................7
Notes to Financial Statements (Statutory Basis).............................9
</TABLE>
<PAGE>
Report of Independent Auditors
Board of Directors
National Integrity Life Insurance Company
We have audited the accompanying statutory basis balance sheets of National
Integrity 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 the years then ended. These financial statements 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 New York Insurance Department, which practices differ from
generally accepted accounting principles. The variances between such practices
and generally accepted accounting principles and the effects on the accompanying
financial statements are described in Note 1.
In our opinion, because of the effects of the matter 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 National Integrity Life Insurance Company at December 31, 1996 and 1995, or
the results of its operations or its cash flows for the years then ended.
1
<PAGE>
Also, in our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of National Integrity Life
Insurance Company at December 31, 1996 and 1995, and the results of its
operations and its cash flows for the years then ended in conformity with
accounting practices prescribed or permitted by the New York Insurance
Department.
/s/ Ernst & Young LLP
Louisville, Kentucky
February 12, 1997
2
<PAGE>
National Integrity Life Insurance Company
Balance Sheets (Statutory Basis)
<TABLE>
<CAPTION>
December 31,
1996 1995
------------------
(In Thousands)
<S> <C> <C>
Admitted assets
Cash and investments:
Bonds $451,439 $635,249
Preferred stocks 50,715 14,428
Mortgage loans 3,929 5,318
Policy loans 24,981 22,606
Cash and short-term investments 14,570 20,268
Other invested assets 36 8,827
------------------
Total cash and investments 545,670 706,696
Separate accounts assets 370,988 265,264
Receivable for investments sold 4,576 -
Accrued investment income 6,513 7,959
Federal income tax recoverable 438 -
Other admitted assets 1,740 -
------------------
Total admitted assets $929,925 $979,919
==================
</TABLE>
3
<PAGE>
<TABLE>
<CAPTION>
December 31,
1996 1995
------------------
(In Thousands)
<S> <C> <C>
Liabilities and capital and surplus
Liabilities:
Policy and contract liabilities:
Life and annuity reserves $513,639 $671,322
Unpaid claims 124 1,813
Deposits on policies to be issued 645 -
------------------
Total policy and contract liabilities 514,408 673,135
Separate accounts liabilities 370,988 265,264
Accounts payable and accrued expenses 213 264
Transfers to separate accounts due or accrued, net (21,247) (16,329)
Reinsurance balances payable 589 98
Federal income taxes - 1,005
Asset valuation reserve 1,773 1,969
Interest maintenance reserve 8,914 6,992
Payable for investments purchased - 6,082
Other liabilities 6,016 2,300
------------------
Total liabilities 881,654 940,780
Capital and surplus:
Common stock, $10 par value, 200,000 shares
authorized, issued, and outstanding 2,000 2,000
Paid-in surplus 59,244 59,244
Special surplus funds 750 750
Unassigned surplus (13,723) (22,855)
------------------
Total capital and surplus 48,271 39,139
------------------
Total liabilities and capital and surplus $929,925 $979,919
==================
</TABLE>
See accompanying notes.
4
<PAGE>
National Integrity Life Insurance Company
Statements of Operations (Statutory Basis)
<TABLE>
<CAPTION>
Year Ended December 31,
1996 1995
-----------------------
(In Thousands)
<S> <C> <C>
Premiums and other revenues:
Premiums and annuity considerations $ 8,640 $ 1,262
Deposit-type funds 352,899 261,378
Net investment income 53,553 46,548
Amortization of the interest maintenance reserve 1,001 823
Other revenues 5,653 3,913
-----------------------
Total premiums and other revenues 421,746 313,924
Benefits paid or provided:
Death benefits 8,260 9,098
Annuity benefits 12,106 3,581
Surrender benefits 101,241 119,789
Payments on supplementary contracts 1,879 1,869
Increase in insurance and annuity reserves 192,985 80,945
Other benefits 7,818 1,492
-----------------------
Total benefits paid or provided 324,289 216,774
Insurance and other expenses:
Commissions 5,817 4,809
General expenses 8,051 8,150
Taxes, licenses and fees 349 301
Net transfers to separate accounts 69,158 77,166
Other expenses 3,110 -
-----------------------
Total insurance and other expenses 86,485 90,426
Gain from operations before federal income taxes
and net realized capital losses 10,972 6,724
Federal income tax expense (benefit) (444) 991
-----------------------
Gain from operations before net realized capital losses 11,416 5,733
Net realized capital losses, less capital gains
tax expense (1996-$544; 1995-$1,800)
and excluding net gains (losses) transferred
to the interest maintenance reserve
(1996-$2,923; 1995-$(2,850)| (2,500) (900)
-----------------------
Net income $ 8,916 $ 4,833
=======================
</TABLE>
See accompanying notes.
5
<PAGE>
National Integrity Life Insurance Company
Statements of Changes in Capital and Surplus (Statutory Basis)
Years Ended December 31, 1996 and 1995
<TABLE>
<CAPTION>
Special Total
Common Paid-In Surplus Unassigned Capital and
Stock Surplus Funds Surplus Surplus
------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance, January 1, 1995 $2,000 $59,244 $ 750 $ (26,437) $ 35,557
Net income 4,833 4,833
Decrease in nonadmitted assets 20 20
Increase in asset valuation reserve (1,271) (1,271)
------------------------------------------------------------
Balance, December 31, 1995 2,000 59,244 750 (22,855) 39,139
Net income 8,916 8,916
Decrease in nonadmitted assets 19 19
Decrease in asset valuation reserve 197 197
------------------------------------------------------------
Balance, December 31, 1996 $2,000 $59,244 $ 750 $ (13,723) $ 48,271
============================================================
</TABLE>
See accompanying notes.
6
<PAGE>
National Integrity Life Insurance Company
Statements of Cash Flows (Statutory Basis)
<TABLE>
<CAPTION>
Year Ended December 31,
1996 1995
-----------------------
(In Thousands)
<S> <C> <C>
Operations:
Premiums, policy proceeds, and other considerations received $ 361,539 $ 262,639
Net investment income received 53,492 47,165
Commission and expense allowances received on reinsurance ceded 644 6
Benefits paid (125,238) (134,780)
Insurance expenses paid (14,170) (13,461)
Other income received net of other expenses paid 5,009 3,942
Net transfers to separate accounts (74,076) (83,932)
-----------------------
Net cash provided by operations 207,200 81,579
Investment activities:
Proceeds from sales, maturities, or repayments of investments:
Bonds 455,716 339,361
Preferred stocks 19,067 6,913
Mortgage loans 1,389 1,326
Other invested assets 8,826 -
-----------------------
Total investment proceeds 484,998 347,600
Taxes paid on capital gains (1,212) -
-----------------------
Net proceeds from sales, maturities, or repayments of investments 483,786 347,600
Cost of investments acquired:
Bonds 626,879 416,110
Preferred stocks 55,045 7,818
Other invested assets - 8,841
Miscellaneous proceeds 36 -
-----------------------
Total cost of investments acquired 681,960 432,769
Net increase in policy loans and premium notes 2,375 2,876
-----------------------
Net cash used in investment activities (200,549) (88,045)
Financing and miscellaneous activities:
Other cash provided:
Other sources 3,826 7,899
-----------------------
Total other cash provided 3,826 7,899
-----------------------
7
</TABLE>
<PAGE>
National Integrity Life Insurance Company
Statements of Cash Flows (Statutory Basis) (continued)
<TABLE>
<CAPTION>
Year Ended December 31,
1996 1995
-----------------------
(In Thousands)
<S> <C> <C>
Other cash applied:
Other applications, net 16,175 2,236
-----------------------
Total other cash applied 16,175 2,236
-----------------------
Net cash provided by (used in) financing and miscellaneous activities (12,349) 5,663
-----------------------
Net decrease in cash and short-term investments (5,698) (803)
Cash and short-term investments at beginning of year 20,268 21,071
-----------------------
Cash and short-term investments at end of year $ 14,570 $ 20,268
=======================
See accompanying notes.
8
</TABLE>
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis)
1. Organization and Accounting Policies
Organization
National Integrity Life Insurance Company ("National Integrity" or the
"Company") is a wholly owned subsidiary of Integrity Life Insurance Company
("Integrity") which is an indirect wholly owned subsidiary of ARM Financial
Group, Inc. ("ARM"). ARM acquired Integrity and the Company from The National
Mutual Life Association of Australasia Limited ("National Mutual"). The Company
is domiciled in the state of New York. The Company, currently licensed in eight
states and the District of Columbia, provides retail and institutional products
to the long-term savings and retirement marketplace.
Basis of Presentation
The accompanying financial statements of the Company have been prepared in
conformity with accounting practices prescribed or permitted by the New York
Insurance Department. Such practices vary from generally accepted accounting
principles ("GAAP"). The more significant variances from GAAP are as follows:
Investments
Investments in bonds and preferred stocks are reported at amortized cost or
market value based on the National Association of Insurance Commissioners (the
"NAIC") rating; for GAAP, such fixed maturity investments are designated at
purchase as held-to-maturity, trading or available-for-sale. Held-to-maturity
fixed investments are reported at amortized cost, and the remaining fixed
maturity investments are reported at fair value with unrealized holding gains
and losses reported in operations for those designated as trading and as a
separate component of shareholder's equity for those designated as available-
for-sale. In addition, fair values of certain investments in bonds and stock
are based on values specified by the NAIC, rather than on actual or estimated
market values used for GAAP.
Realized gains and losses are reported in income net of income tax and
transfers to the interest maintenance reserve. Changes between cost and
admitted investment asset amounts are credited or charged directly to
unassigned surplus rather than to a separate surplus account. The Asset
Valuation Reserve is determined by an NAIC prescribed formula and is reported
as a liability rather than unassigned surplus.
9
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
1. Organization and Accounting Policies (continued)
Under a formula prescribed by the NAIC, the Company defers 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 based on the individual security sold using the seriatim method.
The net deferral is reported as the Interest Maintenance Reserve in the
accompanying balance sheets. Under GAAP, realized gains and losses are
reported in the income statement on a pretax basis in the period that the
asset giving rise to the gain or loss is sold and include provisions when
there has been a decline in asset values deemed other than temporary.
Policy Acquisition Costs
Costs of acquiring and renewing business are expensed when incurred. Under
GAAP, acquisition costs related to investment-type products, to the extent
recoverable from future gross profits, are amortized generally in proportion
to the emergence of future gross profits over the estimated term of the
underlying policies.
Nonadmitted Assets
Certain assets designated as "nonadmitted," principally receivables greater
than 90 days past due, are excluded from the accompanying balance sheets and
are charged directly to unassigned surplus.
Premiums
Revenues include premiums and deposits received and benefits include death
benefits paid and the change in policy reserves. Under GAAP, such premiums
and deposits received are accounted for as a deposit liability and therefore
not recognized as premium revenue; benefits paid equal to the policy account
value are accounted for as a return of deposit instead of benefit expense.
10
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis)(continued)
1.Organization and Accounting Policies (continued)
Benefit Reserves
Certain policy reserves are calculated using statutorily prescribed interest
and mortality assumptions rather than on estimated expected experience or
actual account balances as would be required under GAAP.
Federal Income Taxes
Deferred federal income taxes are not provided for differences between the
financial statement amounts and tax bases of assets and liabilities.
The effects of the foregoing variances from GAAP on the accompanying statutory
basis financial statements are as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
1996 1995
-----------------------
(In Thousands)
<S> <C> <C>
Net income as reported in the accompanying
statutory basis financial statements $ 8,916 $ 4,833
Deferred policy acquisition costs, net of
amortization 5,187 7,614
Adjustments to customer deposits (441) (3,669)
Adjustments to invested asset carrying values
at acquisition date (160) (180)
Amortization of value of insurance in force (1,470) (2,905)
Amortization of interest maintenance reserve (1,001) (823)
Adjustments for realized investment gains (losses) 852 (747)
Adjustments for federal income tax benefit (expense) (2,185) 564
Other (200) 356
-----------------------
Net income, GAAP basis $ 9,498 $ 5,043
=======================
</TABLE>
11
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis)(continued)
1. Organization and Accounting Policies (continued)
<TABLE>
<CAPTION>
December 31,
1996 1995
-------------------
(In Thousands)
<S> <C> <C>
Capital and surplus as reported in the accompanying
statutory basis financial statements $ 48,271 $ 39,139
Adjustments to customer deposits (27,233) (26,792)
Adjustments to invested asset carrying values
at acquisition date (5,197) (5,889)
Asset valuation reserve and interest maintenance
reserve 19,369 20,567
Value of insurance in force 13,913 15,383
Deferred policy acquisition costs 23,728 18,541
Net unrealized gains on available-for-sale securities 1,416 5,577
Other (2,650) (246)
-------------------
Shareholder's equity, GAAP basis $ 71,617 $ 66,280
===================
</TABLE>
Other significant accounting practices are as follows:
Investments
Bonds, preferred stocks, common stocks, and short-term investments are stated at
values prescribed by the NAIC, as follows:
Bonds and short-term investments are reported at cost or amortized cost. The
discount or premium on bonds is amortized using the interest method. For
loan-backed bonds, anticipated prepayments are considered when determining
the amortization of discount or premium.
Prepayment assumptions for loan-backed bonds and structured securities are
obtained from broker-dealer survey values or internal estimates. These
assumptions are consistent with the current interest rate and economic
environment. The retrospective adjustment method is used to value all such
securities.
12
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
1. Organization and Accounting Policies (continued)
Preferred stocks are reported at cost.
Short-term investments include investments with maturities of less than one
year at the date of acquisition.
Mortgage loans and policy loans are reported at unpaid principal balances.
Realized capital gains and losses are determined using the specific
identification method.
Benefits
Life and annuity 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 or guaranteed policy cash values or the amounts
required by the New York Insurance Department. The Company waives deduction of
deferred fractional premiums upon the death of life and annuity policy insureds
and does not return any premium beyond the date of death. Surrender values on
policies do not exceed the corresponding benefit reserves. Policies issued
subject to multiple table substandard extra premiums are valued on the standard
reserve basis which recognizes the non-level incidence of the excess mortality
costs. Additional reserves are established when the results of cash flow testing
under various interest rate scenarios indicate the need for such reserves.
Tabular interest, tabular less actual reserve released, and tabular cost have
been determined by formula as prescribed by the NAIC.
13
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
1. Organization and Accounting Policies (continued)
Reinsurance
Reinsurance premiums, benefits and expenses are accounted for on bases
consistent with those used in accounting for the original policies issued and
the terms of the reinsurance contracts. Premiums, benefits and expenses, and the
reserves for policy and contract liabilities are reported net, rather than
gross, of reinsured amounts.
Separate Accounts
Separate account assets and liabilities reported in the accompanying financial
statements represent funds that are separately administered, principally for
variable annuity contracts. Separate account assets are reported at market
value. Surrender charges collectible by the general account in the event of
variable policy surrenders are reported as a negative liability rather than an
asset pursuant to prescribed NAIC accounting practices. The operations of the
separate accounts are not included in the accompanying financial statements,
except for separate accounts with guarantees. Fees charged on separate account
policyholder deposits are included in other revenues.
Use of Estimates
The preparation of financial statements in compliance with statutory accounting
practices requires management to make estimates and assumptions that affect
amounts reported in the financial statements and accompanying notes. Actual
results could differ from these estimates.
Reclassifications
Certain prior year amounts have been reclassified to conform with the
presentation of the 1996 financial statements. These reclassifications had no
effect on previously reported net income or surplus.
2. Permitted Statutory Accounting Practices
The Company's statutory basis financial statements are prepared in accordance
with accounting practices prescribed or permitted by the New York Insurance
Department. "Prescribed" statutory accounting practices include state laws,
regulations, and general
14
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
2. Permitted Statutory Accounting Practices (continued)
administrative rules, as well as a variety of publications of the NAIC.
"Permitted" statutory accounting practices encompass all accounting practices
that are not prescribed; such practices may differ from state to state, may
differ from company to company within a state, and may change in the future. The
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 effective for 1999, 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 financial statements. Although the
recodification project is meant to be surplus neutral, there is not enough
available information for the industry to assess the impact of such project.
3. Investments
The cost or amortized cost and the fair value of investments in bonds are
summarized as follows:
<TABLE>
<CAPTION>
Cost or Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------------------------------------------
(In Thousands)
<S> <C> <C> <C> <C>
At December 31, 1996:
U.S. Treasury securities and
obligations of U.S. government
agencies $ 16,243 $ 415 $ 110 $ 16,548
Foreign governments 12,363 643 - 13,006
Public utilities 40,882 379 644 40,617
Other corporate securities 127,264 396 6,534 121,126
Asset-backed securities 10,311 - - 10,311
Mortgage-backed securities 244,376 - - 244,376
--------------------------------------------
Total bonds $451,439 $1,833 $7,288 $445,984
============================================
</TABLE>
15
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
3. Investments (continued)
<TABLE>
<CAPTION>
Cost or Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-------------------------------------------
(In Thousands)
<S> <C> <C> <C> <C>
At December 31, 1995:
U.S. Treasury securities
and obligations of U.S.
government agencies $ 51,434 $1,381 $ 22 $ 52,793
States and political
subdivisions 5,997 43 - 6,040
Foreign governments 1,898 62 - 1,960
Public utilities 19,861 190 41 20,010
Other corporate
securities 229,776 5,366 1,653 233,489
Assets-backed securities 27,695 - - 27,695
Mortgage-backed
securities 298,588 - - 298,588
-------------------------------------------
Total bonds $635,249 $7,042 $1,716 $640,575
===========================================
</TABLE>
Fair values are based on published quotations of the Securities Valuation Office
of the NAIC. Fair values generally represent quoted market value prices for
securities traded in the public marketplace, or analytically determined values
using bid or closing prices for securities not traded in the public marketplace.
However, for certain investments for which the NAIC does not provide a value,
the Company uses the amortized cost amount as a substitute for fair value in
accordance with prescribed guidance. As of December 31, 1996 and 1995, the fair
value of investments in bonds includes $312,677,000 and $426,972,000,
respectively, of bonds that were valued at amortized cost.
16
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
3. Investments (continued)
A summary of the cost or amortized cost and fair value of the Company's
investments in bonds at December 31, 1996, by contractual maturity, is as
follows:
<TABLE>
<CAPTION>
Cost or
Amortized Fair
Cost Value
--------------------
(In Thousands)
<S> <C> <C>
Years to maturity:
After one through five $ 20,176 $ 16,110
After five through ten 32,815 31,575
After ten 143,761 143,612
Asset-backed securities 10,311 10,311
Mortgage-backed securities 244,376 244,376
-------------------
Total $451,439 $445,984
===================
</TABLE>
The expected maturities in the foregoing table may differ from the contractual
maturities because certain borrowers have the right to call or prepay
obligations with or without call or prepayment penalties and because asset-
backed and mortgage-backed securities (including floating-rate securities)
provide for periodic payments throughout their life.
Proceeds from the sales of investments in bonds during 1996 and 1995 were
$755,711,000 and $286,601,000; gross gains of $7,901,000 and $4,404,000, and
gross losses of $4,450,000 and $5,621,000 were realized on those sales,
respectively.
At December 31, 1996 and 1995, bonds with an admitted asset value of $1,234,000
and $1,235,000, respectively, were on deposit with state insurance departments
to satisfy regulatory requirements.
17
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
3. Investments (continued)
The Company has made no new investments in mortgage loans since 1988. The
maximum percentage of any one loan to the value of the security at the time of
the loan exclusive of any purchase money mortgages was 75%. Fire insurance at
least equal to the excess of the loan over the maximum loan which would be
permitted by law on the land without the buildings is required on all properties
covered by mortgage loans. As of year-end, the Company held no mortgages with
interest more than one year past due. During 1996, no interest rates of
outstanding mortgage loans were reduced. No amounts have been advanced by the
Company.
In connection with the change in control of the Company during 1993, National
Mutual agreed to indemnify the Company pursuant to a Guaranty Agreement dated
November 26, 1993, with respect to (i) principal (up to 100%) of the Company's
mortgage loans' statutory book value as of December 31, 1992 and (ii)
contractual interest payments (based on the original principal amount) of all
acquired commercial and agricultural mortgage loans. In support of its
indemnification obligations, National Mutual has placed $23.0 million into
escrow in favor of the Company and Integrity until the mortgage loans have been
repaid in full.
Major categories of the Company's net investment income are summarized as
follows:
<TABLE>
<CAPTION>
Year Ended December 31,
1996 1995
-----------------------
(In Thousands)
<S> <C> <C>
Income:
Bonds $47,487 $43,591
Preferred stocks 4,150 1,282
Mortgage loans 610 565
Policy loans 1,886 1,751
Short-term investments and cash 1,277 773
Other investment income 3 383
------------------
Total investment income 55,413 48,345
Investment expenses (1,860) (1,797)
------------------
Net investment income $53,553 $46,548
==================
</TABLE>
18
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
4. Reinsurance
Consistent with prudent business practices and the general practice of the
insurance industry, National Integrity reinsures risks under certain of its
insurance products with other insurance companies through reinsurance
agreements. Through these reinsurance agreements substantially all mortality
risks associated with single premium endowment and variable annuity deposits and
substantially all risks associated with variable life business have been
reinsured with non-affiliated insurance companies. A contingent liability exists
with respect to insurance ceded which would become a liability should the
reinsurer be unable to meet the obligations assumed under these reinsurance
agreements. Reinsurance ceded is not significant to the Company's premiums,
benefits or policy and contract liabilities. During 1995, the Company entered
into a reinsurance agreement with General American Life Insurance Company to
assume, on a 50% coinsurance basis, guaranteed investment contracts ("GICs").
Policy and contract liabilities assumed under this agreement were zero and
$117,770,000 at December 31, 1996 and 1995, respectively.
The effect of reinsurance on premiums and amounts earned is as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
1996 1995
-----------------------------------
(In Thousands)
<S> <C> <C>
Direct premiums and amounts assessed
against policyholders $115,547 $145,630
Reinsurance assumed 246,571 117,175
Reinsurance ceded (580) (165)
-----------------------------------
Net premiums and amounts earned $361,538 $262,640
===================================
</TABLE>
5. Federal Income Taxes
The Company files a consolidated return with Integrity. The method of allocation
between the companies is based on separate return calculations after
consolidated losses and credits.
19
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis)(continued)
5. Federal Income Taxes (continued)
Income before income taxes differs from taxable income principally due to value
of insurance in-force, interest maintenance reserves and differences in policy
and contract liabilities and investment income for tax and financial reporting
purposes.
The December 31, 1995 tax provision was calculated including net operating loss
carryover benefits of $4,304,000.
6. Surplus
The ability of the Company to pay dividends is limited by state insurance laws.
Under New York insurance laws, the Company may pay dividends only out of its
earnings and surplus, subject to at least thirty days prior notice to the New
York Insurance Superintendent and no disapproval from the Superintendent prior
to the date of such dividend. The Superintendent may disapprove a proposed
dividend if the Superintendent finds that the financial condition of the Company
does not warrant such distribution.
The NAIC adopted Risk-Based Capital ("RBC") requirements which became effective
December 31, 1993, that attempt to evaluate the adequacy of a life insurance
company's adjusted statutory capital and surplus in relation to investment,
insurance and other business risks. The RBC formula will be used by the states
as an early warning tool to identify possible under-capitalized companies for
the purpose of initiating regulatory action and is not designed to be a basis
for ranking the financial strength of insurance companies. In addition, the
formula defines a new minimum capital standard which supplements the previous
system of low fixed minimum capital and surplus requirements. The RBC
requirements provide for four different levels of regulatory attention depending
on the ratio of the company's adjusted capital and surplus to its RBC. As of
December 31, 1996 and 1995, the adjusted capital and surplus of the Company is
substantially in excess of the minimum level of RBC that would require
regulatory response.
20
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
7. Annuity Reserves
At December 31, 1996 and 1995, the Company's annuity reserves, including
separate accounts, and deposit fund liabilities that are subject to
discretionary withdrawal (with adjustment), subject to discretionary withdrawal
without adjustment, and not subject to discretionary withdrawal provisions are
summarized as follows:
<TABLE>
<CAPTION>
Amount Percent
-----------------------
(In Thousands)
<S> <C> <C>
At December 31, 1996:
Subject to discretionary withdrawal
(with adjustment):
With market value adjustment $ 89,668 11.5%
At book value less surrender charge
of 5% or more 23,208 3.0
At market value 257,419 33.0
-------------------
Total with adjustment or at market
value 370,295 47.5
Subject to discretionary withdrawal
(without adjustment) at book value
with minimal or no charge or
adjustment 347,883 44.7
Not subject to discretionary withdrawal 60,995 7.8
-------------------
Total annuity reserves and deposit
fund liabilities-before reinsurance 779,173 100.0%
=====
Less reinsurance ceded -
--------
Net annuity reserves and deposit fund
liabilities $779,173
========
At December 31, 1995:
Subject to discretionary withdrawal
(with adjustment):
With market value adjustment $ 67,407 8.1%
At book value less surrender charge
of 5% or more 190,629 22.7
At market value 180,991 21.6
-------------------
Total with adjustment or at market
value 439,027 52.4
Subject to discretionary withdrawal
(without adjustment) at book value
with minimal or no charge or
adjustment 337,299 40.2
Not subject to discretionary withdrawal 61,710 7.4
-------------------
Total annuity reserves and deposit
fund liabilities-before reinsurance 838,036 100.0%
=====
Less reinsurance ceded -
--------
Net annuity reserves and deposit fund
liabilities $838,036
========
</TABLE>
The Company sold $358,339,000 of guaranteed investment contracts, assumed by the
Company through a coinsurance agreement with General American Life Insurance
Company, to Integrity as of June 30, 1996.
21
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
8. Separate Accounts
Separate accounts assets and liabilities represent funds segregated for the
benefit of variable annuity and variable life policyholders who generally bear
the investment risk (mutual fund options), or for certain policyholders who are
guaranteed a fixed rate of return (guaranteed rate options). Assets held in
separate accounts are carried at estimated fair values.
Information regarding the separate accounts of the Company as of and for the
year ended December 31, 1996 is as follows:
<TABLE>
<CAPTION>
*Nonindexed
Guaranteed Nonguaranteed
More Separate
than 4% Accounts Total
------------------------------------------
(In Thousands)
<S> <C> <C> <C>
Premiums, deposits and other
considerations $32,363 $ 70,537 $102,900
==========================================
Reserves for separate accounts with
assets at fair value $90,084 $257,514 $347,598
==========================================
Reserves for separate accounts by
withdrawal characteristics:
Subject to discretionary withdrawal
(with adjustment):
With market value adjustment $89,668 $ - $ 89,668
At book value without market value
adjustment and with current
surrender charge of 5% or more 416 257,514 257,930
------------------------------------------
Total with adjustment or at market
value 90,084 257,514 347,598
Not subject to discretionary
withdrawal - - -
------------------------------------------
Total separate accounts reserves $90,084 $257,514 $347,598
==========================================
</TABLE>
*Separate accounts with guarantees.
22
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
8. Separate Accounts (continued)
A reconciliation of the amounts transferred to and from the separate accounts
for the years ended December 31, 1996 and 1995 is presented below:
<TABLE>
<CAPTION>
1996 1995
--------------------
(In Thousands)
<S> <C> <C>
Transfers as reported in the Summary of Operations
of the Separate Accounts Statement:
Transfers to separate accounts $102,901 $ 96,982
Transfers from separate accounts (37,150) (21,800)
-------------------
Net transfers to separate accounts 65,751 75,182
Reconciling adjustments:
Mortality and expense charges reported as other revenues 3,194 1,928
Other revenues 213 56
-------------------
Transfers as reported in the Summary of Operations
of the Life, Accident and Health Annual Statement $ 69,158 $ 77,166
===================
</TABLE>
9. Fair Values of Financial Instruments
Statement of Financial Accounting Standards ("SFAS") No. 107, "Disclosures About
Fair Value of Financial Instruments," requires disclosures of fair value
information about all financial instruments, including insurance liabilities
classified as investment contracts, unless specifically exempted. The fair value
of a financial instrument is the amount at which the instrument could be
exchanged in a current transaction between willing parties, other than in a
forced or liquidation sale. 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. Accordingly, the aggregate fair value amounts presented do not
necessarily represent the underlying value of such instruments. For financial
instruments not separately disclosed below, the carrying amount is a reasonable
estimate of fair value.
23
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
9. Fair Values of Financial Instruments (continued)
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
----------------------------------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
----------------------------------------------
(In Thousands)
<S> <C> <C> <C> <C>
Assets:
Bonds $451,439 $457,875 $635,249 $666,955
Preferred stocks 50,715 50,454 14,428 15,964
Mortgage loans 3,929 3,929 5,318 5,318
Liabilities:
Life and annuity reserves for
investment-type contracts $432,013 $426,516 $472,037 $474,465
Separate accounts annuity reserves 347,503 347,072 248,398 247,220
</TABLE>
Bonds and Preferred Stocks
Fair values for bonds and preferred stocks are based on quoted market prices
where available. For bonds and preferred stocks for which a quoted market price
is not available, fair values are estimated using internally calculated
estimates or quoted market prices of comparable investments.
Mortgage Loans on Real Estate
Pursuant to the terms of ARM's acquisition of the Company, payments of principal
and interest on mortgage loans acquired on November 26, 1993 are guaranteed by
National Mutual. Principal received in excess of statutory book value is to be
returned to National Mutual. Accordingly, book value is deemed to be fair value.
Life and Annuity Reserves for Investment-Type Contracts
The fair value of single premium immediate annuities is based on discounted
cash flow calculations using a market yield rate for assets with similar
durations. The fair value of the remaining annuities is based on the cash
surrender value of the underlying policies.
24
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
9. Fair Values of Financial Instruments (continued)
Separate Accounts Annuity Reserves
The fair value of separate accounts annuity reserves for investment-type
products equals the cash surrender values.
10. Related Party Transactions
Effective January 1, 1994, the Company entered into an Administrative Services
Agreement and an Investment Advisory Agreement with ARM. Under these agreements,
ARM performs certain administrative investment advisory and special services for
the Company to assist with its business operations. The services include
policyholder services; accounting, tax and auditing; underwriting; marketing and
product development; functional support services; payroll functions; personnel
functions; administrative support services; and investment functions. During
1996 and 1995, the Company was charged $6,008,000 and $5,641,000, respectively,
for these services in accordance with the requirements of applicable insurance
law and regulations.
25
<PAGE>
PART C
OTHER INFORMATION
-----------------
Item 24. Financial Statements and Exhibits
---------------------------------
(a) Financial Statements included in Part A:
---------------------------------------
Part 1 - Financial Information
Financial Statements included in Part B:
----------------------------------------
Separate Account II:
--------------------
Report of Independent Auditors
Statement of Assets and Liabilities as of December 31, 1996
Statement of Operations for the Year Ended December 31, 1996
Statements of Changes in Net Assets for the Years Ended December 31,
1996 and 1995
Notes to Financial Statements
National Integrity Life Insurance Company:
------------------------------------------
Report of Independent Auditors
Balance Sheets (Statutory Basis) as of December 31, 1996 and 1995
Statements of Operations (Statutory Basis) for the Years Ended
December 31, 1996 and 1995
Statements of Changes in Capital and Surplus (Statutory Basis) for the
Years Ended December 31, 1996 and 1995
Statements of Cash Flows (Statutory Basis) for the Years Ended
December 31, 1996 and 1995
Notes to Financial Statements
(b) Exhibits:
--------
The following exhibits are filed herewith:
1. Resolutions of the Board of Directors of National Integrity
Life Insurance Company (National Integrity) and Certification
of Chief Executive Officer authorizing the establishment of the
Separate Account II, the Registrant. Incorporated by reference
from Registrant's registration statement filed on August 20,
1992.
2. Not applicable.
3.(a) Form of Selling/General Agent Agreement among National
Integrity, Integrity Financial Services, Inc. (IFS) and
Painewebber Incorporated, incorporated by reference to Pre-
Effective Amendment No. 1 to Registrant's registration
statement on Form N-4 filed October 23, 1992.
3.(b) Form of Variable Contract Principal Underwriter Agreement with
ARM Securities Corporation. Incorporated by reference from
Registrant's registration statement (File No. 33-51126) filed
on May 1, 1996.
4.(a) Form of trust agreement. Incorporated by reference from
Registrant's registration statement filed on August 20, 1992.
<PAGE>
4.(b) Form of group variable annuity contract. Incorporated by
reference from Form N-4 registration statement (File No. 33-
56658).
4.(c) Form of variable annuity certificate. Incorporated by reference
from Form N-4 registration statement (File No. 33-56658).
4.(d) Form of riders to certificate for qualified plans. Incorporated
by reference from pre-effective amendment no. 1 to Registrant's
registration statement filed on October 23, 1992.
5. Form of application. Incorporated by reference from post-
effective amendment no. 1 to Registrant's Form S-1 registration
statement (File No. 33-51122).
6.(a) Certificate of Incorporation of National Integrity.
Incorporated by reference from Registrant's Form N-4
registration statement (File No. 33-33119).
6.(b) By-Laws of National Integrity. Incorporated by reference to
Registrant's Form N-4 registration statement (File No. 33-
33119).
7.(a) Reinsurance Agreement between National Integrity and
Connecticut General Life Insurance Company (CIGNA).
Incorporated by reference to Registrant's Form N-4 registration
statement (File No. 33-51126), filed on April 28, 1995.
7.(b) Reinsurance Agreement between National Integrity and
Connecticut General Life Insurance Company (CIGNA) effective
January 1, 1995. Incorporated by reference from Registrant's
registration statement (File No. 33-51126) filed on May 1,
1996.
8. Form of Participation Agreement among Integrity Series Fund,
Inc., National Integrity and IFS incorporated by reference to
Registrant's registration statement on Form N-4 filed August
20, 1992.
9. Opinion and Consent of Kevin L. Howard (filed herewith).
10. Consents of Ernst & Young LLP (filed herewith).
11. Not applicable.
12. Not applicable.
13. Schedule for computation of performance quotations.
Incorporated by reference from Registrant's registration
statement (File No. 33-51126) filed on May 1, 1996.
14. Not applicable.
2
<PAGE>
Item 25. Directors and Officers of the Depositor
---------------------------------------
Set forth below is information regarding the directors and principal
officers of National Integrity, the Depositor.
Directors:
- ----------
Name and Principal Business Address Position and Offices with National Integrity
- ----------------------------------- --------------------------------------------
Debra E. Abramovitz Director
Morgan Stanley Group Inc.
1221 Avenue of the Americas
New York, New York 10020
Kenneth F. Clifford Director
Morgan Stanley Group Inc.
1221 Avenue of the Americas
New York, New York 10020
James S. Cole Director
Morgan Stanley Group Inc.
1221 Avenue of the Americas
New York, New York 10020
Warren S. Foss Director
Bear Stearnes Co.
245 Park Avenue, 3rd Floor
New York, New York 10167
John Franco Director, Co-Chairman of the Board and
ARM Financial Group, Inc. Co-Chief Executive Officer
515 West Market Street
Louisville, Kentucky 40202
Dudley J. Godfrey, Jr. Director
Godfrey & Kahn, S.C.
780 North Water Street
Milwaukee, Wisconsin 53202-3590
Donald B. Henderson, Jr. Director
LeBoeuf, Lamb, Greene & MacRae
125 West 55th Street
New York, New York 10019-4513
Edward D. Powers Director
6064 Shipyard Lane
Easton, Maryland 21601
Colin F. Raymond Director
Morgan Stanley Group Inc.
1221 Avenue of the Americas
New York, New York 10020
Martin H. Ruby Director, Co-Chairman of the Board and
ARM Financial Group Inc. Co-Chief Executive Officer
3
<PAGE>
515 West Market Street
Louisville, Kentucky 40202
4
<PAGE>
Directors, continued
- --------------------
Name and Principal Business Address Position and Offices with National Integrity
- ----------------------------------- --------------------------------------------
Irwin T. Vanderhoof Director
18 Two Bridges Road
Towaco, New Jersey
Peter R. Vogelsang Director
Morgan Stanley Group Inc.
1221 Avenue of the Americas
New York, New York 10020
Emad A. Zikry Director, President and Chief Investment
Officer
ARM Capital Advisors, Inc.
200 Park Avenue, 20th Floor
New York, New York 10166
Selected Officers: (The business address for each of the principal officers
listed below is 515 West Market Street, Louisville, Kentucky
40202.)
Name and Principal Business Address Position and Offices with National Integrity
- ----------------------------------- --------------------------------------------
Robert H. Scott Executive Vice President, General Counsel
and Secretary
Dennis L. Carr Executive Vice President and Chief Actuary
David E. Ferguson Executive Vice President and Chief
Technology Officer
John R. Lindholm Executive Vice President and Chief
Marketing Officer
Edward L. Zeman Executive Vice President and Chief
Financial Officer
John R. McGeeney Executive Vice President-Retail Business
Division
Daniel R. Gattis Executive Vice President-Institutional
Business Group
Rose M. Culbertson Tax Officer
Peter S. Resnik Treasurer
Barry G. Ward Controller
Item 26. Persons Controlled by or Under Common Control with National Integrity
---------------------------------------------------------------------
or Registrant
- -------------
National Integrity, the depositor of Separate Account II, is a wholly owned
subsidiary of Integrity Life Insurance Company, an Ohio stock life insurance
corporation. Integrity Life Insurance Company is a wholly owned subsidiary of
Integrity Holdings, Inc., a Delaware corporation which is a holding company
engaged in no active business. All outstanding shares of Integrity Holdings,
Inc. are owned by ARM Financial Group, Inc. (ARM), a Delaware corporation which
is a financial services company focusing on the long-term savings and retirement
marketplace by providing retail and institutional products and services
throughout the United States. ARM owns 100% of the stock of (i) ARM Securities
Corporation (ARM Securities), a Minnesota corporation registered with the SEC as
a
5
<PAGE>
broker-dealer and a member of the National Association of Securities Dealers,
Inc., (ii) ARM Capital Advisors, Inc., a New York corporation registered with
the SEC as an investment adviser, (iii) SBM Certificate Company, a Minnesota
corporation registered with the SEC as an issuer of face-amount certificates,
and (iv) ARM Transfer Agency, Inc., a Delaware corporation registered with the
SEC as a transfer and disbursing agency. Approximately 91% of the outstanding
voting stock of ARM is owned by The Morgan Stanley Leveraged Equity Fund II,
L.P., Morgan Stanley Capital Partners III, L.P., Morgan Stanley Capital
Investors, L.P., and MSCP III 892 Investors, L.P., each of which is a Delaware
limited partnership (collectively, the MSCP Funds). The MSCP Funds are private
equity funds sponsored by Morgan Stanley Group Inc., a Delaware corporation
that, through its subsidiaries, provides a wide range of financial services on a
global basis (Morgan Stanley). The general partner of each of the MSCP Funds is
a wholly owned subsidiary of Morgan Stanley. Oldarm Limited Partnership, a
Kentucky limited partnership, New ARM, LLC, a Kentucky limited liability
company, and certain current and former employees and management of ARM own in
the aggregate approximately 9% of the voting stock of ARM.
No person has the direct or indirect power to control Morgan Stanley except
insofar as he or she may have such power by virtue of his or her capacity as a
director or executive officer thereof. Morgan Stanley is publicly held; no
individual beneficially owns more than 5% of the common shares; however,
approximately 31% of such shares are subject to a stockholders' agreement or
voting agreement among certain current and former principals and employees of
Morgan Stanley and its predecessor.
The following is a complete list of the subsidiaries of Morgan Stanley. All
subsidiaries are wholly owned by their immediate parent company and are
incorporated in Delaware, except where noted otherwise in parentheses.
MORGAN STANLEY GROUP INC.
- -------------------------
Fourth Street Development Co. Incorporated
Fourth Street Ltd.
Jolter Investments Inc.
Morgan Rundle Inc.
MR Ventures Inc.
Morgan Stanley ABS Capital Inc.
Morgan Stanley Advisory Partnership Inc.
Morgan Stanley Asset Management (CPO) Inc.
Morgan Stanley Asset Management Inc.
Morgan Stanley Asset Management Holdings Inc.
*Miller Anderson & Sherrerd, LLP (Pennsylvania)
Morgan Stanley Baseball, Inc.
Morgan Stanley Capital Group Inc.
Morgan Stanley Capital I Inc.
Morgan Stanley Capital Group Inc.
Morgan Stanley Capital (Jersey) Limited (Jersey, Channel Islands)
Morgan Stanley Capital Partners III, Inc.
Morgan Stanley Capital Services Inc.
Morgan Stanley Commercial Mortgage Capital, Inc.
Morgan Stanley Commodities Management, Inc.
Morgan Stanley Derivative Products Inc.
Morgan Stanley Developing Country Debt II, Inc.
Morgan Stanley Emerging Markets Inc.
Morgan Stanley Equity (C.I.) Limited (Jersey, Channel Islands)
Morgan Stanley Equity Investors Inc.
Morgan Stanley Finance (Jersey) Limited (Jersey, Channel Islands)
Morgan Stanley Global Emerging Markets, Inc.
Morgan Stanley Insurance Agency Inc.
6
<PAGE>
Morgan Stanley (Jersey) Limited (Jersey, Channel Islands)
Morgan Stanley LEF I, Inc.
Morgan Stanley Leveraged Capital Fund Inc.
Morgan Stanley Leveraged Equity Fund II, Inc.
Morgan Stanley Capital Partners Asia Limited (Hong Kong)
Morgan Stanley Leveraged Equity Holdings Inc.
Morgan Stanley Market Products Inc.
Morgan Stanley Mortgage Capital Inc. (New York)
Morgan Stanley Overseas Finance Ltd. (Caymen Islands)
Morgan Stanley Overseas Services (Jersey) Limited (Jersey, Channel Islands)
Morgan Stanley Real Estate Investment Management Inc.
Morgan Stanley Real Estate Fund, Inc.
MSREF I, L.L.C.
MSREF I-CO, L.L.C.
Morgan Stanley Real Estate Investment Management II, Inc.
MSREF II-CO, L.L.C.
Morgan Stanley Realty Incorporated
Brooks Harvey & Co., Inc.
Morgan Stanley Realty of California Inc. (California)
Morgan Stanley Realty of Illinois Inc.
Brooks Harvey of Florida, Inc. (Florida)
Brooks Harvey & Co. of Hawaii, Inc.
Morgan Stanley Realty Japan Ltd. (Japan)
BH-MS Realty Inc.
BH-MS Leasing Inc.
BH-Sartell Inc.
The Morgan Stanley Scholarship Fund, Inc. (Not-for-Profit)
Morgan Stanley Senior Funding, Inc.
Morgan Stanley Services Inc.
Morgan Stanley Technical Services Inc.
Morgan Stanley Technical Services MB/VC Inc.
Morgan Stanley Trust Company (New York)
Morgan Stanley Venture Capital Inc.
Morgan Stanley Venture Capital II, Inc.
Morgan Stanley Venture Capital III, Inc.
Morgan Stanley Ventures Inc.
Morstan Development Company, Inc.
Moranta, Inc. (Georgia)
Porstan Development Company, Inc. (Oregon)
MS 10020, Inc.
MS 10036, Inc.
MS Financing Inc.
Morgan Stanley 750 Building Corp.
MS Tokyo Properties Ltd. (Japan)
MS Holdings Incorporated
MS Venture Capital (Japan) Inc.
MSAM Holdings II, Inc.
VK/AC Holding, Inc.
Van Kampen American Capital, Inc.
ACCESS Investor Services, Inc.
Advantage Capital Credit Services, Inc.
American Capital Contractual Services, Inc. (New York)
Van Kampen American Capital Advisors, Inc.
Van Kampen American Capital Asset Management, Inc.
Van Kampen American Capital Distributors, Inc.
7
<PAGE>
Van Kampen American Capital Exchange Corp. (California)
Van Kampen American Capital Insurance Agency of Illinois, Inc. (Illinois)
Van Kampen American Capital Investment Advisory Corp.
Van Kampen American Capital Management, Inc.
Van Kampen American Capital Recordkeeping Services, Inc.
Van Kampen American Capital Services, Inc.
Van Kampen American Capital Trust Company (Texas)
Van Kampen Merritt Equity Holdings Corp.
Van Kampen Merritt Equity Advisors Corp.
VKAC Cayman Limited (Cayman Islands)
VK/AC System, Inc.
MSBF Inc.
MSCP III Holdings, Inc.
MSIT Holdings, Inc.
MSPL Co. Inc.
MSREF II, Inc.
MSREF II, L.L.C.
MSUH Holdings I, Inc.
MSUH Holdings II, Inc.
MS SP Urban Horizons, Inc.
MS Urban Horizons, Inc.
PG Holdings, Inc.
PG Investors, Inc.
PG Investors II, Inc.
Pierpont Power, Inc. (New York)
Romley Computer Leasing Inc.
Strategic Investments I, Inc.
THE MORGAN STANLEY LEVERAGED EQUITY FUND II, L.P.
- -------------------------------------------------
(The general partner of which is Morgan Stanley Leveraged Equity Fund II, Inc.)
American Italian Pasta Company
Amerin Corporation
Amerin Guaranty Corporation
ARM Financial Group, Inc.
CIMIC Holdings Limited
Consolidated Hydro, Inc.
Fort Howard Corporation
Hamilton Services Limited
PageMart Nationwide, Inc.
PSF Finance L.P.
Premium Standard Forms, Inc.
Container Corporation of America
Risk Management Solutions
Silgan Holding Inc.
Silgan Corporation
Sullivan Holdings Inc.
Sullivan Communications, Inc.
Sullivan Graphics, Inc.
MORGAN STANLEY CAPITAL PARTNERS III, L.P.
- -----------------------------------------
(The general partner of the general partner which is Morgan Stanley Capital
Partners III, Inc.)
ARM Financial Group, Inc.
CSG Systems International, Inc.
The Compucare Company
Highlands Gas Corporation
8
<PAGE>
ECO II Holdings
PSF Finance, L.P.
Premium Standard Forms, Inc.
Nokia Aluminum
SITA Telecommunications Holdings, N.V.
MORGAN STANLEY & CO. INCORPORATED
- ---------------------------------
(100% owned by Morgan Stanley Group Inc.)
Morgan Stanley Flexible Agreements Inc.
MS Securities Services Inc.
Prime Dealer Services Corp.
MORGAN STANLEY INTERNATIONAL INCORPORATED
- -----------------------------------------
(100% owned by Morgan Stanley Group Inc.)
Bank Morgan Stanley AG (Switzerland)
Morgan Stanley AOZT (Russia)
Morgan Stanley Asia (China) Limited (Hong Kong)
Morgan Stanley Asia Holdings I Inc.
Morgan Stanley Asia Holdings II Inc.
Morgan Stanley Asia Holdings III Inc.
Morgan Stanley Asia Holdings IV Inc.
Morgan Stanley Asia Holdings V Inc.
Morgan Stanley Asia Holdings VI Inc.
Morgan Stanley Asia Pacific (Holdings) Limited (Cayman Islands)
Morgan Stanley Asia Regional (Holdings) I LLC (Cayman Islands)
Morgan Stanley Asia Limited (Hong Kong)
Morgan Stanley Futures (Hong Kong) Limited (Hong Kong)
Morgan Stanley Hong Kong Securities Limited (Hong Kong)
Morgan Stanley Pacific Limited (Hong Kong)
Morgan Stanley Asia Regional (Holdings) II LLC (Cayman Islands)
Morgan Stanley Asia Regional (Holdings) III LLC (Cayman Islands)
Morgan Stanley Japan Limited (Hong Kong)
Morgan Stanley Asia Pacific (Holdings) I Limited (Cayman Islands)
Morgan Stanley Asia (Taiwan) Ltd. (Republic of China)
Morgan Stanley Asset & Investment Trust Management Co., Limited (Japan)
Morgan Stanley Australia Limited (Australia)
Morgan Stanley Bank Luxembourg S.A. (Luxembourg)
Morgan Stanley Canada Limited (Canada)
Morgan Stanley Capital SA (France)
Morgan Stanley Capital (Luxembourg) S.A. (Luxembourg)
Morgan Stanley Financial Services Beteiligungs GmbH (Germany)
Morgan Stanley Financial Services GmbH & Co. KG (Germany)
Morgan Stanley Group (Europe) Plc (England)
Morgan Stanley Asset Management Limited (England)
Morgan Stanley Capital Group Limited (England)
Morgan Stanley (Europe) Limited (England)
Morgan Stanley Finance plc (England)
Morgan Stanley Properties Limited (England)
Morgan Stanley Property Management (UK) Limited (England)
Morgan Stanley Services (UK) Limited (England)
Morgan Stanley UK Group (England)
Morgan Stanley & Co. International Limited (England)
Morgan Stanley International Nominees Limited (England)
Morgan Stanley & Co. Limited (England)
Morgan Stanley Securities Limited (England)
9
<PAGE>
Morstan Nominees Limited (England)
MS Leasing UK Limited (England)
Morgan Stanley Holding (Deutschland) GmbH (Germany)
Morgan Stanley Bank AG (Germany)
Morgan Stanley Hong Kong Nominees Limited (Hong Kong)
Morgan Stanley International Insurance Ltd. (Bermuda)
Morgan Stanley Latin America Incorporated
Morgan Stanley Administadora de Carteiras Ltda. (Brazil)
Morgan Stanley do Brasil Limitada (Brazil)
MS Carbocol Advisors Incorporated
Morgan Stanley Mauritius Company Limited (Mauritius)
***Morgan Stanley Asset Management India Private Limited (India)
***Morgan Stanley India Securities Private Limited (India)
Morgan Stanley India Private Limited (India)
Morgan Stanley Offshore Investment Company Ltd. (Cayman Islands)
Morgan Stanley S.A. (France)
Morgan Stanley SICAV Management S.A. (Luxembourg)
Morgan Stanley South Africa (Pty) Limited (South Africa)
Morgan Stanley SPV I (Cayman Islands) LLC (Cayman Islands)
Farlington Corporation (Ireland)
Morgan Stanley SPV II (Cayman Islands) LLC (Cayman Islands)
Morgan Stanley (Structured Products) Jersey Limited (Jersey, Channel Islands)
Morgan Stanley Wertpapiere GmbH (Germany)
MS Italy (Holdings) Inc.
Banca Morgan Stanley SpA (Italy)
MS LDC, Ltd.
MSAM/Kokusai (Cayman Islands), Inc. (Cayman Islands)
MSL Incorporated
___________________________
* 95% owned by Morgan Stanley Asset Management Holdings Inc., 3% owned by
MSLIncorporated and 2% owned by MS Holdings Incorporated.
** 25% owned by Morgan Stanley Asia Pacific (Holdings) I Limited.
*** 25% owned by non-Morgan Stanley entities.
[There are no subsidiaries of National Integrity. The financial statements
for National Integrity are not consolidated with any affiliate.]
Item 27. Number of Contract Owners
-------------------------
As of March 31, 1997 there were 917 contract owners of Pinnacle(version II)
and no contract owners of Pinnacle(version III) of Separate Account II of
National Integrity.
Item 28. Indemnification
---------------
By-Laws of National Integrity. National Integrity's By-Laws provide, in Article
VII, as follows:
7.1 Indemnification of Directors, Officers, Employees and Incorporators.
To the extent permitted by the law of the State of New York and subject to all
applicable requirements thereof:
(a) any person made or threatened to be made a party to any action or
proceeding, whether civil or criminal, by reason of the fact that he, his
testator or intestate, is or was a director, officer, employee or
incorporator of the Company shall be indemnified by the Company;
10
<PAGE>
(b) any person made or threatened to be made a party to any action or
proceeding, whether civil or criminal, by reason of the fact that he, his
testator or intestate serves or served any other organization in any
capacity at the request of the Company may be indemnified by the Company;
and
(c) the related expenses of any such person in any other of said
categories may be advanced by the Company.
By-Laws of ARM Securities: ARM Securities' By-Laws provide, in Sections 4.01
and 4.02, as follows:
Section 4.01 Indemnification. The Corporation shall indemnify its
officers and directors for such expenses and liabilities, in such manner, under
such circumstances, and to such extent, as required or permitted by Minnesota
Statutes, Section 302A.521, as amended from time to time, or as required or
permitted by other provisions of law.
Section 4.02 Insurance. The Corporation may purchase and maintain
insurance on behalf of any person in such person's official capacity against any
liability asserted against and incurred by such person in or arising from that
capacity, whether or not the Corporation would otherwise be required to
indemnify the person against the liability.
Agreements. National Integrity and ARM Securities, including each director,
officer, and controlling person of National Integrity and ARM Securities, are
entitled to indemnification against certain liabilities as described in Sections
5.2, 5.3 and 5.5 of the Selling Agreement and Section 9 of the Form of Variable
Contract Principal Underwriter Agreement filed as Exhibit 3(a) to this
Registration Statement. Those sections are incorporated by reference into this
response. In addition, National Integrity and ARM Securities, including each
director, officer and controlling person of National Integrity and ARM
Securities, are entitled to indemnification against certain liabilities as
described in Article VIII of the Participation Agreement filed as Exhibit 8 to
this Registration Statement. That article is incorporated by reference into this
response. Certain officers and directors of National Integrity are officers and
directors of ARM Securities (see Item 25 and Item 29 of this Part C).
Insurance. The directors and officers of National Integrity and ARM Securities
are insured under a policy, issued by National Union. The total annual limit on
such policy is $10 million, and the policy insures the officers and directors
against certain liabilities arising out of their conduct in such capacities.
Undertaking. Insofar as indemnification for liability arising under the
Securities Act of 1933 may be permitted to directors, officers and controlling
persons of the registrant pursuant to the foregoing provisions, or otherwise,
the registrant has been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as expressed
in the Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer, or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Act and will
be governed by the final adjudication of such issue.
Item 29. Principal Underwriters
----------------------
(a) ARM Securities is the principal underwriter for Separate Account II.
ARM Securities also serves as an underwriter for Separate Account I of National
Integrity, Separate Accounts I and II of Integrity, and The Legends Fund, Inc.
National Integrity is the Depositor of Separate Accounts II, I and VUL.
11
<PAGE>
(b) The names and business addresses of the officers and directors of, and
their positions with, ARM Securities, are as follows:
Name and Principal Business Address Position and Offices with ARM Securities
- ----------------------------------- ----------------------------------------
Edward J. Haines Director and President
515 West Market Street
Louisville, Kentucky 40202
John R. McGeeney Director, Secretary, General Counsel &
515 West Market Street Compliance Officer
Louisville, Kentucky 40202
Peter S. Resnik Treasurer
515 West Market Street
Louisville, Kentucky 40202
Walter W. Balek Vice President
200 East Wilson Bridge Road
Worthington, Ohio 43085
12
<PAGE>
Dale C. Bauman Vice President
100 North Minnesota Street
New Ulm, Minnesota 46073
Robert Bryant Vice President
1550 East Shaw #120
Fresno, California 93710
Ronald Geiger Vice President
100 North Minnesota Street
New Ulm, Minnesota 46073
Barry G. Ward Controller
515 West Market Street
Louisville, Kentucky 40202
Rose M. Culbertson Tax Officer
515 West Market Street
Louisville, Kentucky 40202
William H. Guth Operations Officer
200 East Wilson Bridge Road
Worthington, Ohio 43085
David L. Anders Marketing Officer
515 West Market Street
Louisville, Kentucky 40202
Robert L. Maddox Assistant Secretary
515 West Market Street
Louisville, Kentucky 40202
Sheri L. Bean Assistant Secretary
515 West Market Street
Louisville, Kentucky 40202
(c) Not applicable.
13
<PAGE>
Item 30. Location of Accounts and Records
--------------------------------
The records required to be maintained by Section 31(a) of the Investment
Company Act of 1940 and Rules 31a-1 to 31a-3 promulgated thereunder, are
maintained by National Integrity at 515 West Market Street, Louisville, Kentucky
40202 or 200 Park Avenue, 20th Floor, New York, New York 10166.
Item 31. Management Services
-------------------
The contract under which management-related services are provided to
National Integrity is discussed under Part 1 of Part B.
Item 32. Undertakings
------------
The Registrant hereby undertakes:
(a) to file a post-effective amendment to this registration statement as
frequently as is necessary to ensure that the audited financial
statements in the registration statement are never more than 16 months
old for so long as payments under the variable annuity contracts may
be accepted;
(b) to include either (1) as part of any application to purchase a
contract offered by the prospectus, a space that an applicant can
check to request a Statement of Additional Information, or (2) a
postcard or similar written communication affixed to or included in
the prospectus that the applicant can remove to send for a Statement
of Additional Information; and
(c) to deliver any Statement of Additional Information and any financial
statements required to be made available under this Form promptly upon
written or oral request.
National Integrity represents that the aggregate charges under variable
annuity contracts described in this Registration Statement are reasonable in
relation to the services rendered, the expenses expected to be incurred, and the
risks assumed by National Integrity.
14
<PAGE>
SIGNATURES
As required by the Securities Act of 1933 and the Investment Company Act of
1940, the Registrant and the Depositor certify that they meet all of the
requirements for effectiveness of this post-effective amendment to their
Registration Statement pursuant to Rule 485(b) under the Securities Act of 1933
and have duly caused this amendment to the Registration Statement to be signed
on their behalf, in the City of Louisville and State of Kentucky on this 29th
day of April, 1997.
SEPARATE ACCOUNT II OF
NATIONAL INTEGRITY LIFE INSURANCE COMPANY
(Registrant)
By: National Integrity Life Insurance Company
(Depositor)
By: /s/ Emad A. Zikry
-----------------------------
Emad A. Zikry
President and Chief Investment Officer
NATIONAL INTEGRITY LIFE INSURANCE COMPANY
(Depositor)
By: /s/ Emad A. Zikry
-----------------------------
Emad A. Zikry
President and Chief Investment Officer
15
<PAGE>
SIGNATURES
As required by the Securities Act of 1933 and the Investment Company Act of
1940, the Depositor has duly caused this amendment to the Registration Statement
to be signed on its behalf, in the City of Louisville and State of Kentucky on
this 29th day of April, 1997.
NATIONAL INTEGRITY LIFE INSURANCE COMPANY
(Depositor)
By: /s/ Emad A. Zikry
-----------------------------
Emad A. Zikry
President and Chief Investment Officer
As required by the Securities Act of 1933, this amendment to the
Registration Statement has been signed by the following persons in the
capacities and on the date indicated.
PRINCIPAL EXECUTIVE OFFICER: /s/ Emad A. Zikry
--------------------------------
Emad A. Zikry, President and Chief Investment
Officer
Date: 04/29/97
PRINCIPAL FINANCIAL OFFICER: /s/ Edward L. Zeman
--------------------------------
Edward L. Zeman, Executive Vice President-
Chief Financial Officer
Date: 04/29/97
PRINCIPAL ACCOUNTING OFFICER: /s/ Barry G. Ward
-------------------------------
Barry G. Ward, Controller
Date: 04/29/97
DIRECTORS:
<TABLE>
<S> <C>
/s/ Debra E. Abramovitz /s/ Warren S. Foss
- ------------------------------ -------------------------
Debra E. Abramovitz Warren S. Foss
Date: 04/29/97 Date: 04/29/97
/s/ Kenneth F. Clifford /s/ Colin F. Raymond
- ------------------------------ -------------------------
Kenneth F. Clifford Colin F. Raymond
Date: 04/29/97 Date: 04/29/97
/s/ James S. Cole /s/ Martin H. Ruby
- ------------------------------ -------------------------
James S. Cole Martin H. Ruby
Date: 04/29/97 Date: 04/29/97
/s/ John Franco /s/ Irwin T. Vanderhoof
- ------------------------------ -------------------------
John Franco Irwin T. Vanderhoof
Date: 04/29/97 Date: 04/29/97
/s/ Dudley J. Godfrey, Jr. /s/ Peter R. Vogelsang
- ------------------------------ -------------------------
Dudley J. Godfrey, Jr. Peter R. Vogelsang
Date: 04/29/97 Date: 04/29/97
/s/ Donald B. Henderson, Jr. /s/ Emad A. Zikry
- ------------------------------ -------------------------
Donald B. Henderson, Jr. Emad A. Zikry
Date: 04/29/97 Date: 04/29/97
/s/ Edward D. Powers
- ------------------------------
Edward D. Powers
Date: 04/29/97
</TABLE>
16
<PAGE>
EXHIBIT INDEX
Exhibit No.
- -----------
9. Opinion and Consent of Kevin L. Howard.
10. Consents of Ernst & Young LLP.
17
<PAGE>
April 21, 1997
National Integrity Life Insurance Company
200 Park Avenue, 20th Floor
New York, New York 10166
Re: Separate Account II of National Integrity Life Insurance Company (the
"Separate Account")
Dear Sirs:
This opinion is furnished in connection with the Registration Statement on Form
N-4 for the Separate Account and National Integrity Life Insurance Company
("National Integrity"), filed under the Securities Act of 1933 and the
Investment Company Act of 1940.
The Registration Statement covers an indefinite number of units of interest in
the Separate Account. Contributions to be received under individual variable
annuity contracts ("Contracts") and group variable annuity certificates
("Certificates") offered by National Integrity may be allocated to the Separate
Account to support reserves for such Contracts and Certificates.
I have examined all such corporate records of National Integrity and such other
documents and such laws as I consider appropriate as a basis for the opinion
hereinafter expressed. On the basis of such examination, it is my opinion that:
1. National Integrity is a corporation duly organized and validly existing
under the laws of the State of New York.
2. The Separate Account was established and is maintained pursuant to the laws
of the State of New York, under which income, gains and losses, whether or
not realized, from assets allocated to such Separate Account are, in
accordance with the contracts and certificates, credited to or charged
against the Separate Account without regard to other income, gains or
losses of National Integrity. Although contractual obligations with respect
to the funds of the Separate Account constitute corporate obligations of
National Integrity, the specific amounts payable from accumulations in the
Separate Account in accordance with the Contracts and Certificates depend
upon the investment experience of the Separate Account.
<PAGE>
3. Assets allocated to the Separate Account will be owned by National
Integrity; National Integrity will not be a trustee with respect thereto.
The Contracts and Certificates provide that the portion of the assets of
the Separate Account equal to the reserves and other Contract and
Certificate liabilities with respect to the Separate Account will not be
chargeable with liabilities arising out of any other business National
Integrity may conduct, and that National Integrity reserves the right to
transfer assets of the Separate Account in excess of such reserves and
other Contract and Certificate liabilities to the General Account of
National Integrity.
4. When issued and sold as described above, the Contracts and Certificates
will be duly authorized and will constitute validly issued and binding
obligations of National Integrity in accordance with their terms.
Purchasers of the Contracts and Certificates will be subject only to the
deductions, charges and fees set forth in the Prospectus.
I hereby consent to the use of this opinion as an exhibit to the Registration
Statement.
Sincerely,
/s/ Kevin L. Howard
Kevin L. Howard
<PAGE>
Exhibit No. (10)
CONSENT OF INDEPENDENT AUDITORS
We consent to the reference to our firm under the caption "Financial Statements"
and to the use of our report dated April 18, 1997, with respect to the financial
statements of Separate Account II of National Integrity Life Insurance Company
in Post-Effective Amendment No. 7 to the Registration Statement (Form N-4 No.
33-51126) and Amendment No. 8 to the Registration Statement (Form N-4 No.
811-7132) and related Prospectuses of National Integrity Life Insurance Company.
/s/ Ernst & Young LLP
Louisville, Kentucky
April 25, 1997
<PAGE>
Exhibit No. (10)
CONSENT OF INDEPENDENT AUDITORS
We consent to the reference to our firm under the caption "Financial Statements"
and to the use of our report dated February 12, 1997, with respect to the
statutory basis financial statements of National Integrity Life Insurance
Company in Post-Effective Amendment No. 7 to the Registration Statement (Form
N-4 No. 33-51126) and Amendment No. 8 to the Registration Statement (Form N-4
No.811-7132) and related Prospectuses of National Integrity Life Insurance
Company.
/s/ Ernst & Young LLP
Louisville, Kentucky
April 25, 1997
