<PAGE>
RULE 497(c)
Prospectus PINNACLE (VERSION III) REGISTRATION NO. 33-51126
- ---------- 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. The contracts are funded by Separate Account II. Contributions under
the contracts may be allocated to the various available investment divisions of
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 of Separate Account II are
invested in shares of corresponding portfolios of the following list of Funds
or Insurance Trust Funds (FUNDS): BT Insurance Funds Trust (BT FUNDS TRUST);
Variable Insurance Products Fund (VIP), Variable Insurance Products Fund II
(VIP II), and Variable Insurance Products Fund III (VIP III), part of the
Fidelity Investments-Registered Trademark- group of companies (collectively,
FIDELITY'S VIP FUNDS); The Legends Fund, Inc. (LEGENDS FUND); Janus Aspen
Series; J.P. Morgan Series Trust II (J.P. MORGAN SERIES); and Morgan Stanley
Universal Funds, Inc. (MORGAN STANLEY UNIVERSAL FUNDS). The values allocated
to the Options reflect the investment performance of the Funds' Portfolios.
Bankers Trust Global Asset Management Services, a unit of Bankers Trust
Company, is the investment manager of the BT Funds Trust. Fidelity
Management and Research Company serves as investment adviser to Fidelity's
VIP Funds. Integrity Capital Advisors, Inc., a member of the ARM Financial
Group, is the investment adviser of the Legends Fund. Janus Capital
Corporation serves as investment adviser to the Janus Aspen Series. J.P.
Morgan Investment Management Inc. is the investment adviser to the J.P.
Morgan Series. Morgan Stanley Asset Management Inc. serves as investment
adviser to the Morgan Stanley Universal Funds except for Morgan Stanley High
Yield Portfolio, for which Miller Anderson & Sherrerd, LLP serves as
investment adviser. The prospectuses for the Funds describe the investment
objectives, policies and risks of each of the Funds' portfolios. There are 21
Variable Account Options available under Separate Account II:
BT FUNDS TRUST
EAFE-Registered Trademark- Equity Index Fund
Equity 500 Index Fund
Small Cap Index Fund
FIDELITY'S VIP FUNDS
VIP Equity-Income Portfolio
VIP II Contrafund Portfolio
VIP III Growth & Income Portfolio
VIP III Growth Opportunities Portfolio
JANUS ASPEN SERIES
Janus Aspen Capital Appreciation Portfolio
Janus Aspen Balanced Portfolio
Janus Aspen Worldwide Growth Portfolio
Janus Aspen Money Market Portfolio
J.P. MORGAN SERIES
J.P. Morgan International Opportunities Portfolio
J.P. Morgan Bond Portfolio
LEGENDS FUND
Harris Bretall Sullivan & Smith Equity Growth Portfolio
Zweig Asset Allocation Portfolio
Zweig Equity (Small Cap) Portfolio
Scudder Kemper Value Portfolio
MORGAN STANLEY UNIVERSAL FUNDS
Morgan Stanley Asian Equity Portfolio
Morgan Stanley Emerging Markets Debt Portfolio
Morgan Stanley High Yield Portfolio
Morgan Stanley U.S. Real Estate Portfolio
<PAGE>
THERE CAN BE NO ASSURANCE THAT THE JANUS MONEY MARKET PORTFOLIO WILL ACHIEVE ITS
INVESTMENT OBJECTIVE OR BE ABLE TO MAINTAIN A STABLE NET ASSET VALUE OF $1.00
PER SHARE.
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). Withdrawal charges and an annual administrative charge may be
applicable, which may invade principal.
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 Fund prospectuses, 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.
Registration statements relating to the contracts, which include a Statement of
Additional Information (SAI) dated May 1, 1998, have 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.
THE CONTRACTS ARE NOT DEPOSITS OR OTHER OBLIGATIONS OF OR GUARANTEED BY ANY
BANK, NOR ARE THEY INSURED BY THE FDIC. THEY ARE SUBJECT TO INVESTMENT RISKS,
INCLUDING POSSIBLE LOSS OF THE PRINCIPAL AMOUNT INVESTED.
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, 1998.
<PAGE>
TABLE OF CONTENTS
PART I PAGE
SECTION 1 - SUMMARY
Your Variable Annuity Contract . . . . . . . . . . . . . . . . . . . . . . .1
Your Benefits. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1
How Your Contract is Taxed . . . . . . . . . . . . . . . . . . . . . . . . .1
Your Contributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1
Your Investment Options. . . . . . . . . . . . . . . . . . . . . . . . . . .1
Variable Account Options . . . . . . . . . . . . . . . . . . . . . . . . . .2
Account Value, Adjusted Account Value and Cash Value . . . . . . . . . . . .2
Transfers. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2
Charges and Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2
Withdrawals. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3
Your Initial Right to Revoke . . . . . . . . . . . . . . . . . . . . . . . .3
Table of Annual Fees and Expenses. . . . . . . . . . . . . . . . . . . . . .4
Financial Information. . . . . . . . . . . . . . . . . . . . . . . . . . . .9
SECTION 2 - NATIONAL INTEGRITY AND SEPARATE ACCOUNT II
National Integrity Life Insurance Company. . . . . . . . . . . . . . . . . 11
Separate Account II and the Variable Account Options . . . . . . . . . . . 11
Assets of Separate Account II. . . . . . . . . . . . . . . . . . . . . . . 11
Changes In How We Operate. . . . . . . . . . . . . . . . . . . . . . . . . 12
SECTION 3 - YOUR INVESTMENT OPTIONS
The Legends Fund . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
The Legends Fund's Investment Adviser and Sub-Advisers. . . . . . . . 12
Investment Objectives of the Portfolios . . . . . . . . . . . . . . . 13
BT Insurance Funds Trust . . . . . . . . . . . . . . . . . . . . . . . . . 14
The Bankers Trust Funds' Investment Adviser . . . . . . . . . . . . . 14
Investment Objectives of the Portfolios . . . . . . . . . . . . . . . 14
Fidelity Variable Insurance Products Funds . . . . . . . . . . . . . . . . 16
Fidelity's VIP Funds' Investment Adviser. . . . . . . . . . . . . . . 16
Investment Objectives of the Portfolios . . . . . . . . . . . . . . . 17
Janus Aspen Series . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Janus Aspen Series' Investment Adviser. . . . . . . . . . . . . . . . 18
Investment Objectives of the Portfolios . . . . . . . . . . . . . . . 18
J.P. Morgan Series Trust II. . . . . . . . . . . . . . . . . . . . . . . . 19
The J.P. Morgan Series= Investment Adviser. . . . . . . . . . . . . . 19
Investment Objectives of the Portfolios . . . . . . . . . . . . . . . 20
Morgan Stanley Universal Funds, Inc. . . . . . . . . . . . . . . . . . . . 20
The Morgan Stanley Universal Funds' Investment Advisers . . . . . . . 20
Investment Objectives of the Portfolios . . . . . . . . . . . . . . . 19
Guaranteed Rate Options. . . . . . . . . . . . . . . . . . . . . . . . . . 20
Renewals of GRO Accounts. . . . . . . . . . . . . . . . . . . . . . . 21
Market Value Adjustments. . . . . . . . . . . . . . . . . . . . . . . 21
SECTION 4 - DEDUCTIONS AND CHARGES
Separate Account Charges . . . . . . . . . . . . . . . . . . . . . . . . . 22
Annual Administrative Charge . . . . . . . . . . . . . . . . . . . . . . . 22
<PAGE>
PAGE
Reduction or Elimination of Separate Account or
Annual Administrative Charges. . . . . . . . . . . . . . . . . . . . . . 22
Fund Charges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
State Premium Tax Deduction. . . . . . . . . . . . . . . . . . . . . . . . 22
Contingent Withdrawal Charge . . . . . . . . . . . . . . . . . . . . . . . 22
Reduction or Elimination of Contingent Withdrawal Charge . . . . . . . . . 22
Transfer Charge. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
Hardship Waiver. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
Tax Reserve. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
SECTION 5 - TERMS OF YOUR PINNACLE VARIABLE ANNUITY
Contributions Under Your Contract. . . . . . . . . . . . . . . . . . . . . 24
Your Account Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
Your Purchase of Units in Separate Account II. . . . . . . . . . . . . . . 24
How We Determine Unit Value. . . . . . . . . . . . . . . . . . . . . . . . 25
Transfers. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Withdrawals. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Assignments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Death Benefits and Similar Benefit Distributions . . . . . . . . . . . . . 27
Annuity Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
Annuities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
Annuity Payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
Timing of Payment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
How You Make Requests and Give Instructions. . . . . . . . . . . . . . . . 29
SECTION 6 - VOTING RIGHTS
Fund Voting Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
How We Determine Your Voting Shares. . . . . . . . . . . . . . . . . . . . 29
How Fund Shares Are Voted. . . . . . . . . . . . . . . . . . . . . . . . . 29
Separate Account Voting Rights . . . . . . . . . . . . . . . . . . . . . . 30
SECTION 7 - TAX ASPECTS OF THE CONTRACTS
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
Tax Status of National Integrity . . . . . . . . . . . . . . . . . . . . . 30
Your Contract is an Annuity. . . . . . . . . . . . . . . . . . . . . . . . 30
Taxation of Annuities Generally. . . . . . . . . . . . . . . . . . . . . . 31
Distribution-at-Death Rules. . . . . . . . . . . . . . . . . . . . . . . . 31
Diversification Standards. . . . . . . . . . . . . . . . . . . . . . . . . 32
Tax-Favored Retirement Programs. . . . . . . . . . . . . . . . . . . . . . 32
Traditional Individual Retirement Annuities . . . . . . . . . . . . . 33
Roth Individual Retirement Annuities. . . . . . . . . . . . . . . . . 33
SIMPLE Individual Retirement Annuities. . . . . . . . . . . . . . . . 33
Tax-Sheltered Annuities . . . . . . . . . . . . . . . . . . . . . . . 33
Simplified Employee Pensions. . . . . . . . . . . . . . . . . . . . . 33
Corporate and Self-Employed (H.R. 10 and Keogh) Pension
and Profit Sharing Plans. . . . . . . . . . . . . . . . . . . . . . 33
Deferred Compensation Plans of State and Local Governments
and Tax-Exempt Organizations. . . . . . . . . . . . . . . . . . . . 33
Distributions Under Tax-Favored Retirement Programs. . . . . . . . . . . . 33
Federal and State Income Tax Withholding . . . . . . . . . . . . . . . . . 34
Impact of Taxes on National Integrity. . . . . . . . . . . . . . . . . . . 34
Transfers Among Investment Options . . . . . . . . . . . . . . . . . . . 34
<PAGE>
PAGE
SECTION 8 - ADDITIONAL INFORMATION
Systematic Withdrawals . . . . . . . . . . . . . . . . . . . . . . . . . . 35
Income Plus Withdrawal Program . . . . . . . . . . . . . . . . . . . . . . 35
Dollar Cost Averaging. . . . . . . . . . . . . . . . . . . . . . . . . . . 36
Customized Asset Rebalancing . . . . . . . . . . . . . . . . . . . . . . . 36
Asset Allocation and Rebalancing Program . . . . . . . . . . . . . . . . . 36
Systematic Contributions . . . . . . . . . . . . . . . . . . . . . . . . . 37
Performance Information. . . . . . . . . . . . . . . . . . . . . . . . . . 37
SECTION 9 - PRIOR CONTRACTS
Death Benefit Information For Contracts Issued Prior To January 1, 1997. . 38
Reduction In Charges . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
Contingent Withdrawal Charge . . . . . . . . . . . . . . . . . . . . . . . 38
Retirement Date. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
APPENDIX A - ILLUSTRATION OF A MARKET VALUE ADJUSTMENT . . . . . . . . . 41
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 B National Integrity and Custodian
Part 2 B Distribution of the Contracts
Part 3 B Performance Information
Part 4 B Determination of Annuity Unit Values
Part 5 B 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 (Pinnacle)
Name:
------------------------------------
Address:
----------------------------------
City: State: Zip:
-------------------------------- --------- ---------
<PAGE>
PART I
SECTION 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. If a Joint Owner is named, the contract
rights are shared with the Owner. Contract changes or any transactions allowed
under the contract require both signatures. The rules governing distribution at
death apply when the first Owner dies. See Section 7, "Distribution-at-Death
Rules."
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 I, Section 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 I, Section 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 I, Section 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 I, Section 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 I,
Section 5. To select Investment Options most suitable for you, see Part I,
Section 3, "Your Investment Options."
1
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VARIABLE ACCOUNT OPTIONS
The Variable Account Options invest in shares of corresponding investment
portfolios of the Funds, each 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 a Fund, see each Fund's
prospectus and the Fund's Statement of Additional Information.
ACCOUNT VALUE, ADJUSTED ACCOUNT VALUE AND CASH VALUE
The sum of your values under the 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 I,
Section 5. Transfers from any Investment Option must be for at least $250.
Transfers may be arranged through our telephone transfer service. See
"Transfers" in Part I, Section 5. Transfers may also be made under special
services we offer to dollar cost average or rebalance your investment in the
Variable Account Options. See "Dollar Cost Averaging" and "Customized Asset
Rebalancing" in Part I, Section 8.
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 I, Section 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 I,
Section 4, "Deductions and Charges."
Investment management fees and other expenses are deducted from amounts invested
by the Separate Account in the Funds.
For providing investment management services to the BT Funds Trust, Bankers
Trust Company (BANKERS TRUST) receives fees from the EAFE-Registered
Trademark- Equity Index Fund, the Equity 500 Index Fund, and the Small Cap
Index Fund (each a BT FUND and together BT FUNDS) based on the net assets of
each Fund after waivers at a rate of .34% for the EAFE-Registered Trademark-
Equity Index Fund, .11% for the Equity 500 Index Fund, and .22% for the Small
Cap Index Fund. The expenses reflect a voluntary undertaking by Bankers
Trust to waive or reimburse expenses.
For providing investment management services to the Portfolios of the Legends
Fund, Integrity Capital Advisors, Inc. (INTEGRITY CAPITAL ADVISORS), the
investment adviser of the Legends Fund, receives fees ranging from an annual
rate of .65% to 1.05% of the average net assets of the Portfolios.
For providing investment management services to the Portfolios of Fidelity's VIP
Funds, Fidelity Management and Research Company (FMR) receives fees from the
Portfolios based on the average net assets of each Portfolio. The highest annual
rate at which any of the Portfolios of Fidelity's VIP Funds paid advisory fees
in 1997 was .60% of average net assets.
For providing investment management services to the Portfolios of the Janus
Aspen Series, Janus Capital Corporation (JANUS) receives fees from the
Portfolios based on the net assets of each Portfolio. The highest annual rate
at which any of the Janus Portfolios paid advisory fees in 1997 was .76% of
average net assets. Please see Table of Annual Fees and Expenses for rates
associated with specific Portfolios.
2
<PAGE>
For providing investment management services to the J.P. Morgan Series, J.P.
Morgan Investment Management Inc. (JPMIM) receives fees based on the net assets
of the Portfolios at a rate of .30% from the J.P. Morgan Bond Portfolio and .60%
from the J.P. Morgan International Opportunities Portfolio.
A Fund's advisory fees cannot be increased without the consent of its
shareholders. See "Table of Annual Fees and Expenses" below and the discussions
relating to the various investment advisers and sub-advisers in Part I, Section
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 I, Section 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 I, Section 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. 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. 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 I,
Section 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 I, Section 7, "Tax Aspects of the Contracts." 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.
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
<TABLE>
<CAPTION>
Contract Owner Transaction Expenses
- -----------------------------------
<S> <C>
Sales Load on Purchases. . . . . . . . . . . . . . . . . . . . . . . . $0
Deferred Sales Load (1). . . . . . . . . . . . . . . . . . . . 7% Maximum
Exchange Fee (2) . . . . . . . . . . . . . . . . . . . . . . . . . . . $0
Annual Administrative Charge (3) . . . . . . . . . . . . . . . . . . . $30
<CAPTION>
Separate Account Annual Expenses
(As a Percentage of Average Account Value) (4)
- ----------------------------------------------
<S> <C>
Mortality and Expense Risk Charge. . . . . . . . . . . . . . . . . . .1.20%
Administrative Expenses. . . . . . . . . . . . . . . . . . . . . . . . .15%
-----
Total Separate Account Annual Expenses . . . . . . . . . . . . . . . .1.35%
-----
-----
<CAPTION>
Portfolio Annual Expenses After Waivers/Reimbursements
(as a percentage of average net assets)
- ---------------------------------------
<S>
Management Other Total Annual
Portfolio Fees(5) Expenses Expenses
- --------- ------- -------- --------
<S> <C> <C> <C>
EAFE-Registered Trademark- Equity Index. . . . . . . . 0.34%(6)(7) 0.31%(6)(7) 0.65%(6)(7)
Equity 500 Index . . . . . . . . . . . . . . . . . . . 0.11%(6)(7) 0.19%(6)(7) 0.30%(6)(7)
Small Cap Index. . . . . . . . . . . . . . . . . . . . 0.22%(6)(7) 0.23%(6)(7) 0.45%(6)(7)
VIP Equity-Income. . . . . . . . . . . . . . . . . . . 0.50% 0.08% 0.58%(8)
VIP II Contrafund. . . . . . . . . . . . . . . . . . . 0.60% 0.11% 0.71%(8)
VIP III Growth & Income. . . . . . . . . . . . . . . . 0.49% 0.21% 0.70%
VIP III Growth Opportunities . . . . . . . . . . . . . 0.60% 0.14% 0.74%(8)
Harris Bretall Sullivan & Smith Equity Growth. . . . . 0.65% 0.38% 1.03%(9)
Scudder Kemper Value . . . . . . . . . . . . . . . . . 0.65% 0.40% 1.05%(9)
Zweig Asset Allocation . . . . . . . . . . . . . . . . 0.90% 0.38% 1.28%(9)
Zweig Equity (Small Cap) . . . . . . . . . . . . . . . 1.05% 0.50% 1.55%(9)
Janus Aspen Capital Appreciation . . . . . . . . . . . 0.23%(10) 1.03%(10) 1.26%(10)
Janus Aspen Balanced . . . . . . . . . . . . . . . . . 0.76%(10) 0.07%(10) 0.83%(10)
Janus Aspen Worldwide Growth . . . . . . . . . . . . . 0.66%(10) 0.08%(10) 0.74%(10)
Janus Aspen Money Market . . . . . . . . . . . . . . . 0.22%(10) 0.28%(10) 0.50%(10)
J.P. Morgan International Opportunities. . . . . . . . 0.60% 0.60%(11) 1.20%(11)
J.P. Morgan Bond . . . . . . . . . . . . . . . . . . . 0.30% 0.45%(11) 0.75%(11)
Morgan Stanley Asian Equity. . . . . . . . . . . . . . 0.00%(12) 1.20%(12) 1.20%(12)
Morgan Stanley Emerging Markets Debt . . . . . . . . . 0.00%(12) 1.30%(12) 1.30%(12)
Morgan Stanley High Yield. . . . . . . . . . . . . . . 0.00%(12) 0.80%(12) 0.80%(12)
Morgan Stanley U.S. Real Estate. . . . . . . . . . . . 0.00%(12) 1.10%(12) 1.10%(12)
</TABLE>
- -------------------------
(1) See "Deductions and Charges - Contingent Withdrawal Charge" in Part I,
Section 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, asset allocation and
rebalancing or customized asset rebalancing. See "Deductions and Charges -
Transfer Charge" in Part I, Section 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 I, Section 4.
4
<PAGE>
(4) See "Deductions and Charges - Separate Account Charges" in Part I, Section
4.
(5) The stated management fee is the highest applicable rate, or, with respect
to the Janus Portfolios is for the year ended December 31, 1997. The fee for
certain portfolios may be reduced as assets increase. See Part I, Section 3 -
Your Investment Options for the applicable fee rates for particular portfolios.
(6) Estimated.
(7) The fees and expenses in the table show the costs that an investor will
bear directly or indirectly as a shareholder of the Fund. Bankers Trust has
voluntarily agreed to waive a portion of its management fee with respect to each
Fund. Without such waiver, each Fund's management fee would be equal to the
following: EAFE Equity Index - 0.45%; Equity 500 Index - 0.20% and Small Cap
Index - 0.35%. The expense table reflects a voluntary undertaking by Bankers
Trust to waive or reimburse expenses such that the total annual expenses of the
Fund for the fiscal year will not exceed the following percentages of the Funds'
average daily net assets; EAFE Equity Index - 0.65%; Equity 500 Index - 0.30%
and Small Cap Index - 0.45%. In the absence of this undertaking, "Total Annual
Expenses" would be the following: EAFE Equity Index - 0.85%; Equity 500 Index -
0.54% and Small Cap Index - 0.73%. The example should not be considered a
representation of past or future expenses and actual expenses may be greater or
less than those shown.
(8) A portion of the brokerage commissions that certain of Fidelity's VIP Funds
pay was used to reduce the Funds' expenses. In addition, certain Funds have
entered into arrangements with their custodian whereby credits realized, as a
result of uninvested cash balances, were used to reduce custodian expenses.
Including these reductions, the total operating expenses presented in the table
would have been 0.57% for VIP Equity-Income Portfolio, 0.68% for VIP II
Contrafund Portfolio, and 0.73% for VIP III Growth Opportunities Portfolio.
(9) Integrity Capital Advisors has agreed to reimburse each of the Legends Fund
Portfolios for operating expenses (excluding management fees) above an annual
rate of .50% of average net assets for all Portfolios of the Legends Fund.
Without reimbursements, total annual expenses for the Fund=s fiscal year ended
June 30, 1997 would have been 1.82% for the Zweig Equity (Small Cap) Portfolio.
Integrity Capital Advisors 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 1998. In the Legends Fund=s prospectus, see "Management of the
Fund."
(10) The fees and expenses in the table above are based on gross expenses before
expense offset arrangements for the fiscal year ended December 31, 1997. Fee
reductions for the Janus Aspen Balanced, Janus Aspen Capital Appreciation and
Janus Aspen Worldwide Growth Portfolios reduce the management fee to the level
of the corresponding Janus retail fund. Other waivers, if applicable, are
first applied against the management fee and then against other expenses.
Without such waivers or reductions, the Management Fee, Other Expenses, and
Total Annual Expenses would have been .72%, .09%, and .81% for Worldwide Growth
Portfolio, 1.14%, 1.05% and 2.19% for Capital Appreciation Portfolio, .77%, .06%
and 0.83% for Balanced Portfolio, and .25%, .30% and .55% for the Money Market
Portfolio. Janus may modify or terminate the waivers or reductions at any time
upon at least 90 days' notice to the Trustees.
(11) The information in the foregoing table has been restated to reflect a
voluntary agreement by Morgan Guaranty Trust Company of New York, an affiliate
of JPMIM, to reimburse the Trust to the extent certain expenses exceed in any
fiscal year 1.20% and .75% of the average daily net assets of J.P. Morgan
International Opportunities Portfolio and J.P. Morgan Bond Portfolio,
respectively. Absent such agreement, the Other Expenses and Total Annual
Expenses for the fiscal year ended December 31, 1997 would have been as follows:
3.65% and 4.25% for the International Opportunities Portfolio, and 1.61% and
1.91% for the Bond Portfolio.
(12) The Portfolios' expenses were voluntarily waived and reimbursed by the
Portfolios' investment advisers. Absent waiver and/or reimbursement the
Management Fee, Other Expenses and Total Annual Expenses would have been as
follows: .80%, 2.30% and 3.10% for the Asian Equity Portfolio for the annualized
period March 3, 1997 through December 31, 1997; .80%, 1.26% and 2.06% for the
Emerging Markets Debt Portfolio for the annualized period June 16, 1997 through
December 31, 1997; .50%, 1.18% and 1.68% for the High Yield Portfolio for the
annualized period January 2, 1997 through December 31, 1997; and .80%, 1.52% and
2.32% for the U.S. Real Estate Portfolio for the annualized period March 3, 1997
through December 31, 1997. MSAM may modify or terminate the waivers or
redemptions at any time.
5
<PAGE>
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.
CUMULATIVE EXPENSES PER $1,000 INVESTMENT IF YOU SURRENDER YOUR CONTRACT AT THE
END OF THE APPLICABLE PERIOD:
<TABLE>
<CAPTION>
Portfolio 1 year 3 years 5 years 10 years
- --------- ------ ------- ------- --------
<S> <C> <C> <C> <C>
EAFE7 Equity Index . . . . . . . . . . . . . . . . $ 90.99 $114.75 $140.98 $238.35
Equity 500 Index . . . . . . . . . . . . . . . . . $ 87.41 $103.87 $122.66 $200.80
Small Cap Index. . . . . . . . . . . . . . . . . . $ 88.94 $108.54 $130.54 $217.06
VIP Equity-Income. . . . . . . . . . . . . . . . . $ 90.28 $112.58 $137.34 $230.95
VIP II Contrafund. . . . . . . . . . . . . . . . . $ 91.61 $116.61 $144.09 $244.65
VIP III Growth & Income. . . . . . . . . . . . . . $ 91.51 $116.30 $143.57 $243.61
VIP III Growth Opportunities . . . . . . . . . . . $ 91.92 $117.53 $145.65 $247.79
Harris Bretall Sullivan & Smith Equity Growth. . . $ 94.89 $126.47 $160.56 $277.64
Scudder Kemper Value . . . . . . . . . . . . . . . $ 95.09 $127.08 $161.59 $279.66
Zweig Asset Allocation . . . . . . . . . . . . . . $ 97.45 $134.13 $173.28 $302.67
Zweig Equity (Small Cap) . . . . . . . . . . . . . $ 100.22 $142.36 $186.85 $328.99
Janus Aspen Capital Appreciation . . . . . . . . . $ 97.24 $133.52 $172.26 $300.69
Janus Aspen Balanced . . . . . . . . . . . . . . . $ 92.84 $120.31 $150.30 $257.15
Janus Aspen Worldwide Growth . . . . . . . . . . . $ 91.92 $117.53 $145.65 $247.79
Janus Aspen Money Market . . . . . . . . . . . . . $ 89.46 $110.10 $133.16 $222.42
J.P. Morgan International Opportunities. . . . . . $ 96.63 $131.68 $169.22 $294.73
J.P. Morgan Bond. . . . . . . . . . . . . . . . . $ 92.02 $117.84 $146.16 $248.84
Morgan Stanley Asian Equity. . . . . . . . . . . . $ 96.63 $131.68 $169.22 $294.73
Morgan Stanley Emerging Markets Debt . . . . . . . $ 97.65 $134.74 $174.29 $304.64
Morgan Stanley High Yield. . . . . . . . . . . . . $ 92.53 $119.39 $148.75 $254.04
Morgan Stanley U.S. Real Estate. . . . . . . . . . $ 95.61 $128.62 $164.14 $284.71
</TABLE>
6
<PAGE>
CUMULATIVE EXPENSES PER $1,000 INVESTMENT IF YOU ELECT THE NORMAL FORM OF
ANNUITY OR DO NOT SURRENDER YOUR CONTRACT AT THE END OF THE APPLICABLE PERIOD
(I.E., NO DEFERRED SALES LOAD ASSESSED):
<TABLE>
<CAPTION>
Portfolio 1 year 3 years 5 years 10 years
- --------- ------ ------- ------- --------
<S> <C> <C> <C> <C>
EAFE7 Equity Index . . . . . . . . . . . . . . . . $20.99 $64.75 $110.98 $238.35
Equity 500 Index . . . . . . . . . . . . . . . . . $17.41 $53.87 $ 92.66 $200.80
Small Cap Index. . . . . . . . . . . . . . . . . . $18.94 $58.54 $100.54 $217.06
VIP Equity-Income. . . . . . . . . . . . . . . . . $20.28 $62.58 $107.34 $230.95
VIP II Contrafund. . . . . . . . . . . . . . . . . $21.61 $66.61 $114.09 $244.65
VIP III Growth & Income. . . . . . . . . . . . . . $21.51 $66.30 $113.57 $243.61
VIP III Growth Opportunities . . . . . . . . . . . $21.92 $67.53 $115.65 $247.79
Harris Bretall Sullivan & Smith Equity Growth. . . $24.89 $76.47 $130.56 $277.64
Scudder Kemper Value . . . . . . . . . . . . . . . $25.09 $77.08 $131.59 $279.66
Zweig Asset Allocation . . . . . . . . . . . . . . $27.45 $84.13 $143.28 $302.67
Zweig Equity (Small Cap) . . . . . . . . . . . . . $30.22 $92.36 $156.85 $328.99
Janus Aspen Capital Appreciation . . . . . . . . . $27.24 $83.52 $142.26 $300.69
Janus Aspen Balanced . . . . . . . . . . . . . . . $22.84 $70.31 $120.30 $257.15
Janus Aspen Worldwide Growth . . . . . . . . . . . $21.92 $67.53 $115.65 $247.79
Janus Aspen Money Market . . . . . . . . . . . . . $19.46 $60.10 $103.16 $222.42
J.P. Morgan International Opportunities. . . . . . $26.63 $81.68 $139.22 $294.73
J.P. Morgan Bond. . . . . . . . . . . . . . . . . $22.02 $67.84 $116.16 $248.84
Morgan Stanley Asian Equity. . . . . . . . . . . . $26.63 $81.68 $139.22 $294.73
Morgan Stanley Emerging Markets Debt . . . . . . . $27.65 $84.74 $144.29 $304.64
Morgan Stanley High Yield. . . . . . . . . . . . . $22.53 $69.39 $118.75 $254.04
Morgan Stanley U.S. Real Estate. . . . . . . . . . $25.61 $78.62 $134.14 $284.71
</TABLE>
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
Portfolios as they were for their most recent fiscal years ended or estimated
expenses (after reimbursement), if applicable. ACTUAL PORTFOLIO 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 Separate Account II as well as those of the
Portfolios. Premium taxes upon annuitization also may be applicable.
7
<PAGE>
FINANCIAL INFORMATION
The table below shows the unit value for certain Variable Account Options 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
1997 1996 1995 1994 1993 INCEPTION*
---- ---- ---- ---- ---- ---------
<S> <C> <C> <C> <C> <C> <C>
SCUDDER KEMPER VALUE
Unit value at beginning of period . . . . . . . . . $18.39 $14.98 $10.43 $10.65 $10.00
Unit value at end of period . . . . . . . . . . . . $23.67 $18.39 $14.98 $10.43 $10.65
Number of units outstanding at end of period . . . 288,596 297,625 244,538 156,325 80,112
HARRIS BRETALL SULLIVAN & SMITH EQUITY GROWTH
Unit value at beginning of period . . . . . . . . . $14.71 $13.08 $10.07 $9.81 $10.00
Unit value at end of period . . . . . . . . . . . . $19.55 $14.71 $13.08 $10.07 $9.81
Number of units outstanding at end of period . . . 404,243 438,465 374,724 280,091 83,619
ZWEIG ASSET ALLOCATION
Unit value at beginning of period . . . . . . . . . $14.45 $12.75 $10.65 $10.75 $10.00
Unit value at end of period . . . . . . . . . . . . $17.38 $14.45 $12.75 $10.65 $10.75
Number of units outstanding at end of period . . . 356,623 389,517 421,439 535,776 205,268
ZWEIG EQUITY (SMALL CAP)
Unit value at beginning of period . . . . . . . . . $14.69 $12.57 $10.52 $10.73 - $10.00
Unit value at end of period . . . . . . . . . . . . $18.14 $14.69 $12.57 $10.52 $10.73
Number of units outstanding at end of period . . . 164,970 138,864 234,629 180,961 68,249
BT EAFE 7 EQUITY INDEX
Unit value at beginning of period . . . . . . . . . - - - -
Unit value at end of period . . . . . . . . . . . . $9.88
Number of units outstanding at end of period . . . 5,623
BT EQUITY 500 INDEX
Unit value at beginning of period . . . . . . . . . - - - - $10.00
Unit value at end of period . . . . . . . . . . . . $10.32
Number of units outstanding at end of period . . . 76,431
BT SMALL CAP
Unit value at beginning of period . . . . . . . . . - - - - $10.00
Unit value at end of period . . . . . . . . . . . . $9.85
Number of units outstanding at end of period . . . 42,210
VIP EQUITY INCOME
Unit value at beginning of period . . . . . . . . . - - - - $10.00
Unit value at end of period . . . . . . . . . . . . $10.42
Number of units outstanding at end of period . . . 63,398
VIP II CONTRAFUND
Unit value at beginning of period . . . . . . . . . - - - - $10.00
Unit value at end of period . . . . . . . . . . . . $9.91
Number of units outstanding at end of period . . . 65,551
VIP III GROWTH & INCOME
Unit value at beginning of period . . . . . . . . . - - - - $10.00
Unit value at end of period . . . . . . . . . . . . $10.31
Number of units outstanding at end of period . . . 19,862
VIP GROWTH OPPORTUNITIES
Unit value at beginning of period . . . . . . . . . - - - - $10.00
Unit value at end of period . . . . . . . . . . . . $10.65
Number of units outstanding at end of period . . . 73,667
JANUS ASPEN CAPITAL APPRECIATION
Unit value at beginning of period . . . . . . . . . - - - - $10.00
Unit value at end of period . . . . . . . . . . . . $10.03
Number of units outstanding at end of period . . . 59,108
</TABLE>
8
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1997 1996 1995 1994 1993 INCEPTION*
---- ---- ---- ---- ---- ---------
<S> <C> <C> <C> <C> <C> <C>
JANUS ASPEN BALANCED
Unit value at beginning of period . . . . . . . . . - - - - $10.00
Unit value at end of period . . . . . . . . . . . . $10.01
Number of units outstanding at end of period . . . 1,827,787
JANUS ASPEN WORLDWIDE GROWTH
Unit value at beginning of period . . . . . . . . . - - - - $10.00
Unit value at end of period . . . . . . . . . . . . $9.93
Number of units outstanding at end of period . . . 20,675
JANUS ASPEN MONEY MARKET
Unit value at beginning of period . . . . . . . . . - - - - $10.00
Unit value at end of period . . . . . . . . . . . . $10.06
Number of units outstanding at end of period . . . 159,980
J.P. MORGAN INTERNATIONAL OPPORTUNITIES
Unit value at beginning of period . . . . . . . . . - - - - $10.00
Unit value at end of period . . . . . . . . . . . . $10.19
Number of units outstanding at end of period . . . 5,359
J.P. MORGAN BOND
Unit value at beginning of period . . . . . . . . . - - - - $10.00
Unit value at end of period . . . . . . . . . . . . $10.16
Number of units outstanding at end of period . . . 158,477
MORGAN STANLEY ASIAN EQUITY
Unit value at beginning of period . . . . . . . . . - - - - $10.00
Unit value at end of period . . . . . . . . . . . . $9.23
Number of units outstanding at end of period . . . 151,273
MORGAN STANLEY EMERGING MARKETS DEBT
Unit value at beginning of period - - - - $10.00
Unit value at end of period $10.88
Number of units outstanding at end of period 92,322
MORGAN STANLEY HIGH YIELD
Unit value at beginning of period . . . . . . . . . - - - - $10.00
Unit value at end of period . . . . . . . . . . . . $10.19
Number of units outstanding at end of period . . . 33,125
MORGAN STANLEY U.S. REAL ESTATE
Unit value at beginning of period . . . . . . . . . - - - - $10.00
Unit value at end of period . . . . . . . . . . . . $10.38
Number of units outstanding at end of period . . . 8,831
- --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
* The unit value for each Variable Account Option at inception is $10.00.
Inception Dates for the Variable Account Options were December 14, 1992 for the
Zweig Asset Allocation, Scudder Kemper Value and Zweig Equity Options; and
December 8, 1992 for the Harris Bretall Sullivan & Smith Equity Growth Option.
The Inception Date for each of the following: EAFE7 Equity Index, Equity 500
Index, Small Cap Index, VIP Equity-Income, VIP II Contrafund, VIP III Growth &
Income, VIP III Growth Opportunities, Janus Aspen Capital Appreciation, Janus
Aspen Balanced, Janus Aspen Worldwide Growth, Janus Aspen Money Market, J.P.
Morgan International Opportunities, J.P. Morgan Bond, Morgan Stanley Asian
Equity, Morgan Stanley Emerging Markets Debt, Morgan Stanley High Yield, and
Morgan Stanley U.S. Real Estate Options is October 1, 1997.
9
<PAGE>
SECTION 2 - NATIONAL INTEGRITY AND SEPARATE ACCOUNT II
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
underlying investment options other than the Funds, 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, 1997, ARM had $6.9
billion of assets under management.
National Integrity is currently evaluating, on an ongoing basis, its computer
systems and the systems of other companies on which National Integrity's
operations rely to determine if they will function properly with respect to
dates in the year 2000 and beyond. These activities are designed to ensure that
there is no adverse effect on National Integrity's core business operations.
While National Integrity believes its planning efforts are adequate to address
its Year 2000 concerns, there can be no guarantee that the systems of other
companies on which operations rely will be converted on a timely basis and will
not have a material effect on National Integrity.
SEPARATE ACCOUNT II AND THE VARIABLE ACCOUNT OPTIONS
Separate Account II is established and maintained under the insurance laws of
the State of New York. Separate Account II contains unit investment trust
divisions 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 Separate Account II. Each of
its Variable Account Options invests in shares of a corresponding Portfolio of
the Funds. 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 SEPARATE ACCOUNT II
Under New York law, we own the assets of Separate Account II 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 II in proportion to the amounts relating to their
contracts. Separate Account II=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
Separate Account II are credited to or charged against Separate Account II
without regard to our other income, gains or losses. We may permit charges owed
to us to stay in Separate Account II, and thus may participate proportionately
in Separate Account II. Amounts in Separate Account II 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 Separate Account II 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, Separate Account II, combine
two or more Options within Separate Account II, or withdraw assets
relating to your contract from one Option and put them into another;
- register or end the registration of Separate Account II under the 1940
Act;
10
<PAGE>
- operate Separate Account II 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);
- restrict or eliminate any voting rights of Owners or others who have
voting rights that affect Separate Account II;
- cause one or more Options to invest in a mutual fund other than or in
addition to the Funds;
- operate Separate Account II 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.
SECTION 3 - YOUR INVESTMENT OPTIONS
THE LEGENDS FUND, INC.
The Legends Fund, a Maryland corporation, 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
Legends Fund. The Legends Fund is a "series" type of investment company with
diversified portfolios. The Legends Fund does not impose a sales charge or
"load" for buying and selling its shares. The shares of the Portfolios of the
Legends Fund are bought and sold by Separate Account II at their respective net
asset values.
The Legends 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 Legends Fund currently are available to the separate accounts
of National Integrity and Integrity, the parent of National Integrity.
Shares of Portfolios of the Legends Fund are made available to Separate Account
II under a participation agreement (PARTICIPATION AGREEMENT). The Participation
Agreement is among the Legends Fund, ARM Securities Corporation (ARM
SECURITIES), a wholly owned subsidiary of ARM which is the principal underwriter
for Legends Fund shares, and National Integrity. If state or federal law
precludes the sale of the Legends Fund's or any Portfolio's shares to Separate
Account II, or in certain other circumstances, sales of shares to Separate
Account II may be suspended and/or the Participation Agreement may be terminated
as to the Legends 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 Legends Fund and
ARM Securities are obligated to continue to make the Legends 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 contractowners of different separate accounts. If
for any reason the shares of any Portfolio are no longer available for purchase
by Separate Account II 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 Separate Account II or
any Variable Account Option.
THE LEGENDS FUND'S INVESTMENT ADVISER AND SUB-ADVISERS. Integrity Capital
Advisors (formerly known as ARM Capital Advisors, Inc.) became the investment
adviser to the Legends Fund on February 1, 1996. Integrity Capital Advisors is a
wholly owned subsidiary of ARM Financial Group, Inc. (ARM), and is registered as
an investment adviser under the Investment Advisers Act of 1940. Its offices are
located at 515 West Market Street, Louisville, Kentucky 40202.
Integrity Capital Advisors has entered into a sub-advisory agreement with a
professional manager for investment of the assets of each of the Portfolios. The
sub-adviser for each Portfolio is listed under "Investment Objectives of the
Portfolios" below. The Portfolios pay monthly investment management fees to
Integrity Capital Advisors, and Integrity Capital Advisors pays the sub-advisers
for their services to the Portfolios. Integrity Capital Advisors retains a
management fee at an annual rate of .25% of each Portfolio=s net assets as
compensation for providing certain services to the Portfolios. The management
fees paid by each Portfolio to Integrity Capital Advisors as a percentage of net
assets are as follows:
11
<PAGE>
<TABLE>
<CAPTION>
Legends Fund Portfolio Management Fee
---------------------- --------------
<S> <C>
Harris Bretall Sullivan & Smith Equity Growth. . . . . . 0.65%
Scudder Kemper Value . . . . . . . . . . . . . . . . . . 0.65%
Zweig Asset Allocation . . . . . . . . . . . . . . . . . 0.90%
Zweig Equity (Small Cap) . . . . . . . . . . . . . . . . 1.05%
</TABLE>
INVESTMENT OBJECTIVES OF THE PORTFOLIOS. Set forth below is a summary of the
investment objectives of the Portfolios of the Legends Fund. There can be no
assurance that these objectives will be achieved. YOU SHOULD READ THE LEGENDS
FUND'S PROSPECTUS CAREFULLY BEFORE INVESTING.
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, LLC is the sub-adviser to the Portfolio.
SCUDDER KEMPER VALUE PORTFOLIO
Scudder Kemper 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. Scudder Kemper Investors, Inc. 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.
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.
BT INSURANCE FUNDS TRUST
The BT Funds Trust is an open-end management investment company registered under
the 1940 Act. Each of the BT Funds is a separate "series" or portfolio of the
BT Funds Trust. The BT Funds Trust does not impose a sales charge or "load" for
buying and selling its shares. Shares of the BT Funds Trust are bought and sold
by Separate Account II at their respective net asset values.
THE BANKERS TRUST FUNDS' INVESTMENT ADVISER. Bankers Trust Global Asset
Management Services, a unit of Bankers Trust, serves as the investment adviser
to the BT Funds Trust. Bankers Trust, a New York banking corporation with
executive offices at 130 Liberty Street (One Bankers Trust Plaza), New York, New
York 10006, is a wholly owned subsidiary of Bankers Trust New York Corporation.
12
<PAGE>
As of June 30, 1997, Bankers Trust New York Corporation was the seventh largest
bank holding company in the United States with total assets of approximately
$129 billion. Bankers Trust conducts a variety of general banking and trust
activities and is a major wholesaler supplier of financial services to the
international and domestic institutional markets, servicing the needs of
corporations, governments, financial institutions and private clients through a
global network of over 80 offices in more than 50 countries.
As compensation for its services to the BT Funds, Bankers Trust receives a fee
from each BT Fund, accrued daily and paid monthly. The BT Funds are subject to
the following management fee schedule (after waivers):
<TABLE>
<CAPTION>
-------------------------------------------------
FUNDS MANAGEMENT FEE
-------------------------------------------------
<S> <C>
EAFE-Registered Trademark-
Equity Index 0.34%
-------------------------------------------------
Equity 500 Index 0.11%
-------------------------------------------------
Small Cap Index 0.22%
-------------------------------------------------
</TABLE>
INVESTMENT OBJECTIVES OF THE PORTFOLIOS. Set forth below is a summary of the
investment objectives of the BT Funds Trust. There can be no assurance that
these objectives will be achieved. YOU SHOULD READ THE BT FUNDS TRUST
PROSPECTUSES CAREFULLY BEFORE INVESTING.
EAFE7 EQUITY INDEX FUND
The EAFE-Registered Trademark- Equity Index Fund seeks to replicate as
closely as possible (before the deduction of expenses) the total return of
the Morgan Stanley Capital International Europe, Australia, Far East (EAFE)
Index, a capitalization-weighted index containing approximately 1,100 equity
securities of companies located outside the United States. The BT Fund will
be invested primarily in equity securities of business enterprises organized
and domiciled outside of the United States or for which the principal trading
market is outside the United States. Statistical methods will be employed to
replicate the EAFE Index by buying most of the EAFE Index securities.
Securities purchased for the Fund will generally, but not necessarily, be
traded on a foreign securities exchange.
The Fund is not sponsored, endorsed, sold or promoted by Morgan Stanley. Morgan
Stanley makes no representation or warranty, express or implied, to the owners
of the Fund or any member of the public regarding the advisability of investing
in securities generally or in the Fund particularly or the ability of the EAFE
Index to track general stock market performance. Morgan Stanley is the licenser
of certain trademarks, service marks and trade names of Morgan Stanley and of
the EAFE Index which is determined, composed and calculated by Morgan Stanley
without regard to the issuer of the Fund or the Fund itself. Morgan Stanley has
no obligation to take the needs of the issuer of the Fund or the owners of the
Fund into consideration in determining, composing or calculating the EAFE Index.
Inclusion of a security in the EAFE Index in no way implies an opinion by Morgan
Stanley as to its attractiveness as an investment. Morgan Stanley is not
responsible for and has not participated in the determination of the timing of,
prices at, or quantities of the Fund to be issued or in the determination or
calculation of the equation by which the Fund is redeemable for cash. Morgan
Stanley has no obligation or liability to owners of the Fund in connection with
the administration, marketing or trading of the Fund. The Fund is neither
sponsored by nor affiliated with Morgan Stanley.
Although Morgan Stanley shall obtain information for inclusion in or for use in
the calculation of the indices from sources which Morgan Stanley considers
reliable, Morgan Stanley does not guarantee the accuracy and/or the completeness
of the indices or any data included therein. Morgan Stanley makes no warranty,
express or implied, as to results to be obtained by licensee, licensee's
customers and counterparties, owners of the products, or any other person or
entity from the use of the indices or any data included therein in connection
with the rights licensed hereunder or for any other use. Morgan Stanley makes
no express or implied warranties, and hereby expressly disclaims all warranties
of merchantability or fitness for a particular purpose with respect to the
indices or any data included therein. Without limiting any of the foregoing, in
no event shall Morgan Stanley have any liability for any direct, indirect,
special, punitive, consequential or any other damages (including lost profits)
even if notified of the possibility of such damages.
13
<PAGE>
For more information about the performance of the EAFE Index, see the
EAFE-Registered Trademark- Equity Index Fund's Prospectus and Statement of
Additional Information.
EQUITY 500 INDEX FUND
The Equity 500 Index Fund seeks to replicate as closely as possible (before the
deduction of expenses) the total return of the Standard & Poor's 500 Composite
Stock Price Index (the S&P 500), an index emphasizing large-capitalization
stocks. The BT Fund will include the common stock of those companies included
in the S&P 500, other than Bankers Trust New York Corporation, selected on the
basis of computer generated statistical data, that are deemed representative of
the industry diversification of the entire S&P 500.
The S&P 500 is a well-known stock market index that includes common stocks of
500 companies from several industrial sectors representing a significant portion
of the market value of all common stocks publicly traded in the United States,
most of which are listed on the New York Stock Exchange. Stocks in the S&P 500
are weighted according to their market capitalization (i.e., the number of
shares outstanding multiplied by the stock's current price). The composition of
the S&P 500 is determined by S&P and is based on such factors as the market
capitalization and trading activity of each stock and its adequacy as a
representation of stocks in a particular industry group, and may be changed from
time to time.
The Fund is not sponsored, endorsed, sold or promoted by S&P. S&P makes no
representation or warranty, express or implied, to the shareholders of the Fund
or any member of the public regarding the advisability of investing in
securities generally or in the Fund particularly or the ability of the S&P 500
to track general stock market performance.
S&P does not guarantee the accuracy and/or the completeness of the S&P 500 or
any data included therein.
S&P MAKES NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE RESULTS TO BE OBTAINED BY
THE FUND, OWNERS OF THE FUND, OR ANY OTHER PERSON OR ENTITY FROM THE USE OF THE
S&P 500 OR ANY DATA INCLUDED THEREIN. S&P MAKES NO EXPRESS OR IMPLIED
WARRANTIES AND HEREBY EXPRESSLY DISCLAIMS ALL SUCH WARRANTIES OF MERCHANTABILITY
OR FITNESS FOR A PARTICULAR PURPOSE OR USE WITH RESPECT TO THE S&P 500 OR ANY
DATA INCLUDED THEREIN.
For more information about the performance of the S&P 500, see the Equity 500
Index Fund's Prospectus and Statement of Additional Information.
SMALL CAP INDEX FUND
The Small Cap Index Fund seeks to replicate as closely as possible (before
deduction of expenses) the total return of the Russell 2000 Small Stock Index
(the RUSSELL 2000), an index consisting of 2,000 small-capitalization common
stocks. The Fund will include the common stock of companies included in the
Russell 2000, on the basis of computer-generated statistical data, that are
deemed representative of the industry diversification of the entire Russell
2000.
The Fund is neither sponsored by nor affiliated with the Frank Russell Company.
Frank Russell's only relationship to the Fund is the licensing of the use of the
Russell 2000. Frank Russell Company is the owner of the trademarks and
copyrights relating to the Russell indices.
The Fund invests in a statistically selected sample of the 2,000 stocks included
in the Russell 2000. The stocks of the Russell 2000 to be included in the Fund
will be selected utilizing a statistical sampling technique known as
"optimization." This process selects stocks for the Fund so that various
industry weightings, market capitalizations and fundamental characteristics
(e.g., price-to-book, price-to-earnings and debt-to-asset ratios and dividend
yields) closely approximate those of the Russell 2000. For instance, if 10% of
the capitalization of the Russell 2000 consists of utility companies with
relatively small capitalizations, then the Fund is constructed so that
approximately 10% of the Fund's assets are invested in the stocks of utility
companies with relatively small capitalizations. The stocks held by the Fund
are weighted to make the Fund's aggregate investment characteristics similar to
those of the Russell 2000 as a whole.
For more information about the performance of the Russell 2000, see the Small
Cap Index Fund's Prospectus and Statement of Additional Information.
14
<PAGE>
FIDELITY VARIABLE INSURANCE PRODUCTS FUNDS
Each of Fidelity's VIP Funds 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 Fidelity's
VIP Funds. Fidelity's VIP Funds are each a "series" type of investment company
with diversified portfolios. Fidelity's VIP Funds do not impose a sales charge
or "load" for buying and selling their shares. The shares of the Portfolios of
Fidelity's VIP Funds are bought and sold by Separate Account II at their
respective net asset values.
FIDELITY'S VIP FUNDS' INVESTMENT ADVISER. FMR, a registered investment
adviser under the Investment Advisers Act of 1940, serves as the investment
adviser to each Fund. FMR, whose principal address is 82 Devonshire Street,
Boston, Massachusetts, is a wholly owned subsidiary of FMR Corp. and is part
of Fidelity Investments-Registered Trademark-, one of the largest investment
management organizations in the United States. Fidelity
Investments-Registered Trademark- includes a number of different companies,
which provide a variety of financial services and products to individuals and
corporations.
FMR provides investment research and portfolio management services to mutual
funds and other clients. At April 30, 1997, FMR advised funds having more
than 29 million shareholder accounts with a total value of more than $432
billion. For certain of the Portfolios, FMR has entered into sub-advisory
agreements with affiliated companies that are part of the Fidelity
Investments-Registered Trademark- organization. FMR, not the Portfolios, pays
the sub-advisers for their services to the Portfolios.
The Portfolios of Fidelity's VIP Funds pay monthly advisory fees to FMR. The
advisory fee payable by each of the Portfolios is composed of a group fee rate
and an individual fund fee rate. The group fee rate is based on the average
monthly net assets of all mutual funds advised by FMR. For the VIP Equity-Income
and VIP II Contrafund Portfolios, the group fee rate cannot rise above .52%.
The group fee rate drops as total assets under management increase.
Set forth in the table below is the individual fund fee rate for the portfolios
and their 1997 management fee rate, comprised of the individual and group rates,
as a percentage of average net assets:
<TABLE>
<CAPTION>
-------------------------------------------------------------------------
1997
PORTFOLIO INDIVIDUAL RATE MANAGEMENT FEE
-------------------------------------------------------------------------
<S> <C> <C>
VIP Equity-Income 0.20% 0.50%
-------------------------------------------------------------------------
VIP II Contrafund 0.30% 0.60%
-------------------------------------------------------------------------
VIP III Growth & Income 0.20% 0.49%
-------------------------------------------------------------------------
VIP III Growth Opportunities 0.30% 0.60%
-------------------------------------------------------------------------
</TABLE>
INVESTMENT OBJECTIVES OF THE PORTFOLIOS. Set forth below is a summary of the
investment objectives of the Portfolios of Fidelity's VIP Funds. There can be no
assurance that these objectives will be achieved. YOU SHOULD READ FIDELITY'S VIP
FUNDS' PROSPECTUS CAREFULLY BEFORE INVESTING.
VIP EQUITY-INCOME PORTFOLIO
VIP Equity-Income Portfolio seeks reasonable income by investing primarily in
income producing equity securities, with the potential for capital
appreciation as a consideration. It normally invests at least 65% of its
assets in income-producing equity securities. The Portfolio has the
flexibility, however, to invest the balance in all types of domestic and
foreign securities, including bonds.
15
<PAGE>
VIP II CONTRAFUND PORTFOLIO
VIP II Contrafund Portfolio is a growth fund which seeks to increase the value
of your investment over the long term by investing in equity securities of
companies that are undervalued or out of favor. This approach focuses on
companies that are currently out of public favor but show potential for capital
appreciation. VIP II Contrafund Portfolio invests primarily in common stock and
securities convertible into common stock, but it has the flexibility to invest
in any type of security that may produce capital appreciation.
VIP III GROWTH & INCOME PORTFOLIO
VIP III Growth & Income Portfolio seeks high total return through a combination
of current income and capital appreciation by investing mainly in equity
securities. It invests primarily in stocks of companies that offer potential
for growth in earnings while paying dividends, but offer the potential for
capital appreciation on future income. Investments may include common and
preferred stocks, convertible securities, fixed-income securities and foreign
securities.
VIP III GROWTH OPPORTUNITIES PORTFOLIO
VIP III Growth Opportunities Portfolio seeks to provide capital growth by
investing primarily in common stocks and securities convertible into common
stock. Although the Portfolio invests in common stock and securities
convertible into common stock, it has the ability to purchase other securities,
such as preferred stock and bonds, that may produce capital growth.
JANUS ASPEN SERIES
Each of the Portfolios of Janus Aspen Series currently offers two classes of
shares. The Institutional Shares are sold under the name "Janus Aspen Series."
The Janus Aspen Series is registered with the SEC as an open-end management
investment company. The Janus Aspen Series sells and redeems its Shares at net
asset value without any sales charges, commissions or redemption fees.
THE JANUS ASPEN SERIES' INVESTMENT ADVISER. Janus, a registered investment
adviser under the Investment Advisers Act of 1940, serves as the investment
adviser to each Fund. Janus, whose principal address is 100 Fillmore Street,
Denver, Colorado 80206-4928, is approximately 83% owned by Kansas City Southern
Industries, Inc., and approximately 12% owned by Thomas H. Bailey, President and
Chairman of the Board of Janus. Janus has served as investment adviser to Janus
Fund since its inception in 1970 and currently serves as investment adviser to
all of the Janus retail funds, as well as adviser or sub-adviser to other mutual
funds and individual, corporate, charitable and retirement accounts. Janus has
been in the investment advisory business for over 26 years and as of September
1997 managed over $60 billion in assets.
The Portfolios of the Janus Aspen Series pay a management fee to Janus which is
calculated daily. Each of the Portfolios is subject to the following management
fee schedule (expressed as an annual rate):
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------
PORTFOLIO AVERAGE DAILY NET ANNUAL RATE EXPENSE LIMIT
ASSETS OF PORTFOLIO PERCENTAGE (%) PERCENTAGE (%)
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Janus Aspen Capital Appreciation First $300 Million 0.75* 1.25%
Janus Aspen Balanced Next $200 Million 0.70 N/A
Janus Aspen Worldwide Growth Over $500 Million 0.65 N/A
- ------------------------------------------------------------------------------------------
Janus Aspen Money Market All Asset Levels 0.25 0.50
- ------------------------------------------------------------------------------------------
</TABLE>
* Janus has agreed to reduce each of the Capital Appreciation, Balanced, and
Worldwide Growth Portfolios' advisory fees to the extent that such fee exceeds
the effective rate of the Janus retail fund corresponding to such Portfolio,
which are the Janus Olympus Fund, Janus Balanced Fund, and Janus Worldwide Fund,
respectively. Janus may terminate this fee reduction or any of the expense
limitations set forth above at any time upon at least 90 days' notice to the
Trustees. The effective rate is the advisory fee calculated by the
corresponding retail fund as of the last day of each calendar quarter (expressed
as an annual rate). The effective rates of Janus Olympus
16
<PAGE>
Fund, Janus Balanced Fund and Janus Worldwide Fund were .70%, .73% and .65%,
respectively, for the quarter ended March 31, 1998. Janus has agreed to limit
the expenses of the Janus Capital Appreciation Portfolio's Institutional Shares
to an annual rate of 1.25% of average net assets through at least April 30,
1999.
INVESTMENT OBJECTIVES OF THE PORTFOLIOS. Set forth below is a summary of the
investment objectives of the Portfolios of the Janus Aspen Series. There can be
no assurance that these objectives will be achieved. YOU SHOULD READ THE JANUS
ASPEN SERIES' PROSPECTUSES CAREFULLY BEFORE INVESTING.
JANUS ASPEN CAPITAL APPRECIATION PORTFOLIO
Janus Aspen Capital Appreciation Portfolio seeks long-term growth of capital.
It is a non-diversified portfolio that pursues its objective by investing
primarily in common stocks of issuers of any size, which may include larger
well-established issuers and/or smaller emerging growth companies. The
Portfolio invests primarily in common stocks of foreign and domestic companies,
and may invest to a lesser degree in other types of securities including
preferred stock, warrants, convertible securities and debt securities when its
portfolio manager perceives an opportunity for capital growth from such
securities or to receive a return on idle cash.
JANUS ASPEN BALANCED PORTFOLIO
Janus Aspen Balanced Portfolio seeks long-term capital growth, consistent
with preservation of capital and balanced by current income. It is a
diversified portfolio that, under normal circumstances, pursues its objective
by investing 40-60% of its assets in securities selected primarily for their
growth potential and 40-60% of its assets in securities selected primarily
for their income potential. The Portfolio normally invests at least 25% of
its assets in fixed-income senior securities, which include debt securities
and preferred stocks.
JANUS ASPEN WORLDWIDE GROWTH PORTFOLIO
Janus Aspen Worldwide Growth Portfolio seeks long-term growth of capital in a
manner consistent with the preservation of capital. It is a diversified
portfolio that pursues its objective primarily through investments in common
stocks of foreign and domestic issuers. The Portfolio has the flexibility to
invest on a worldwide basis in companies and other organizations of any size,
regardless of country of organization or place of principal business activity.
Janus Aspen Worldwide Growth Portfolio normally invests in issuers from at least
five different countries, including the United States. The Portfolio may at any
time invest in fewer than five countries or even a single country.
JANUS ASPEN MONEY MARKET PORTFOLIO
Janus Aspen Money Market Portfolio seeks maximum current income to the extent
consistent with stability of capital. There can be no assurance that the
Portfolio will achieve its investment objective or be able to maintain a stable
net asset value of $1.00 per share. The Portfolio will invest only in eligible
high quality, short-term money market instruments that present minimal credit
risks, as determined by Janus, the Portfolio's investment adviser, pursuant to
procedures adopted by the Trustees. The Portfolio may invest only in U.S.
dollar-denominated instruments that have a remaining maturity of 397 days or
less and will maintain a dollar-weighted average portfolio maturity of 90 days
or less.
J.P. MORGAN SERIES TRUST II
The J.P. Morgan Series is an open-end management investment company organized as
a Delaware business trust. Shares of each Portfolio are both offered and
redeemed at their net asset value without the addition of any sales load or
redemption charge. The shares of the Portfolios of J.P. Morgan Series are
bought and sold by Separate Account II at their respective net asset values.
THE J.P. MORGAN SERIES= INVESTMENT ADVISER. JPMIM is a registered investment
adviser which maintains its principal office at 522 Fifth Avenue, New York, New
York 10036. JPMIM is a wholly owned subsidiary of J.P. Morgan & Co.
Incorporated (J.P. MORGAN & CO.), a bank holding company organized under the
laws of Delaware. Through offices in New York City and abroad, J.P. Morgan &
Co., through JPMIM and its other subsidiaries, offers a wide range of services
to governmental, institutional, corporate and individual customers and acts as
investment adviser to individual and institutional clients. As of December 31,
1996, J.P. Morgan &
17
<PAGE>
Co. and its subsidiaries had total combined assets under management of
approximately $208 billion. J.P. Morgan & Co. has a long history of service as
adviser, underwriter and lender to an extensive roster of major companies and as
a financial adviser to national governments. The firm, through its predecessor
firms, has been in business for over a century and has been managing investments
since 1913.
As compensation for JPMIM's services under the Investment Advisory Agreement,
the J.P. Morgan Series has agreed to pay JPMIM a monthly fee at the following
annual rate, set forth as a percentage of the average daily net
assets of the relevant Portfolio:
<TABLE>
<CAPTION>
------------------------------------------------------
Portfolio Management Fee
------------------------------------------------------
<S> <C>
J.P. Morgan Bond Portfolio 0.30%
------------------------------------------------------
J.P. Morgan International 0.60%
Opportunities Portfolio
------------------------------------------------------
</TABLE>
INVESTMENT OBJECTIVES OF THE PORTFOLIOS. Set forth below is a summary of the
investment objectives of the Portfolios of the J.P. Morgan Series. There can be
no assurance that these objectives will be achieved. YOU SHOULD READ THE J.P.
MORGAN SERIES' PROSPECTUS CAREFULLY BEFORE INVESTING.
J.P. MORGAN BOND PORTFOLIO
J.P. Morgan Bond Portfolio seeks to provide a high total return consistent with
moderate risk of capital and maintenance of liquidity. Total return will
consist of realized and unrealized capital gains and losses plus income less
expenses. Although the net asset value of the Portfolio will fluctuate, the
Portfolio attempts to preserve the value of its investments to the extent
consistent with its objective.
J.P. MORGAN INTERNATIONAL OPPORTUNITIES PORTFOLIO
J.P. Morgan International Opportunities Portfolio seeks to provide a high total
return from a portfolio of equity securities of foreign corporations. Total
return will consist of realized and unrealized capital gains and losses plus
income less expenses. The Portfolio is designed for investors with a long-term
investment horizon who want to diversify their investments by adding
international equities and take advantage of investment opportunities outside
the U.S. The Portfolio seeks to achieve its investment objective through
country allocation and stock valuation and selection.
MORGAN STANLEY UNIVERSAL FUNDS, INC.
Each of the Morgan Stanley Universal Funds is an open-end 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 Morgan
Stanley Universal Funds. The shares of the Portfolios of the Morgan Stanley
Universal Funds are bought and sold by Separate Account II at their respective
net asset values.
THE MORGAN STANLEY UNIVERSAL FUNDS' INVESTMENT ADVISERS. The Adviser assigned to
a Portfolio provides investment advice and portfolio management services
pursuant to an Investment Advisory Agreement. MSAM serves as the Adviser for
the Emerging Markets Debt, U.S. Real Estate, and Asian Equity Portfolios. MAS
serves as the Adviser for the High Yield Portfolio. MSAM, with principal
offices at 1221 Avenue of the Americas, New York, New York 10020, conducts a
worldwide investment management businesess, providing a broad range of portfolio
management services to customers in the United States and abroad. MSAM is a
wholly owned subsidiary of Morgan Stanley, Dean Witter, Discover & Co. (MSDW), a
preeminent global financial services firm that maintains leading market
positions in each of its three primary businesses - securities, asset management
and credit services. MAS is a Pennsylvania limited liability partnership with
principal offices at One Tower Bridge, West Conshohocken, Pennsylvania 19428.
MAS is also indirectly wholly owned by MSDW. MAS provides investment advisory
services to employee benefit plans, endowment funds, foundations and other
institutional investors and has served as investment adviser to several open-end
investment companies since 1984. As of December 31, 1997, MSAM and its
institutional investment advisory affiliates (exclusive of MAS) managed assets
of approximately $86.6 billion, and MAS managed assets of approximately $59.4
billion.
18
<PAGE>
The Adviser assigned to a Portfolio is entitled to receive from such Portfolio a
management fee, payable quarterly, at an annual rate as a percentage of average
daily net assets. Each of the Portfolios is subject to the following management
fee schedule:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------------
ASSETS OF PORTFOLIO MORGAN STANLEY MORGAN STANLEY U.S. MORGAN STANLEY ASIAN MORGAN STANLEY EMERGING
HIGH YIELD REAL ESTATE EQUITY MARKETS DEBT
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
First $500 Million 0.50% 0.80% 0.80% 0.80%
- --------------------------------------------------------------------------------------------------------------------------------
Next $500 Million 0.45% 0.75% 0.75% 0.75%
- --------------------------------------------------------------------------------------------------------------------------------
More than $1 Billion 0.40% 0.70% 0.70% 0.70%
- --------------------------------------------------------------------------------------------------------------------------------
Maximum Total Annual 0.80% 1.10% 1.20% 1.30%
Operating Expenses After
Fee Waivers*
- --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
* The Advisers have voluntarily waived receipt of their management fees and
agreed to reimburse the Portfolios, if necessary, if such fees would cause the
total annual operating expenses of the Portfolio to exceed the respective
percentage of average daily net assets set forth in the table. The fee waivers
are voluntary and may be terminated by MSAM or MAS at any time without notice.
INVESTMENT OBJECTIVES OF THE PORTFOLIOS. Set forth below is a summary of the
investment objectives of the Portfolios of the Morgan Stanley Universal Funds.
There can be no assurance that these objectives will be achieved. YOU SHOULD
READ THE MORGAN STANLEY UNIVERSAL FUNDS' PROSPECTUS CAREFULLY BEFORE INVESTING.
MORGAN STANLEY ASIAN EQUITY PORTFOLIO
Morgan Stanley Asian Equity Portfolio seeks long-term capital appreciation by
investing primarily in equity securities of Asian issuers (excluding Japan)
using an approach that is oriented to the selection of individual stocks that
the Adviser believes are undervalued. The Portfolio intends to invest primarily
in equity securities that are traded on recognized stock exchanges of countries
in Asia and in equity securities of companies organized under the laws of an
Asian country whose business is conducted principally in Asia.
MORGAN STANLEY EMERGING MARKETS DEBT PORTFOLIO
Morgan Stanley Emerging Markets Debt Portfolio seeks high total return by
investing primarily in fixed income securities of government and
government-related issuers located in emerging market countries, which
securities provide a high level of current income, while at the same time
holding the potential for capital appreciation if the perceived
creditworthiness of the issuer improves due to improving economic, financial,
political, social or other conditions in the country in which the issuer is
located.
MORGAN STANLEY HIGH YIELD PORTFOLIO
Morgan Stanley High Yield Portfolio seeks above-average total return over a
market cycle of three to five years by investing primarily in a diversified
portfolio of high yield securities, including corporate bonds and other fixed
income securities and derivatives. High yield securities are rated below
investment grade and are commonly referred to as "junk bonds." The Portfolio's
average weighted maturity will ordinarily exceed five years and will usually be
between five and fifteen years.
MORGAN STANLEY U.S. REAL ESTATE PORTFOLIO
Morgan Stanley U.S. Real Estate Portfolio seeks above-average current income and
long-term capital appreciation by investing primarily in equity securities of
U.S. and non-U.S. companies principally engaged in the U.S. real estate
industry, including real estate investment trusts ("REITs").
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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 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 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 I, Section 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 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
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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. Withdrawal
charges and the administrative expense charge may invade principal.
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:
N/12 N/12
MVA = GRO Value x [(1 + A) / (1 + B + .0025) - 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.
SECTION 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.
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
21
<PAGE>
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.
REDUCTION OR ELIMINATION OF SEPARATE ACCOUNT OR ADMINISTRATIVE CHARGES
The separate account or administrative charges may be reduced or eliminated when
contract sales are made to individuals or to a group of individuals in such a
manner that results in savings of expenses. The entitlement to such a reduction
will be based on:
(1) the size and type of the group of individuals to whom the contract is
offered; and/or
(2) the amount of expected contributions.
Any reduction or elimination of the separate account or administrative charges
will not unlawfully discriminate against any person.
FUND CHARGES
Separate Account II purchases shares of the Funds at net asset value. That price
reflects investment management fees and other direct expenses that have already
been deducted from the assets of the Funds. The amount charged for investment
management may not be increased without the prior approval of a Fund's
shareholders. See Part I, Section 3, "Your Investment Options."
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 number of years that have
elapsed since 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 contribution year. No withdrawal charge applies when you
withdraw contributions made earlier than your sixth prior contribution 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 and
administrative expense charge, so that the net amount you receive will be the
amount requested.
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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>
CONTRIBUTION 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 I, Section 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.
REDUCTION OR ELIMINATION OF THE CONTINGENT WITHDRAWAL CHARGE
We may reduce or eliminate the contingent withdrawal charge when sales of the
contracts are made to individuals or a group of individuals in such a manner
that results in savings of expenses. The entitlement to such a reduction in the
contingent withdrawal charge will be based on the following:
(1) the size and type of the group of individuals to whom the contract is
offered;
(2) the amount of expected contributions; and/or
(3) whether there is a prior or existing relationship with National
Integrity, such as being an employee of National Integrity or an
affiliate, receiving distributions or making internal transfers from
other contracts issued by National Integrity, or making transfers of
amounts held under qualified plans sponsored by National Integrity or
an affiliate.
Any reduction or elimination of the contingent withdrawal charge will not
unlawfully discriminate against any person.
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 from the amount transferred for each additional transfer during that
contract year. (However, no transfer charge will apply to transfers under our
dollar cost averaging, asset allocation and rebalancing and customized 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 I, Section 5. Transfers from a GRO may be subject to a
Market Value Adjustment. See "Guaranteed Rate Options" in Part I, Section 3.
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<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.
SECTION 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 I,
Section 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 defined as any day that the New
York Stock Exchange is open.
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. See "Transfers" in Section 5.
YOUR ACCOUNT VALUE
Your Account Value reflects various charges. See Part I, Section 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 Separate Account II
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 I, Section 3.
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YOUR PURCHASE OF UNITS IN SEPARATE ACCOUNT II
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 of the Variable Account Options
fluctuates with the investment performance of the corresponding Portfolios of
the Funds which in turn reflects the investment income and realized and
unrealized capital gains and losses of the Portfolios, as well as the Funds'
expenses. The unit values also change because of deductions and charges we make
to Separate Account II. 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 in Separate Account II 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 in Separate Account II 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
Funds, 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 I, Section 3. For amounts in
GROs, transfers will be made according to the order in which monies were
originally allocated to any GRO.
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<PAGE>
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 customized asset rebalancing programs,
described in Part I, Section 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 9:00 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 (or the close of the New York
Stock Exchange, if earlier) 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.
Transfer requests submitted by agents or market timing services that represent
multiple policies will be processed not later than the next Business Day after
the requests are received by our Administrative Office.
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 I, Section 3 and "Contingent Withdrawal Charge" in Part I,
Section 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 I, Section 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 I,
Section 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
We will pay a death benefit to the Annuitant=s surviving beneficiary (or
beneficiaries, in equal shares) if the last Annuitant dies before annuity
payments have started. If the Annuitant dies at or over age 90 (or after the
contract=s 10th anniversary date, if later), the death benefit is the contract
account value at the end of the business day on which we receive due proof of
death. Similarly, if the contract was issued on or after the youngest
Annuitant=s 86th birthday, the death benefit is the contract account value at
the end of the business day on which we receive due proof of death.
For contracts issued before the Annuitant=s 86th birthday, if the Annuitant dies
before age 90 (or the contract=s 10th anniversary date, if later) and before
annuity payments have started, the death benefit is the highest of:
a) the contract account value at the end of the business day on which we
receive due proof of death;
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b) the total of all contributions; and
c) the highest contract account value on any contract anniversary which
occurred prior to the Annuitant=s 81st birthday and prior to the
Annuitant's death, plus any subsequent contributions;
each reduced on a pro rata basis for prior withdrawals (after being adjusted for
any applicable market value adjustments and/or charges). The amount of the
reduction will be determined by dividing the amount of the withdrawal by the
annuity account value on the transaction date and multiplying this percentage by
the then current guaranteed minimum death benefit.
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.
Effective November 1, 1997, the maximum issue age for the Annuitant is 82 years
old.
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.
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 Variable Account Options. 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
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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 Variable Account Options
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 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 Accounts 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 Separate
Account II. 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.
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SECTION 6 - VOTING RIGHTS
FUND VOTING RIGHTS
National Integrity is the legal owner of the shares of the Funds held by
Separate Account II and, as such, has the right to vote on certain matters.
Among other things, we may vote to elect a Fund's Board of Directors, to ratify
the selection of independent auditors for a Fund, and on any other matters
described in a 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 Separate Account II, 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 a Fund in our own right or to
restrict Owner voting, we may do so.
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 a
Fund's Board for a Fund's shareholders' meeting. The record date for this
purpose must be no more than 60 days before the meeting of a 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 a 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 I, Section 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.
SECTION 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
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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 our understanding of the present federal income
tax laws as currently interpreted by the Internal Revenue Service (IRS) and
various courts. 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 tax 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.
TAX STATUS OF NATIONAL INTEGRITY
National Integrity is taxed as a life insurance company under Part I of
Subchapter L of the Internal Revenue Code of 1986, as amended (the CODE). Since
Separate Account II is not a separate entity from National Integrity and their
operations form a part of National Integrity, they will not be taxed separately
as Aregulated investment companies@ under Subchapter M of the Code. Investment
income and realized capital gains on the assets of Separate Account II are
reinvested and taken into account in determining the accumulation value. Under
existing federal income tax law, Separate Account II=s investment income,
including realized net capital gains, is not taxed to National Integrity.
National Integrity reserves the right to make a deduction for taxes should they
be imposed with respect to such items in the future. Finally, the individual
(or employer) may purchase the annuity to fund a Roth IRA (contributions are
with after-tax dollars and earnings are excluded in taxable income at
distribution).
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 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, 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.
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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) part of a series of substantially equal periodic payments (not
less frequently than annually) for the life (or life expectancy) of the taxpayer
or joint lives (or joint life expectancies) of the taxpayer and beneficiary; (4)
attributable to the taxpayer becoming disabled within the meaning of Code
Section 72(m)(7); (5) from certain qualified plans (note, however, other
penalties may apply); (6) under a qualified funding asset (as defined in Section
130(d) of the Code); (7) purchased by an employer on termination of certain
types of qualified plans and held by the employer until the employee separates
from service; (8) under an immediate annuity as defined in Code Section
72(u)(4); or (9) purchase of a first home (distribution up to $10,000,
applicable to IRAs only).
However, the withdrawal provisions of your contract still apply. See
"Withdrawals" in Section 5.
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.
DIVERSIFICATION STANDARDS
Each Portfolio of the Funds 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
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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 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.
TRADITIONAL INDIVIDUAL RETIREMENT ANNUITIES
Code Section 408(b) permits eligible individuals to contribute to an individual
retirement program known as a Traditional IRA. An individual who receives
compensation and who has not reached age 70-1/2 by the end of the tax year may
establish a Traditional IRA and make contributions up to the deadline for filing
his or her federal income tax return for that year (without extensions).
Traditional 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
Traditional IRA, Roth IRA or another tax-favored retirement program to a
Traditional IRA contract. Your Traditional IRA contract will be issued with a
rider outlining the special terms of your contract which apply to Traditional
IRAs. The Owner will be deemed to have consented to any other amendment unless
the Owner notifies us that he or she does not consent within 30 days from the
date we mail the amendment to the Owner.
ROTH INDIVIDUAL RETIREMENT ANNUITIES
Section 408(A) of the Code permits eligible individuals to contribute to an
individual retirement program known as a Roth IRA. An individual who receives
compensation may establish a Roth IRA and make contributions up to the deadline
for filing his or her federal income tax return for that year (without
extensions). Roth IRAs are subject to limitations on the amount that may be
contributed, the persons who are eligible to contribute, and on the time when a
tax-favored distribution may commence. An individual may also rollover amounts
distributed from another Roth IRA or Traditional IRA to a Roth IRA contract.
Your Roth IRA contract will be issued with a rider outlining the special terms
of your contract which apply to Roth IRAs. Any amendment made for the purpose
of complying with provisions of the Code and related regulations may be made
without the consent of the Owner. The Owner will be deemed to have consented to
any other amendment unless the Owner notifies us that he or she does not consent
within 30 days from the date we mail the amendment to the Owner.
SIMPLE INDIVIDUAL RETIREMENT ANNUITIES
Currently we do not issue Individual Retirement Annuities known as a "SIMPLE
IRA" as defined in Section 408(p) of the Code.
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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.
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
Traditional 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
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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.
The Taxpayer Relief Act of 1997 creating Roth IRAs eliminates mandatory
distribution at age 70-1/2 for Roth IRAs.
Distributions from a tax-favored plan (not including a Traditional IRA subject
to Code Section 408 or a Roth IRA) 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 Traditional 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.
FEDERAL AND STATE INCOME TAX WITHHOLDING
When required, 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 Integrity at or before the time of the distribution of an
election not to have any amounts withheld. In certain circumstances, 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%. The withholding rate applicable to eligible rollover
distributions is 20% unless such distribution is paid directly to an eligible
retirement plan.
Certain states have indicated that a 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 ON NATIONAL INTEGRITY
The contracts provide that National Integrity may charge Separate Account II 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.
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SECTION 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 I, Section 4. AMOUNTS WITHDRAWN UNDER THE SYSTEMATIC WITHDRAWAL PROGRAM
IN EXCESS OF THE FREE WITHDRAWAL AMOUNT WILL BE SUBJECT TO A CONTINGENT
WITHDRAWAL CHARGE, AN ADMINISTRATIVE EXPENSE 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 I, Section 7, "Tax Aspects of the Contracts."
INCOME PLUS WITHDRAWAL PROGRAM
We offer the Income Plus Withdrawal Program that allows you to pre-authorize
substantially equal periodic withdrawals from your contract prior to your
reaching age 59-1/2. Income Plus Withdrawals are exempt from the 10% penalty
tax, normally applicable to early distributions made prior to age 59-1/2. See
"Taxation of Annuities Generally," in Section 7. Once distributions begin they
should not be changed or stopped until the later of age 59-1/2 or five years
from the date of the first distribution. If you change or stop the distribution
or take an additional withdrawal, you may be liable for the 10% penalty tax that
would have otherwise been due on all prior distributions made under the Income
Plus Program and for any interest thereon.
The Income Plus Withdrawal Program may be elected at any time if you are below
age 59-1/2. You can elect this option by submitting the proper election form to
our Administrative Office. 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. We will
calculate the amount of the distribution under a method selected by you. The
minimum Income Plus Withdrawal currently is $100. You must also specify an
account for direct deposit of your Income Plus Withdrawals.
To enroll under our Income Plus 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 seven Business Days prior
written notice, and we may terminate or amend the Income Plus 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. This program is not available in
concert with the Systematic Withdrawal Program, Dollar Cost Averaging, or Asset
Allocation and Rebalancing Program.
Amounts withdrawn by you under the Income Plus 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 INCOME PLUS WITHDRAWAL PROGRAM IN EXCESS
OF THE FREE WITHDRAWAL AMOUNT WILL BE SUBJECT TO A CONTINGENT WITHDRAWAL CHARGE
AND A MARKET VALUE ADJUSTMENT IF APPLICABLE.
35
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DOLLAR COST AVERAGING
We offer a dollar cost averaging program under which allocations to the Janus
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 Janus 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.
CUSTOMIZED ASSET REBALANCING
We offer a customized 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 customized 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 customized asset rebalancing program.
To enroll under our customized 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
customized asset rebalancing program. You should, therefore, monitor your use
of such other programs, transfers, and withdrawals while the customized 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 customized asset rebalancing program at any time.
ASSET ALLOCATION AND REBALANCING PROGRAM
We also offer an Asset Allocation and Rebalancing Program developed in
consultation with Callan Associates (MODEL(s)). Callan Associates is an
independent research and consulting firm, specializing in the strategic asset
allocation decision.
You may select one of five proposed Models: Conservative, Moderately
Conservative, Moderate, Moderately Aggressive, or Aggressive. Your current
contribution allocations will be initially allocated among the Options currently
established for each Model. You and your financial representative also have the
option to design a program that is tailored to your specific retirement needs.
When selecting this program, contributions will be allocated and your variable
portfolios will be rebalanced at least annually as recommended by the Asset
Allocation & Rebalancing Program. The program applies to all contributions made
to your annuity contract. You will receive a confirmation notice after each
rebalancing. No transfer charge will apply to transfers under the Asset
Allocation and Rebalancing Program, nor will such transfers count toward the
twelve transfers you may make in a contract year before we may impose a transfer
charge. See "Transfer Charges" in Part I, Section 4.
In each investor profile, a portion of all contributions is allocated to a
five-year Guaranteed Rate Option (GRO). The amount allocated to the GRO will
not be reallocated or rebalanced while participating in a specific investor
profile. You may cancel or change the investment profile you have selected at
any time. However, the GRO funds may be subject to a market value adjustment
(MVA) that may increase or decrease your account value.
36
<PAGE>
To enroll under the Asset Allocation and Rebalancing Program, complete the
Dollar Cost Averaging/Asset Allocation and Rebalancing form (Catalog #1814)
found in the back of this prospectus. You should be aware that other allocation
programs, such as dollar cost averaging, as well as additions, transfers and
withdrawals that you make, may not work in concert with the Customized Asset
Rebalancing program. If, after selecting one of the five Models, you initiate a
transaction that results in a reallocation outside one of the Models, your
participation in the Model program is automatically terminated. You should,
therefore, monitor your use of such other programs, transfers, and withdrawals
while the Customized Asset Rebalancing program is in effect. This program is
not available in concert with the Customized Asset Rebalancing program. We
reserve the right to terminate or amend this program in whole or in part, or to
place restrictions on contributions to the program. This program may not be
available in all states.
You may terminate participation in this program upon one day's prior written
notice.
SYSTEMATIC CONTRIBUTIONS
We offer a program for systematic contributions that allows you to pre-authorize
monthly, quarterly, or semi-annual 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 Janus 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 Janus Aspen 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 J.P. Morgan
Bond 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.
37
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SECTION 9 - PRIOR CONTRACTS
DEATH BENEFIT INFORMATION FOR CONTRACTS ISSUED PRIOR TO JANUARY 1, 1997
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.
Notwithstanding anything in the prospectus to the contrary, for contracts issued
on or after January 1, 1995, 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.
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 totaling 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.
REDUCTION IN CHARGES
If your contract was issued on or after January 1, 1995 but before January 1,
1997, the effective annual rate of mortality, expense and administrative charges
will reduce to 1.10% after your contract has been in effect for six years.
CONTINGENT WITHDRAWAL CHARGE
If your contract was issued prior to February 15, 1997, contributions withdrawn
will be subject to a withdrawal charge of up to 7%. As shown below, this
percentage charge varies, depending upon the "age" of the contributions included
in the withdrawal, that is, the contribution 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 contribution 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
38
<PAGE>
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>
CONTRIBUTION 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 that 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.
FOR CONTRACTS ISSUED PRIOR TO FEBRUARY 15, 1997, THE FOLLOWING SHALL APPLY:
RETIREMENT DATE
For Contracts issued prior to January 1, 1997, the Retirement Date will be the
date you specify, but no later than your 85th birthday or the 10th Contract
Anniversary, whichever is later.
CALLAN ASSET ALLOCATION AND REBALANCING PROGRAM
The Callan Asset Allocation and Rebalancing Program utilizes the 4-year
Guaranteed Rate Option for the Fixed Income Investment Sector of the Model.
HARDSHIP WAIVERS
Hardship Waivers are not available.
39
<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:
48/12 48/12
-0.0551589 = [(1 + .05) / (1 + .0625 + .0025) ] - 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
40
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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:
48/12 48/12
.0290890 = [(1 + .05) / (1 + .04 + .0025) ] - 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
41
<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.
42
<PAGE>
RULE 497 (c)
FILE NO. 33-51126
STATEMENT OF ADDITIONAL INFORMATION
MAY 1, 1998
FOR
PINNACLE(VERSION III)
FLEXIBLE PREMIUM VARIABLE ANNUITY
ISSUED BY
NATIONAL INTEGRITY LIFE INSURANCE COMPANY
AND
FUNDED THROUGH ITS SEPARATE ACCOUNT II
TABLE OF CONTENTS
Page
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. . . . . . . . . . . . . . . . 10
Part 5 - Financial Statements. . . . . . . . . . . . . . . . . . . . . . . . 11
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, 1998.
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.
In June 1997, ARM Financial completed an initial public offering (the
"Offering") of 9.2 million shares of Class A common stock, par value of $.01 per
share (the "New Class As Common Stock"), of which 5.75 million shares were sold
by ARM Financial and 3.45 million shares were sold by the Morgan Stanley
Stockholders (as defined below). Concurrent with the closing of the Offering,
ARM Financial amended and restated its Certificate of Incorporation to
effectuate a recapitalization such that (i) the common equity of ARM Financial
consists of New Class A Common Stock and Class B Non-Voting Common Stock, par
value of $.01 per share (the "New Class B Common Stock" and, together with the
New Class A Common Stock, the "New Common Stock"), (ii) authorized shares of the
New Class A Common Stock and New Class B common Stock were increased to 150
million shares and 50 million shares, respectively, (iii) each outstanding share
of common stock of ARM Financial was converted into one share of New Class A
Common Stock, (iv) certain shares of the New Class A Common Stock owned by
private equity funds sponsored by Morgan Stanley, Dean Witter, Discover & Co.
(the successor to Morgan Stanley Group Inc. in its merger with Dean Witter,
Discover & Co.) (the "Morgan Stanley Stockholders") were converted into New
Class B Common Stock such that, after giving effect to such conversion, but not
giving effect to the Offering, the Morgan Stanley Stockholders owned, in the
aggregate, 49% of the outstanding New Class A Common Stock, and (v) each share
of New Common Stock was split into 706 shares of New Common Stock. Holders of
New Class B Common Stock have not right to vote on matters submitted to a vote
of stockholders, except in certain circumstances. Shares of the New Class B
Common Stock have no preemptive or other subscription rights and are convertible
into an equal number of shares of New Class A Common Stock (1) at the option of
the holder thereof to the extent that, following such conversion, the Morgan
Stanley Stockholders will not, in the aggregate, own more than 49% of the
outstanding shares of New Class A Common Stock, and (2) automatically upon the
transfer of such shares by any Morgan Stanley Stockholder to a person that is
not a Morgan Stanley Stockholder or an affiliate of a Morgan Stanley
Stockholder. The Morgan Stanley Stockholders owned approximately 91% of the
outstanding shares of ARM Financial's common stock prior to the Offering and
approximately 53% following the Offering.
National Integrity is currently evaluating, on an ongoing basis, its computer
systems and the systems of other companies on which National Integrity's
operations rely to determine if they will function properly with respect to
dates in the year 2000 and beyond. These activities are designed to ensure that
there is no adverse effect on National Integrity's core business operations.
While National Integrity believes its planning efforts are adequate to address
its year 2000 concerns, there can be no guarantee that the systems of other
companies on which National Integrity's operations rely will be converted on a
timely basis and will not have a material effect on National Integrity.
No person has the direct or indirect power to control Morgan Stanley, Dean
Witter, Discover & Co., 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, Dean Witter, Discover & Co., is publicly held; no individual
beneficially owns more than 5% of the common shares; however, approximately 13%
of such shares are subject to a stockholders' agreement or voting agreement
among certain current and former principals and employees of Morgan Stanley,
Dean Witter, Discover & Co., and its predecessor.
2
<PAGE>
On April 22, 1998, ARM filed a registration statement with the SEC for a
secondary offering of 10 million shares of its Class A Common Stock (the
"Secondary Offering"). The Morgan Stanley Stockholders propose to sell all 10
million shares and, if the underwriters' over-allotment is exercised, up to an
additional 1.5 million shares. The Secondary Offering is expected to be made in
May 1998 through a syndicate of underwriters led by Morgan Stanley & Co.
Incorporated.
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 1996 and 1997, including services
applicable to the Registrant, were $6,007,766 and $5,855,216, respectively.
National Integrity is the custodian for the shares of Portfolios owned by the
Separate Account. The Portfolios' 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.
We generally pay a maximum distribution allowance of 6.5% of initial
contributions. The amount of distribution allowances paid was $223,270, $51,204,
$123,719 and $684,838 for the years ended December 31, 1997, 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 other information furnished to shareholders. The Janus
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.
3
<PAGE>
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.
Nonstandardized "total return" will be calculated in a similar manner and for
the same time periods as the average annual total return and for three years
except total return will assume an initial investment of $60,000 and will not
reflect the deduction of any applicable contingent withdrawal charge, which, if
reflected, would decrease the level of performance shown. The contingent
withdrawal charge is not reflected because the contracts are designed for long
term investment. An assumed initial investment of $60,000 will be used because
that figure more closely approximates the size of a typical contract than does
the $1,000 figure used in calculating the standardized average annual total
return quotations. The amount of the hypothetical initial investment assumed
affects performance because the annual administrative charge is a fixed per
contract charge. For purposes of determining these investment results, the
actual investment performance of each fund is reflected as of the date each fund
commenced operations although the Contracts were not available at that time.
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
n
annual returns are calculated pursuant to the following formula: P(1+T) = 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.
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:
365/7
Effective Yield = {(Base Period Return) + 1) } - 1
4
<PAGE>
<TABLE>
<CAPTION>
For the period ending: 12/31/97 All figures are unaudited
SEC STANDARDIZED
RETURNS WITH SURRENDER CHARGES VARIABLE AVERAGE ANNUAL RETURN (1)
ACCOUNT ------------------------------------
INCEPTION LIFE OF
VARIABLE OPTIONS DATE (2) 1 YEAR 5 YEAR 10 YEAR ACCOUNT
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BT Insurance Funds Trust - EAFE Equity Index 11/6/97 n/a n/a n/a x.xx%
BT Insurance Funds Trust - Equity 500 Index 11/6/97 n/a n/a n/a x.xx
BT Insurance Funds Trust - Small Cap Index 11/6/97 n/a n/a n/a x.xx
Fidelity's VIP Equity-Income 11/7/97 n/a n/a n/a x.xx
Fidelity's VIP II Contrafund 11/6/97 n/a n/a n/a x.xx
Fidelity's VIP III Growth & Income 11/6/97 n/a n/a n/a x.xx
Fidelity's VIP III Growth Opportunities 11/12/97 n/a n/a n/a x.xx
Harris Bretall Sullivan & Smith Equity Growth 1/12/93 25.92 n/a n/a 14.09
Janus Aspen Series Balanced 11/5/97 n/a n/a n/a x.xx
Janus Aspen Series Capital Appreciation 11/7/97 n/a n/a n/a x.xx
Janus Aspen Series Worldwide Growth 11/6/97 n/a n/a n/a x.xx
JP Morgan Bond 11/12/97 n/a n/a n/a x.xx
JP Morgan International Opportunites 11/18/97 n/a n/a n/a x.xx
Morgan Stanley Asian Equity 11/11/97 n/a n/a n/a x.xx
Morgan Stanley Emerging Markets Debt 11/14/97 n/a n/a n/a x.xx
Morgan Stanley High Yield 11/11/97 n/a n/a n/a x.xx
Morgan Stanley U.S. Real Estate 11/17/97 n/a n/a n/a x.xx
Scudder Kemper Value 1/12/93 21.71 n/a n/a 18.64
Zweig Asset Allocation 3/26/93 13.30 n/a n/a 11.89
Zweig Equity (Small Cap) 1/14/93 16.42 n/a n/a 12.37
Select Ten Plus n/a n/a n/a n/a n/a
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Standard average annual return reflects past fund performance based on a
$1,000 hypothetical investment period over the indicated. The performance
figures reflect the deduction of mortality and expenses and administrative
charges totaling 1.35%. They also reflect any withdrawal charges that
would apply if an owner terminated the policy at the end of the period, but
exclude deductions for the applicable premium tax charges. Surrender
charges are 8% in year one, declining 1% annually in years one through
seven, 0% thereafter.
(2) Inception date of the variable account option represents first trade date.
Returns for accounts in operation for less than one year are not
annualized.
(3) Non-standard returns reflect all historical investment results, less
mortality and expense and administrative charges totaling 1.35%. The
calculation assumes the policy is still in force and therefore does not
take withdrawal charges into consideration.
(4) Italicized returns are calculated from the inception date through
year-end.
(5) Represents the inception date of the underlying funds. Performance data
for periods prior to the actual inception of the variable account options
is hypothetical and based on the performance of the underlying funds. This
performance data has been adjusted to include all insurance company
contract charges and management fees of the underlying funds.
5
<PAGE>
<TABLE>
<CAPTION>
For the period ending: 12/31/97 PLEASE SEE PRIOR PAGE FOR FOOTNOTES 3, 4, AND 5.
RETURNS WITHOUT SURRENDER CHARGES (3)
CUMULATIVE TOTAL RETURN AVERAGE ANNUAL RETURN
FUND ---------------------------------------------------------------------------
INCEPTION LIFE OF LIFE OF
VARIABLE OPTIONS DATE(5) 3 YEAR 5 YEAR 10 YEAR FUND 1 YEAR 3 YEAR 5 YEAR 10 YEAR FUND
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
BT Insurance Funds Trust - EAFE Equity Index 6/21/96 n/a n/a n/a 1.35% 0.40% n/a n/a n/a 0.88%
BT Insurance Funds Trust - Equity 500 Index 12/31/92 101.62 104.30 n/a 104.30 26.77 26.33 15.36 n/a 15.36
BT Insurance Funds Trust - Small Cap Index 8/13/96 n/a n/a n/a 37.32 23.98 n/a n/a n/a 25.78
Fidelity's VIP Equity-Income 10/9/86 90.98 134.04 309.79 299.24 26.38 24.07 18.54 15.15 13.12
Fidelity's VIP II Contrafund 1/3/95 n/a n/a n/a 101.88 22.47 n/a n/a n/a 26.46
Fidelity's VIP III Growth & Income 12/31/96 n/a n/a n/a 28.34 28.34 n/a n/a n/a 28.36
Fidelity's VIP III Growth Opportunities 1/3/95 n/a n/a n/a 95.57 28.20 n/a n/a n/a 25.12
Harris Bretall Sullivan & Smith Equity Growth 1/12/93 94.14 n/a n/a 95.46 32.92 24.75 n/a n/a 14.45
Janus Aspen Series Balanced 9/13/93 69.95 n/a n/a 80.52 20.45 19.34 n/a n/a 14.73
Janus Aspen Series Capital Appreciation 5/1/97 n/a n/a n/a 25.46 n/a n/a n/a n/a 40.43
Janus Aspen Series Worldwide Growth 9/13/93 92.75 n/a n/a 129.02 20.51 24.45 n/a n/a 21.26
JP Morgan Bond 1/3/95 n/a n/a n/a 22.49 7.47 n/a n/a n/a 7.01
JP Morgan International Opportunities 1/3/95 n/a n/a n/a 24.40 4.01 n/a n/a n/a 7.57
Morgan Stanley Asian Equity 12/31/91 -39.31 1.85 n/a 26.79 -43.38 -15.33 .37 n/a 4.03
Morgan Stanley Emerging Markets Debt 2/1/94 116.34 n/a n/a 64.70 15.75 29.33 n/a n/a 13.60
Morgan Stanley High Yield 8/31/92 52.57 70.10 n/a 70.87 11.22 15.12 11.21 n/a 10.57
Morgan Stanley U.S. Real Estate 1/31/95 n/a n/a n/a 102.08 22.88 n/a n/a n/a 27.29
Scudder Kemper Value 1/12/93 126.99 n/a n/a 136.68 28.71 31.42 n/a n/a 18.94
Zweig Asset Allocation 3/26/93 63.24 n/a n/a 73.85 20.30 17.75 n/a n/a 12.30
Zweig Equity (Small Cap) 1/14/93 72.44 n/a n/a 81.36 23.42 19.92 n/a n/a 12.75
Select Ten Plus n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a
- -----------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
CALENDAR YEAR RETURN(4)
------------------------------------------
VARIABLE OPTIONS 1993 1994 1995 1996 1997
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BT Insurance Funds Trust - EAFE Equity Index n/a n/a n/a 0.94% 0.40%
BT Insurance Funds Trust - Equity 500 Index 4.55 -3.08 32.15 20.35 26.77
BT Insurance Funds Trust - Small Cap Index n/a n/a n/a 10.76 23.98
Fidelity's VIP Equity-Income 16.70 5.01 34.05 12.73 26.38
Fidelity's VIP II Contrafund n/a n/a 37.86 19.57 22.47
Fidelity's VIP III Growth & Income n/a n/a n/a n/a 28.34
Fidelity's VIP III Growth Opportunities n/a n/a 30.76 16.67 28.20
Harris Bretall Sullivan & Smith Equity Growth -1.91 2.64 29.93 12.42 32.92
Janus Aspen Series Balanced 6.77 -.51 23.11 14.60 20.45
Janus Aspen Series Capital Appreciation n/a n/a n/a n/a 25.46
Janus Aspen Series Worldwide Growth 18.62 .17 25.66 27.28 20.51
JP Morgan Bond n/a n/a 13.36 .54 7.47
JP Morgan International Opportunities n/a n/a 7.16 11.62 4.01
Morgan Stanley Asian Equity 102.53 -17.14 5.21 1.88 -43.38
Morgan Stanley Emerging Markets Debt n/a -23.87 25.75 48.64 15.75
Morgan Stanley High Yield 18.31 -5.76 21.29 13.10 11.22
Morgan Stanley U.S. Real Estate n/a n/a 19.58 37.53 22.88
Scudder Kemper Value 6.47 -2.07 43.65 22.78 28.71
Zweig Asset Allocation 7.49 -.92 19.75 13.32 20.30
Zweig Equity (Small Cap) 7.29 -1.97 19.54 16.87 23.42
Select Ten Plus n/a n/a n/a n/a n/a
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
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.
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.
7
<PAGE>
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 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 grater.
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.
8
<PAGE>
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.
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 Funds 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.
For those underlying Options which have not been held as Sub-Accounts within the
Separate Account for one of the quoted periods, the standardized average annual
total return and nonstandardized total return quotations will show the
investment performance such underlying Options would have achieved (reduced by
the applicable charges) had they been held as Sub-Accounts within the Separate
Account for the period quoted.
9
<PAGE>
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.
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% or 3.5% a year. 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.
10
<PAGE>
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 ($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, 1997, 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, 1997and 1996 incorporated herein by reference to this SAI have been
audited by Ernst & Young LLP as set forth in their reports incorporated herein
by reference to this SAI.
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.
11
<PAGE>
Financial Statements
Separate Account II
of
National Integrity Life Insurance Company
DECEMBER 31, 1997
WITH REPORT OF INDEPENDENT AUDITORS
<PAGE>
Separate Account II
of
National Integrity Life Insurance Company
Financial Statements
December 31, 1997
CONTENTS
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 . . . . . . . . . . . . . . . . . . . . . . . .9
<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,
Scudder Kemper Value, Zweig Equity (Small Cap), Pinnacle Fixed Income, ARM
Capital Advisors Money Market, Morgan Stanley Asian Growth, Morgan Stanley
Worldwide High Income, EAFE Equity Index, Equity 500 Index, Small Cap Index,
VIP Equity-Income, VIP II Contrafund, VIP III Growth & Income, VIP III Growth
Opportunities, Janus Aspen Capital Appreciation, Janus Aspen Balanced, Janus
Aspen Worldwide Growth, Janus Aspen Money Market, JPM International
Equity, JPM Bond, Morgan Stanley Asian Equity, Morgan Stanley Emerging
Markets Debt, Morgan Stanley High Yield, and Morgan Stanley U.S. Real Estate
Divisions) as of December 31, 1997 and the related statements of operations
and changes in net assets for the periods indicated therein. 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., BT Insurance Funds Trust, Variable Insurance Products
Fund, Variable Insurance Products Fund II, Variable Insurance Products Fund
III, Janus Aspen Series, J.P. Morgan Series Trust II and Morgan Stanley
Universal Funds, Inc. (collectively the "Funds") as of December 31, 1997, by
correspondence with the transfer agents of the Funds. 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, 1997, the results of their operations and
changes in their net assets for each of the periods indicated therein, in
conformity with generally accepted accounting principles.
Louisville, Kentucky
April 17, 1998
1
<PAGE>
Separate Account II of National Integrity Life Insurance Company
Statement of Assets and Liabilities
December 31, 1997
<TABLE>
<CAPTION>
HARRIS BRETALL
NICHOLAS- SULLIVAN &
RENAISSANCE ZWEIG ASSET APPLEGATE SMITH EQUITY SCUDDER ZWEIG EQUITY
BALANCED ALLOCATION BALANCED GROWTH KEMPER VALUE (SMALL CAP)
DIVISION (1) DIVISION DIVISION (1) DIVISION DIVISION (2) DIVISION
------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Investments at value (cost of
$49,372,244 in the aggregate) $ - $ 6,199,853 $ - $ 7,901,499 $ 6,831,557 $ 2,991,892
LIABILITIES
Payable to (receivable from)
the general account of
National Integrity - 1,745 - (1,452) 490 (664)
------------------------------------------------------------------------------------------------
NET ASSETS $ - $ 6,198,108 $ - $ 7,902,951 $ 6,831,067 $ 2,992,556
------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------
Unit value $ - $ 17.38 $ - $ 19.55 $ 23.67 $ 18.14
------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------
Units outstanding - 356,623 - 404,243 288,596 164,970
------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------
<CAPTION>
ARM CAPITAL MORGAN STANLEY MORGAN STANLEY
PINNACLE FIXED ADVISORS WORLDWIDE WORLDWIDE EAFE EQUITY EQUITY 500
INCOME MONEY MARKET HIGH INCOME HIGH INCOME INDEX INDEX
DIVISION (1) DIVISION (1) DIVISION (1) DIVISION (1) DIVISION DIVISION
--------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Investments at value (cost of
$49,372,244 in the aggregate) $ - $ - $ - $ - $ 55,582 $ 789,081
LIABILITIES
Payable to (receivable from)
the general account of
National Integrity - - - - 27 313
--------------------------------------------------------------------------------------------
NET ASSETS $ - $ - $ - $ - $ 55,555 $ 788,768
--------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------
Unit value $ - $ - $ - $ - $ 9.88 $ 10.32
--------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------
Units outstanding - - - - 5,623 76,431
--------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------
<CAPTION>
SMALL CAP VIP EQUITY-
INDEX INCOME
DIVISION DIVISION
----------------------------
<S> <C> <C>
ASSETS
Investments at value (cost of
$49,372,244 in the aggregate) $ 415,702 $ 660,748
LIABILITIES
Payable to (receivable from)
the general account of
National Integrity (67) 141
----------------------------
NET ASSETS $ 415,769 $ 660,607
----------------------------
----------------------------
Unit value $ 9.85 $ 10.42
----------------------------
----------------------------
Units outstanding 42,210 63,398
----------------------------
----------------------------
</TABLE>
(1) Effective November 14, 1997, the net assets of the division were
transferred to a new division through a substitution
(2) Effective December 31, 1997, Scudder Kemper became the sub-adviser to the
portfolio (formerly Dreman Value or Zurich Kemper Value)
SEE ACCOMPANYING NOTES.
2
<PAGE>
Separate Account II of National Integrity Life Insurance Company
Statement of Assets and Liabilities
December 31, 1997
<TABLE>
<CAPTION>
VIP III VIP III JANUS ASPEN JANUS ASPEN
VIP II GROWTH & GROWTH CAPITAL JANUS ASPEN WORLDWIDE
CONTRAFUND INCOME OPPORTUNITIES APPRECIATION BALANCED GROWTH
DIVISION DIVISION DIVISION DIVISION DIVISION DIVISION
--------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Investments at value (cost of
$49,372,244 in the aggregate) $ 649,291 $ 204,727 $ 784,614 $ 592,723 $ 18,293,436 $ 205,276
LIABILITIES
Payable to (receivable from)
the general account of
National Integrity (319) (50) 60 (130) (2,712) (27)
--------------------------------------------------------------------------------------------
NET ASSETS $ 649,610 $ 204,777 $ 784,554 $ 592,853 $ 18,296,148 $ 205,303
--------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------
Unit value $ 9.91 $ 10.31 $ 10.65 $ 10.03 $ 10.01 $ 9.93
--------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------
Units outstanding 65,551 19,862 73,667 59,108 1,827,787 20,675
--------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------
<CAPTION>
JPM MORGAN STANLEY
JANUS ASPEN INTERNATIONAL MORGAN STANLEY EMERGING MORGAN STANLEY
MONEY MARKET EQUITY JPM BOND ASIAN EQUITY MARKETS DEBT HIGH YIELD
DIVISION DIVISION DIVISION DIVISION DIVISION DIVISION
-----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Investments at value (cost of
$49,372,244 in the aggregate) $ 1,608,709 $ 54,507 $ 1,609,655 $ 1,405,865 $ 1,004,781 $ 337,550
LIABILITIES
Payable to (receivable from)
the general account of
National Integrity (690) (101) (471) 9,615 318 6
-----------------------------------------------------------------------------------------------
NET ASSETS $ 1,609,399 $ 54,608 $ 1,610,126 $ 1,396,250 $ 1,004,463 $ 337,544
-----------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------
Unit value $ 10.06 $ 10.19 $ 10.16 $ 9.23 $ 10.88 $ 10.19
-----------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------
Units outstanding 159,980 5,359 158,477 151,273 92,322 33,125
-----------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------
<CAPTION>
MORGAN STANLEY
U.S. REAL ESTATE
DIVISION TOTAL
--------------------------------
<S> <C> <C>
ASSETS
Investments at value (cost of
$49,372,244 in the aggregate) $ 91,536 $ 52,688,584
LIABILITIES
Payable to (receivable from)
the general account of
National Integrity (130) 5,902
--------------------------------
NET ASSETS $ 91,666 $ 52,682,682
--------------------------------
--------------------------------
Unit value $ 10.38
-------------
-------------
Units outstanding 8,831
-------------
-------------
</TABLE>
(1) Effective November 14, 1997, the net assets of the division were
transferred to a new division through a substitution
(2) Effective December 31, 1997, Scudder Kemper became the sub-adviser to the
portfolio (formerly Dreman Value or Zurich Kemper Value)
SEE ACCOMPANYING NOTES.
3
<PAGE>
Separate Account II of National Integrity Life Insurance Company
Statement of Operations
Year Ended December 31, 1997
<TABLE>
<CAPTION>
HARRIS BRETALL
NICHOLAS- SULLIVAN &
RENAISSANCE ZWEIG ASSET APPLEGATE SMITH EQUITY SCUDDER ZWEIG EQUITY
BALANCED ALLOCATION BALANCED GROWTH KEMPER VALUE (SMALL CAP)
DIVISION (1) DIVISION DIVISION (1) DIVISION DIVISION DIVISION
------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
INVESTMENT INCOME
Reinvested dividends $ 1,276,681 $ 73,567 $ 1,725,492 $ 527,167 $ 1,190,467 $ 119,108
EXPENSES
Mortality and expense risk and
administrative charges 97,057 80,370 142,584 99,322 87,575 31,791
------------------------------------------------------------------------------------------------
NET INVESTMENT INCOME (LOSS) 1,179,624 (6,803) 1,582,908 427,845 1,102,892 87,317
REALIZED AND UNREALIZED GAIN (LOSS)
ON INVESTMENTS
Net realized gain (loss) on sales
of investments (47,650) 283,834 1,142,519 416,103 1,054,089 134,755
Net unrealized appreciation
(depreciation) of investments:
Beginning of period 331,511 528,354 745,131 82,343 778,795 4,239
End of period - 1,346,313 - 1,256,040 192,707 273,307
------------------------------------------------------------------------------------------------
Change in net unrealized
appreciation/depreciation
during the period (331,511) 817,959 (745,131) 1,173,697 (586,088) 269,068
------------------------------------------------------------------------------------------------
NET REALIZED AND UNREALIZED
GAIN (LOSS) ON INVESTMENTS (379,161) 1,101,793 397,388 1,589,800 468,001 403,823
------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN NET ASSETS
RESULTING FROM OPERATIONS $ 800,463 $ 1,094,990 $ 1,980,296 $ 2,017,645 $ 1,570,893 $ 491,140
------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------
<CAPTION>
ARM CAPITAL MORGAN STANLEY
PINNACLE FIXED ADVISORS MORGAN STANLEY WORLDWIDE EAFE EQUITY EQUITY 500
INCOME MONEY MARKET ASIAN GROWTH HIGH INCOME INDEX INDEX
DIVISION (1) DIVISION (1) DIVISION (1) DIVISION (1) DIVISION (2) DIVISION (2)
--------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
INVESTMENT INCOME
Reinvested dividends $ 122,635 $ 58,183 $ 8,277 $ 266,243 $ - $ -
EXPENSES
Mortality and expense risk and
administrative charges 16,883 17,592 32,667 12,239 77 817
--------------------------------------------------------------------------------------------
NET INVESTMENT INCOME (LOSS) 105,752 40,591 (24,390) 254,004 (77) (817)
REALIZED AND UNREALIZED GAIN (LOSS)
ON INVESTMENTS
Net realized gain (loss) on sales
of investments 23,940 - (1,083,367) (173,515) (230) 552
Net unrealized appreciation
(depreciation) of investments:
Beginning of period 45,807 - 116,343 23,791 - -
End of period - - - - 648 17,065
--------------------------------------------------------------------------------------------
Change in net unrealized
appreciation/depreciation
during the period (45,807) - (116,343) (23,791) 648 17,065
--------------------------------------------------------------------------------------------
NET REALIZED AND UNREALIZED
GAIN (LOSS) ON INVESTMENTS (21,867) - (1,199,710) (197,306) 418 17,617
--------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN NET ASSETS
RESULTING FROM OPERATIONS $ 83,885 $ 40,591 $(1,224,100) $ 56,698 $ 341 $ 16,800
--------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------
<CAPTION>
SMALL CAP VIP EQUITY-
INDEX INCOME
DIVISION (2) DIVISION (2)
--------------------------------
<S> <C> <C>
INVESTMENT INCOME
Reinvested dividends $ - $ -
EXPENSES
Mortality and expense risk and
administrative charges 586 605
--------------------------------
NET INVESTMENT INCOME (LOSS) (586) (605)
REALIZED AND UNREALIZED GAIN (LOSS)
ON INVESTMENTS
Net realized gain (loss) on sales
of investments (1,178) 804
Net unrealized appreciation
(depreciation) of investments:
Beginning of period - -
End of period 7,146 13,995
--------------------------------
Change in net unrealized
appreciation/depreciation
during the period 7,146 13,995
--------------------------------
NET REALIZED AND UNREALIZED
GAIN (LOSS) ON INVESTMENTS 5,968 14,799
--------------------------------
NET INCREASE (DECREASE) IN NET ASSETS
RESULTING FROM OPERATIONS $ 5,382 $ 14,194
--------------------------------
--------------------------------
</TABLE>
(1) For the period January 1, 1997 to November 14, 1997 (date of substitution)
(2) For the period November 1, 1997 (commencement of operations) to
December 31, 1997
SEE ACCOMPANYING NOTES.
4
<PAGE>
Separate Account II of National Integrity Life Insurance Company
Statement of Operations
Year Ended December 31, 1997
<TABLE>
<CAPTION>
VIP III VIP III JANUS ASPEN JANUS ASPEN
VIP II GROWTH & GROWTH CAPITAL JANUS ASPEN WORLDWIDE
CONTRAFUND INCOME OPPORTUNITIES APPRECIATION BALANCED GROWTH
DIVISION(2) DIVISION(2) DIVISION(2) DIVISION(2) DIVISION(2) DIVISION(2)
--------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
INVESTMENT INCOME
Reinvested dividends $ - $ 5,031 $ - $ 1,874 $ 157,125 $ 438
EXPENSES
Mortality and expense risk and
administrative charges 584 298 679 521 32,457 299
--------------------------------------------------------------------------------------
NET INVESTMENT INCOME (LOSS) (584) 4,733 (679) 1,353 124,668 139
REALIZED AND UNREALIZED GAIN (LOSS)
ON INVESTMENTS
Net realized gain (loss) on sales
of investments (604) (575) 1,560 (471) 10,342 (172)
Net unrealized appreciation
(depreciation) of investments:
Beginning of period - - - - - -
End of period 12,890 335 7,004 14,295 239,772 5,622
--------------------------------------------------------------------------------------
Change in net unrealized appreciation/
depreciation during the period 12,890 335 7,004 14,295 239,772 5,622
--------------------------------------------------------------------------------------
NET REALIZED AND UNREALIZED
GAIN (LOSS) ON INVESTMENTS 12,286 (240) 8,564 13,824 250,114 5,450
--------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN NET ASSETS
RESULTING FROM OPERATIONS $ 11,702 $ 4,493 $ 7,885 $ 15,177 $ 374,782 $ 5,589
--------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------
<CAPTION>
JPM MORGAN STANLEY
JANUS ASPEN INTERNATIONAL MORGAN STANLEY EMERGING
MONEY MARKET EQUITY JPM BOND ASIAN EQUITY MARKETS DEBT
DIVISION(2) DIVISION(2) DIVISION(2) DIVISION(2) DIVISION(2)
----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
INVESTMENT INCOME
Reinvested dividends $ 9,388 $ 6,835 $ 42,804 $ 1,827 $ 36,847
EXPENSES
Mortality and expense risk and
administrative charges 2,509 193 2,661 2,381 1,908
----------------------------------------------------------------------------
NET INVESTMENT INCOME (LOSS) 6,879 6,642 40,143 (554) 34,939
REALIZED AND UNREALIZED GAIN (LOSS)
ON INVESTMENTS
Net realized gain (loss) on sales
of investments - (21) 13 (1,417) 13,489
Net unrealized appreciation
(depreciation) of investments:
Beginning of period - - - - -
End of period 49 (5,952) (20,141) (75,264) 45,758
----------------------------------------------------------------------------
Change in net unrealized appreciation/
depreciation during the period 49 (5,952) (20,141) (75,264) 45,758
----------------------------------------------------------------------------
NET REALIZED AND UNREALIZED
GAIN (LOSS) ON INVESTMENTS 49 (5,973) (20,128) (76,681) 59,247
----------------------------------------------------------------------------
NET INCREASE (DECREASE) IN NET ASSETS
RESULTING FROM OPERATIONS $ 6,928 $ 669 $ 20,015 $ (77,235) $ 94,186
----------------------------------------------------------------------------
----------------------------------------------------------------------------
<CAPTION>
MORGAN STANLEY MORGAN STANLEY
HIGH YIELD U.S. REAL ESTATE
DIVISION(2) DIVISION(2) TOTAL
-------------------------------------------------
<S> <C> <C> <C>
INVESTMENT INCOME
Reinvested dividends $ 21,906 $ 2,051 $ 5,653,946
EXPENSES
Mortality and expense risk and
administrative charges 520 173 665,348
-------------------------------------------------
NET INVESTMENT INCOME (LOSS) 21,386 1,878 4,988,598
REALIZED AND UNREALIZED GAIN (LOSS)
ON INVESTMENTS
Net realized gain (loss) on sales
of investments (99) 33 1,772,734
Net unrealized appreciation
(depreciation) of investments:
Beginning of period - - 2,656,314
End of period (15,980) 731 3,316,340
-------------------------------------------------
Change in net unrealized appreciation/
depreciation during the period (15,980) 731 660,026
-------------------------------------------------
NET REALIZED AND UNREALIZED
GAIN (LOSS) ON INVESTMENTS (16,079) 764 2,432,760
-------------------------------------------------
NET INCREASE (DECREASE) IN NET ASSETS
RESULTING FROM OPERATIONS $ 5,307 $ 2,642 $ 7,421,358
-------------------------------------------------
-------------------------------------------------
</TABLE>
(1) For the period January 1, 1997 to November 14, 1997 (date of substitution)
(2) For the period November 1, 1997 (commencement of operations) to
December 31, 1997
SEE ACCOMPANYING NOTES.
5
<PAGE>
Separate Account II of National Integrity Life Insurance Company
Statement of Changes in Net Assets
Year Ended December 31, 1997
<TABLE>
<CAPTION>
HARRIS BRETALL
NICHOLAS- SULLIVAN &
RENAISSANCE ZWEIG ASSET APPLEGATE SMITH EQUITY SCUDDER
BALANCED ALLOCATION BALANCED GROWTH KEMPER VALUE
DIVISION(1) DIVISION DIVISION(1) DIVISION DIVISION
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
FROM OPERATIONS
Net investment income (loss) $ 1,179,624 $ (6,803) $ 1,582,908 $ 427,845 $ 1,102,892
Net realized gain (loss) on sales of investments (47,650) 283,834 1,142,519 416,103 1,054,089
Change in net unrealized appreciation/
depreciation during the period (331,511) 817,959 (745,131) 1,173,697 (586,088)
-------------------------------------------------------------------------------
Net increase (decrease) in net assets resulting
from operations 800,463 1,094,990 1,980,296 2,017,645 1,570,893
INCREASE (DECREASE) IN NET ASSETS FROM
CONTRACT RELATED TRANSACTIONS
Contributions from contract holders 50,240 282,086 217,130 476,558 1,165,539
Contract terminations and benefits (2,048,893) (447,276) (797,813) (676,940) (637,094)
Net transfers among investment options (6,987,630) (360,213) (13,062,770) (364,132) (741,595)
-------------------------------------------------------------------------------
Net increase (decrease) in net assets
from contract related transactions (8,986,283) (525,403) (13,643,453) (564,514) (213,150)
INCREASE (DECREASE) IN NET ASSETS (8,185,820) 569,587 (11,663,157) 1,453,131 1,357,743
Net assets, beginning of year 8,185,820 5,628,521 11,663,157 6,449,820 5,473,324
-------------------------------------------------------------------------------
NET ASSETS, END OF YEAR $ - $ 6,198,108 $ - $ 7,902,951 $ 6,831,067
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
UNIT TRANSACTIONS
Contributions 3,235 15,508 12,383 24,893 50,208
Terminations and benefits (136,537) (28,230) (48,344) (36,846) (29,791)
Net transfers (458,159) (20,172) (743,141) (22,269) (29,446)
-------------------------------------------------------------------------------
Increase (decrease) in units (591,461) (32,894) (779,102) (34,222) (9,029)
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
<CAPTION>
ARM CAPITAL MORGAN STANLEY
ZWEIG EQUITY PINNACLE FIXED ADVISORS MORGAN STANLEY WORLDWIDE
(SMALL CAP) INCOME MONEY MARKET ASIAN GROWTH HIGH INCOME
DIVISION DIVISION(1) DIVISION(1) DIVISION(1) DIVISION(1)
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
FROM OPERATIONS
Net investment income (loss) $ 87,317 $ 105,752 $ 40,591 $ (24,390) $ 254,004
Net realized gain (loss) on sales of investments 134,755 23,940 - (1,083,367) (173,515)
Change in net unrealized appreciation/
depreciation during the period 269,068 (45,807) - (116,343) (23,791)
-------------------------------------------------------------------------------
Net increase (decrease) in net assets resulting
from operations 491,140 83,885 40,591 (1,224,100) 56,698
INCREASE (DECREASE) IN NET ASSETS FROM
CONTRACT RELATED TRANSACTIONS
Contributions from contract holders 702,306 75,944 253,284 61,870 194,121
Contract terminations and benefits (123,974) (665,750) (2,648,502) (356,571) (47,984)
Net transfers among investment options (116,828) (1,012,688) 1,008,280 (1,958,536) (1,162,798)
-------------------------------------------------------------------------------
Net increase (decrease) in net assets
from contract related transactions 461,504 (1,602,494) (1,386,938) (2,253,237) (1,016,661)
INCREASE (DECREASE) IN NET ASSETS 952,644 (1,518,609) (1,346,347) (3,477,337) (959,963)
Net assets, beginning of year 2,039,912 1,518,609 1,346,347 3,477,337 959,963
-------------------------------------------------------------------------------
NET ASSETS, END OF YEAR $ 2,992,556 $ - $ - $ - $ -
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
UNIT TRANSACTIONS
Contributions 42,184 6,235 22,812 6,152 12,450
Terminations and benefits (6,914) (55,386) (239,148) (37,573) (2,859)
Net transfers (9,164) (83,132) 92,363 (300,386) (79,204)
-------------------------------------------------------------------------------
Increase (decrease) in units 26,106 (132,283) (123,973) (331,807) (69,613)
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
<CAPTION>
EAFE EQUITY EQUITY 500 SMALL CAP VIP EQUITY-
INDEX INDEX INDEX INCOME
DIVISION(2) DIVISION(2) DIVISION(2) DIVISION(2)
--------------------------------------------------------
<S> <C> <C> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
FROM OPERATIONS
Net investment income (loss) $ (77) $ (817) $ (586) $ (605)
Net realized gain (loss) on sales of investments (230) 552 (1,178) 804
Change in net unrealized appreciation/
depreciation during the period 648 17,065 7,146 13,995
--------------------------------------------------------
Net increase (decrease) in net assets resulting
from operations 341 16,800 5,382 14,194
INCREASE (DECREASE) IN NET ASSETS FROM
CONTRACT RELATED TRANSACTIONS
Contributions from contract holders 39,018 578,039 166,071 570,182
Contract terminations and benefits - - (171) -
Net transfers among investment options 16,196 193,929 244,487 76,231
--------------------------------------------------------
Net increase (decrease) in net assets
from contract related transactions 55,214 771,968 410,387 646,413
INCREASE (DECREASE) IN NET ASSETS 55,555 788,768 415,769 660,607
Net assets, beginning of year - - - -
--------------------------------------------------------
NET ASSETS, END OF YEAR $ 55,555 $ 788,768 $ 415,769 $ 660,607
--------------------------------------------------------
--------------------------------------------------------
UNIT TRANSACTIONS
Contributions 4,002 56,973 17,076 55,783
Terminations and benefits - - (17) -
Net transfers 1,621 19,458 25,151 7,615
--------------------------------------------------------
Increase (decrease) in units 5,623 76,431 42,210 63,398
--------------------------------------------------------
--------------------------------------------------------
</TABLE>
(1) For the period January 1, 1997 to November 14, 1997 (date of substitution)
(2) For the period November 1, 1997 (commencement of operations) to
December 31, 1997
SEE ACCOMPANYING NOTES.
6
<PAGE>
Separate Account II of National Integrity Life Insurance Company
Statement of Changes in Net Assets
Year Ended December 31, 1997
<TABLE>
<CAPTION>
VIP III VIP III JANUS ASPEN
VIP II GROWTH & GROWTH CAPITAL JANUS ASPEN
CONTRAFUND INCOME OPPORTUNITIES APPRECIATION BALANCED
DIVISION(2) DIVISION(2) DIVISION(2) DIVISION(2) DIVISION(2)
-------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
FROM OPERATIONS
Net investment income (loss) $ (584) $ 4,733 $ (679) $ 1,353 $ 124,668
Net realized gain (loss) on sales of investments (604) (575) 1,560 (471) 10,342
Change in net unrealized appreciation/
depreciation during the period 12,890 335 7,004 14,295 239,772
-------------------------------------------------------------------------
Net increase (decrease) in net assets resulting
from operations 11,702 4,493 7,885 15,177 374,782
INCREASE (DECREASE) IN NET ASSETS FROM
CONTRACT RELATED TRANSACTIONS
Contributions from contract holders 541,632 58,386 75,419 523,386 90,044
Contract terminations and benefits - (199) (12) - (309,924)
Net transfers among investment options 96,276 142,097 701,262 54,290 18,141,246
-------------------------------------------------------------------------
Net increase (decrease) in net assets
from contract related transactions 637,908 200,284 776,669 577,676 17,921,366
INCREASE (DECREASE) IN NET ASSETS 649,610 204,777 784,554 592,853 18,296,148
Net assets, beginning of year - - - - -
-------------------------------------------------------------------------
NET ASSETS, END OF YEAR $ 649,610 $ 204,777 $ 784,554 $ 592,853 $18,296,148
-------------------------------------------------------------------------
-------------------------------------------------------------------------
UNIT TRANSACTIONS
Contributions 55,713 5,726 7,215 53,566 10,767
Terminations and benefits - (19) (1) - (29,850)
Net transfers 9,838 14,155 66,453 5,542 1,846,870
-------------------------------------------------------------------------
Increase (decrease) in units 65,551 19,862 73,667 59,108 1,827,787
-------------------------------------------------------------------------
-------------------------------------------------------------------------
<CAPTION>
JANUS ASPEN JPM
WORLDWIDE JANUS ASPEN INTERNATIONAL MORGAN STANLEY
GROWTH MONEY MARKET EQUITY JPM BOND ASIAN EQUITY
DIVISION(2) DIVISION(2) DIVISION(2) DIVISION(2) DIVISION(2)
-------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
FROM OPERATIONS
Net investment income (loss) $ 139 $ 6,879 $ 6,642 $ 40,143 $ (554)
Net realized gain (loss) on sales of investments (172) - (21) 13 (1,417)
Change in net unrealized appreciation/
depreciation during the period 5,622 49 (5,952) (20,141) (75,264)
-------------------------------------------------------------------------
Net increase (decrease) in net assets resulting
from operations 5,589 6,928 669 20,015 (77,235)
INCREASE (DECREASE) IN NET ASSETS FROM
CONTRACT RELATED TRANSACTIONS
Contributions from contract holders 54,415 934,647 16,749 42,312 5,253
Contract terminations and benefits - (33,861) (148) (7,095) (29,383)
Net transfers among investment options 145,299 701,685 37,338 1,554,894 1,497,615
-------------------------------------------------------------------------
Net increase (decrease) in net assets
from contract related transactions 199,714 1,602,471 53,939 1,590,111 1,473,485
INCREASE (DECREASE) IN NET ASSETS 205,303 1,609,399 54,608 1,610,126 1,396,250
Net assets, beginning of year - - - - -
-------------------------------------------------------------------------
NET ASSETS, END OF YEAR $ 205,303 $ 1,609,399 $ 54,608 $ 1,610,126 $ 1,396,250
-------------------------------------------------------------------------
-------------------------------------------------------------------------
UNIT TRANSACTIONS
Contributions 5,578 93,292 1,650 4,196 532
Terminations and benefits - (3,383) (15) (704) (3,050)
Net transfers 15,097 70,071 3,724 154,985 153,791
-------------------------------------------------------------------------
Increase (decrease) in units 20,675 159,980 5,359 158,477 151,273
-------------------------------------------------------------------------
-------------------------------------------------------------------------
<CAPTION>
MORGAN STANLEY
EMERGING MORGAN STANLEY MORGAN STANLEY
MARKETS DEBT HIGH YIELD U.S. REAL ESTATE
DIVISION(2) DIVISION(2) DIVISION(2) TOTAL
----------------------------------------------------------------
<S> <C> <C> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
FROM OPERATIONS
Net investment income (loss) $ 34,939 $ 21,386 $ 1,878 $ 4,988,598
Net realized gain (loss) on sales of investments 13,489 (99) 33 1,772,734
Change in net unrealized appreciation/
depreciation during the period 45,758 (15,980) 731 660,026
----------------------------------------------------------------
Net increase (decrease) in net assets resulting
from operations 94,186 5,307 2,642 7,421,358
INCREASE (DECREASE) IN NET ASSETS FROM
CONTRACT RELATED TRANSACTIONS
Contributions from contract holders - 42,907 41,347 7,258,885
Contract terminations and benefits (90,245) (194) - (8,922,029)
Net transfers among investment options 1,000,522 289,524 47,677 181,658
----------------------------------------------------------------
Net increase (decrease) in net assets
from contract related transactions 910,277 332,237 89,024 (1,481,486)
INCREASE (DECREASE) IN NET ASSETS 1,004,463 337,544 91,666 5,939,872
Net assets, beginning of year - - - 46,742,810
----------------------------------------------------------------
NET ASSETS, END OF YEAR $ 1,004,463 $ 337,544 $ 91,666 $52,682,682
----------------------------------------------------------------
----------------------------------------------------------------
UNIT TRANSACTIONS
Contributions - 4,232 4,098
Terminations and benefits (8,475) (19) -
Net transfers 100,797 28,912 4,733
-----------------------------------------------
Increase (decrease) in units 92,322 33,125 8,831
-----------------------------------------------
-----------------------------------------------
</TABLE>
(1) For the period January 1, 1997 to November 14, 1997 (date of substitution)
(2) For the period November 1, 1997 (commencement of operations) to
December 31, 1997
SEE ACCOMPANYING NOTES.
7
<PAGE>
Separate Account II of National Integrity Life Insurance Company
Statement of Changes in Net Assets
Year Ended December 31, 1996
<TABLE>
<CAPTION>
HARRIS BRETALL
NICHOLAS- SULLIVAN & ZWEIG
RENAISSANCE ZWEIG ASSET APPLEGATE SMITH EQUITY DREMAN EQUITY
BALANCED ALLOCATION BALANCED GROWTH VALUE (SMALL CAP)
DIVISION DIVISION DIVISION DIVISION DIVISION DIVISION
-------------------------------------------------------------------------------------
<S> <C> <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 $ 149,430
Net realized gain on sales of investments 393,940 196,615 517,897 472,123 814,248 497,943
Change in net unrealized appreciation/
depreciation during the period (662,988) (123,779) (414,597) (366,257) 44,890 (299,432)
-------------------------------------------------------------------------------------
Net increase in net assets resulting
from operations 665,459 684,030 1,196,084 503,206 1,049,317 347,941
INCREASE (DECREASE) IN NET ASSETS FROM
CONTRACT RELATED TRANSACTIONS
Contributions from contract holders 163,477 442,528 425,966 363,225 654,221 203,396
Contract terminations and benefits (505,425) (626,730) (899,360) (419,837) (512,310) (646,821)
Net transfers among investment options (937,403) (244,654) 457,484 1,101,836 618,917 (813,891)
-------------------------------------------------------------------------------------
Net increase (decrease) in net assets
from contract related transactions (1,279,351) (428,856) (15,910) 1,045,224 760,828 (1,257,316)
-------------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS (613,892) 255,174 1,180,174 1,548,430 1,810,145 (909,375)
Net assets, beginning of year 8,799,712 5,373,347 10,482,983 4,901,390 3,663,179 2,949,287
-------------------------------------------------------------------------------------
NET ASSETS, END OF YEAR $ 8,185,820 $ 5,628,521 $11,663,157 $ 6,449,820 $ 5,473,324 $ 2,039,912
-------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------
UNIT TRANSACTIONS
Contributions 12,452 33,546 24,432 26,839 42,120 15,294
Terminations and benefits (37,773) (47,095) (67,575) (29,734) (30,046) (48,315)
Net transfers (69,088) (18,373) 25,060 66,636 41,013 (62,744)
-------------------------------------------------------------------------------------
Increase (decrease) in units (94,409) (31,922) (18,083) 63,741 53,087 (95,765)
-------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------
<CAPTION>
ARM
CAPITAL MORGAN MORGAN
PINNACLE ADVISORS STANLEY STANLEY
FIXED MONEY ASIAN WORLDWIDE
INCOME MARKET GROWTH HIGH INCOME
DIVISION DIVISION DIVISION DIVISION TOTAL
------------------------------------------------------------------------
<C> <C> <C> <C> <C>
INCREASE (DECREASE) IN NET ASSETS FROM
OPERATIONS
Net investment income (loss) $ 31,210 $ 93,722 $ (45,007) $ 82,534 $ 3,537,893
Net realized gain on sales of investments 6,428 - 26,325 49,594 2,975,113
Change in net unrealized appreciation/
depreciation during the period (29,853) - 66,109 9,516 (1,776,391)
------------------------------------------------------------------------
Net increase in net assets resulting
from operations 7,785 93,722 47,427 141,644 4,736,615
INCREASE (DECREASE) IN NET ASSETS FROM
CONTRACT RELATED TRANSACTIONS
Contributions from contract holders 38,182 556,466 594,972 144,499 3,586,932
Contract terminations and benefits (149,059) (2,026,755) (250,466) (37,245) (6,074,008)
Net transfers among investment options (21,922) (821,309) 663,821 373,794 376,673
------------------------------------------------------------------------
Net increase (decrease) in net assets
from contract related transactions (132,799) (2,291,598) 1,008,327 481,048 (2,110,403)
------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS (125,014) (2,197,876) 1,055,754 622,692 2,626,212
Net assets, beginning of year 1,643,623 3,544,223 2,421,583 337,271 44,116,598
------------------------------------------------------------------------
NET ASSETS, END OF YEAR $ 1,518,609 $ 1,346,347 $ 3,477,337 $ 959,963 $46,742,810
------------------------------------------------------------------------
------------------------------------------------------------------------
UNIT TRANSACTIONS
Contributions 3,365 54,004 56,746 11,893
Terminations and benefits (13,007) (191,155) (24,032) (2,957)
Net transfers (1,874) (75,140) 58,618 30,644
--------------------------------------------------------
Increase (decrease) in units (11,516) (212,291) 91,332 39,580
--------------------------------------------------------
--------------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
8
<PAGE>
Separate Account II
of
National Integrity Life Insurance Company
Notes to Financial Statements
December 31, 1997
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 ("Investment Company Act").
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 growing asset accumulation business with
particular emphasis on retirement savings and investment products.
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 GPO. The Separate Account
divisions invest in shares of the corresponding portfolios of the following
funds or insurance trust funds ("Funds"): BT Insurance Funds Trust ("BT Funds
Trust"); Variable Insurance Products Fund ("VIP"), Variable Insurance Products
Fund II ("VIP II"), and Variable Insurance Products Fund III ("VIP III"), part
of the Fidelity Investments group of companies (collectively, "Fidelity's VIP
Funds"); The Legends Fund, Inc. ("Legends Fund"); Janus Aspen Series; J.P.
Morgan Series Trust II ("JPM Series"); and Morgan Stanley Universal Funds, Inc.
("Morgan Stanley Universal Funds"). Bankers Trust Global Asset Management
Services, a unit of Bankers Trust Company, is the investment manager of the BT
Funds Trust. Fidelity Management and Research Company serves as investment
adviser to Fidelity's VIP Funds. Integrity Capital Advisors, Inc. (formerly
known as ARM Capital Advisors, Inc.), a wholly owned subsidiary of ARM, is the
investment adviser of the Legends Fund. Janus Capital Corporation serves as
investment adviser to the Janus Aspen Series. J.P. Morgan Investment Management
Inc. is the investment adviser to the JPM Series. Morgan Stanley Asset
Management Inc. ("MSAM") serves as investment adviser to the Morgan Stanley
Universal Funds except for
9
<PAGE>
Separate Account II
of
National Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Morgan Stanley High Yield Portfolio, for which Miller Anderson & Sherrerd, LLP
serves as investment adviser. MSAM is a wholly owned subsidiary of Morgan
Stanley Dean Witter & Co. ("Morgan Stanley"). At December 31, 1997,
approximately 53% of the outstanding shares of voting stock of ARM is owned by
private equity funds sponsored by Morgan Stanley, therefore these two entities
are considered affiliates.
On July 23, 1997, National Integrity filed an application (amended on October 9,
1997) with the Securities and Exchange Commission ("SEC") pursuant to Section
26(b) of the Investment Company Act for an order to approve a substitution of
certain divisions of the Separate Account (the "Substitution"). The Substitution
involved the transfer of assets from a division within the Separate Account to a
new division which invests in shares of corresponding investment portfolios of
an insurance trust mutual fund ("New Division") deemed to have (i) substantially
similar investment strategies and (ii) historically stronger investment
performance and/or lower expense ratios (after waivers and reimbursements). The
Substitution was approved by the SEC on November 14, 1997, and was effected on
that day. The divisions of the Separate Account affected by the Substitution and
the New Divisions which received the assets are as follows:
Original Division New Division
- ----------------- ------------
Renaissance Balanced Janus Aspen Balanced
Nicholas-Applegate Balanced Janus Aspen Balanced
Pinnacle Fixed Income JPM Bond
ARM Capital Advisors Money Market Janus Aspen Money Market
Morgan Stanley Asian Growth Morgan Stanley Asian Equity
Morgan Stanley Worldwide High Income Morgan Stanley Emerging Markets Debt
10
<PAGE>
Separate Account II
of
National Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Units of each division of the Separate Account affected by the Substitution were
redeemed in-kind and the redemption proceeds were used to purchase units of the
New Division. The costs of the Substitution were borne by Integrity, and no
fees, transfer charges or sales charges to effect the Substitution were imposed
on the Separate Account or the contract holders. Prior to and immediately
following the Substitution, the account values of contract holders were the
same. In addition, the Substitution did not alter the tax or insurance benefits
to contract holders or the contractual obligation of National Integrity.
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 twenty-one 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
Funds.
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
Standard & Poor's 500 Composite Stock Price Index ("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.
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 United States government securities
when this appears desirable in light of the portfolio's investment
objective or when market conditions warrant. Harris Bretall Sullivan &
Smith, LLC is the sub-adviser to the portfolio.
11
<PAGE>
Separate Account II
of
National Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SCUDDER KEMPER 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. On December 31, 1997,
Zurich Kemper Value, Inc. (formerly Dreman Value Advisors, Inc.) and
Scudder Kemper Investments, Inc. were appointed sub-advisors following the
merger of Zurich Kemper Investments, Inc. into Scudder, Stevens and Clark,
Inc.
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.
EAFE EQUITY INDEX PORTFOLIO seeks to replicate as closely as possible
(before the deduction of expenses) the total return of the Morgan Stanley
Capital International Europe, Australia, Far East (EAFE) Index, a
capitalization-weighted index containing approximately 1,100 equity
securities of companies located outside the United States. The portfolio
will be invested primarily in equity securities of business enterprises
organized and domiciled outside of the United States or for which the
principal trading market is outside the United States. Statistical methods
will be employed to replicate the EAFE Index by buying most of the EAFE
Index securities. Securities purchased for the portfolio will generally,
but not necessarily, be traded on a foreign securities exchange. Bankers
Trust Global Asset Management Services is the investment 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)
EQUITY 500 INDEX PORTFOLIO seeks to replicate as closely as possible
(before the deduction of expenses) the total return of the S&P 500, an
index emphasizing large-capitalization stocks. The portfolio will include
the common stock of those companies included in the S&P 500, other than
Bankers Trust New York Corporation, selected on the basis of computer
generated statistical data, that are deemed representative of the industry
diversification of the entire S&P 500. Bankers Trust Global Asset
Management Services is the investment adviser to the portfolio.
SMALL CAP INDEX PORTFOLIO seeks to replicate as closely as possible (before
the deduction of expenses) the total return of the Russell 2000 Small Stock
Index (the "Russell 2000"), an index consisting of 2,000 small-
capitalization common stocks. The portfolio will include the common stock
of companies included in the Russell 2000, on the basis of computer-
generated statistical data, that are deemed representative of the industry
diversification of the entire Russell 2000. Bankers Trust Global Asset
Management Services is the investment adviser to the portfolio.
VIP EQUITY-INCOME PORTFOLIO seeks reasonable income by investing primarily
in income producing equity securities, with the potential for capital
appreciation as a consideration. It normally invests at least 65% of its
assets in income-producing common or preferred stocks and the remainder in
debt securities. Fidelity Management and Research Company serves as the
investment adviser to the portfolio.
VIP II CONTRAFUND PORTFOLIO is a growth fund which seeks to increase the
value of the investment over the long-term by investing in equity
securities of companies that are undervalued or out of favor. This approach
focuses on companies that are currently out of public favor but show
potential for capital appreciation. The portfolio invests primarily in
common stocks and securities convertible into common stock, but it has the
flexibility to invest in any type of security that may produce capital
appreciation. Fidelity Management and Research Company serves as the
investment adviser to the portfolio.
13
<PAGE>
Separate Account II
of
National Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
VIP III GROWTH & INCOME PORTFOLIO seeks high total return through a
combination of current income and capital appreciation by investing mainly
in equity securities. It invests primarily in stocks of companies that
offer potential for growth in earnings while paying dividends, but offer
the potential for capital appreciation on future income. Investments may
include common and preferred stocks, convertible securities, fixed-income
securities and foreign securities. Fidelity Management and Research Company
serves as the investment adviser to the portfolio.
VIP III GROWTH OPPORTUNITIES PORTFOLIO seeks to provide capital growth by
investing primarily in common stocks and securities convertible into common
stock. Although the portfolio invests in common stocks and securities
convertible into common stock, it has the ability to purchase other
securities, such as preferred stocks and bonds, that may produce capital
growth. Fidelity Management and Research Company serves as the investment
adviser to the portfolio.
JANUS ASPEN CAPITAL APPRECIATION PORTFOLIO seeks long-term growth of
capital. It is a non-diversified portfolio that pursues its objective by
investing primarily in common stocks of issuers of any size, which may
include larger well-established issuers and/or smaller emerging growth
companies. The portfolio invests primarily in common stocks of foreign and
domestic companies, and may invest to a lesser degree in other types of
securities including preferred stocks, warrants, convertible securities and
debt securities when its portfolio manager perceives an opportunity for
capital growth from such securities or to receive a return on idle cash.
Janus Capital Corporation serves as the investment adviser to the
portfolio.
JANUS ASPEN BALANCED PORTFOLIO seeks long-term capital growth, consistent
with preservation of capital and balanced by current income. It is a
diversified portfolio that, under normal circumstances, pursues its
objective by investing 40-60% of its assets in securities selected
primarily for their growth potential and 40-60% of its assets in securities
selected primarily for their income potential. The portfolio normally
invests at least 25% of its assets in fixed-income senior securities, which
include debt securities and preferred stocks. Janus Capital Corporation
serves as the investment adviser to the portfolio.
14
<PAGE>
Separate Account II
of
National Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
JANUS ASPEN WORLDWIDE GROWTH PORTFOLIO seeks long-term growth of capital in
a manner consistent with the preservation of capital. It is a diversified
portfolio that pursues its objective primarily through investments in
common stocks of foreign and domestic issuers. The portfolio has the
flexibility to invest on a worldwide basis in companies and other
organizations of any size, regardless of country of organization or place
of principal business activity. Janus Aspen Worldwide Growth portfolio
normally invests in issuers from at least five different countries,
including the United States. The portfolio may at any time invest in fewer
than five countries or even a single country. Janus Capital Corporation
serves as the investment adviser to the portfolio.
JANUS ASPEN MONEY MARKET PORTFOLIO seeks maximum current income to the
extent consistent with stability of capital. There can be no assurance that
the portfolio will achieve its investment objective or be able to maintain
a stable net asset value of $1.00 per share. The portfolio will invest only
in eligible high quality, short-term money market instruments that present
minimal credit risks, as determined by Janus Capital Corporation, the
portfolio's investment adviser, pursuant to procedures adopted by the
Trustees. The portfolio may at any time invest only in United States
dollar-denominated instruments that have a remaining maturity of 397 days
or less and will maintain a dollar-weighted average portfolio maturity of
90 days or less. Janus Capital Corporation serves as the investment adviser
to the portfolio.
JPM INTERNATIONAL EQUITY PORTFOLIO seeks to provide a high total
return from a portfolio of equity securities of foreign corporations. Total
return will consist of realized and unrealized capital gains and losses
plus income less expenses. The portfolio is designed for investors with a
long-term investment horizon who want to diversify their investments by
adding international equities and take advantage of investment
opportunities outside the United States. The portfolio seeks to achieve its
investment objective through country allocation and stock valuation and
selection. J.P Morgan Investment Management Inc. is the investment adviser
to the portfolio.
15
<PAGE>
Separate Account II
of
National Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
JPM BOND PORTFOLIO seeks to provide a high total return consistent with
moderate risk of capital and maintenance of liquidity. Total return will
consist of realized and unrealized capital gains and losses plus income
less expenses. Although the net asset value of the portfolio will
fluctuate, the portfolio attempts to preserve the value of its investments
to the extent consistent with its objective. J.P Morgan Investment
Management Inc. is the investment adviser to the portfolio.
MORGAN STANLEY ASIAN EQUITY PORTFOLIO seeks long-term capital appreciation
by investing primarily in equity securities of Asian issuers (excluding
Japan) using an approach that is oriented to the selection of individual
stocks that the adviser believes are undervalued. The portfolio intends to
invest primarily in equity securities that are traded on recognized stock
exchanges of countries in Asia and in equity securities of companies
organized under the laws of an Asian country whose business is conducted
principally in Asia. MSAM serves as the investment adviser to the
portfolio.
MORGAN STANLEY EMERGING MARKETS DEBT PORTFOLIO seeks high total return by
investing primarily in fixed income securities of government and
government-related issuers located in emerging market countries, which
securities provide a high level of current income, while at the same time
holding the potential for capital appreciation if the perceived
creditworthiness of the issuer improves due to improving economic,
financial, political, social or other conditions in the country in which
the issuer is located. MSAM serves as the investment adviser to the
portfolio.
MORGAN STANLEY HIGH YIELD PORTFOLIO seeks above-average total return over a
market cycle of three to five years by investing primarily in a diversified
portfolio of high yield securities, including corporate bonds and other
fixed income securities and derivatives. High yield securities are rated
below investment grade and are commonly referred to as "junk bonds." The
portfolio's average weighted maturity will ordinarily exceed five years and
will usually be between five and fifteen years. Miller Anderson & Sherrerd,
LLP serves as the investment adviser to the portfolio.
16
<PAGE>
Separate Account II
of
National Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
MORGAN STANLEY U.S. REAL ESTATE PORTFOLIO seeks above-average current
income and long-term capital appreciation by investing primarily in equity
securities of United States and non-United States companies principally
engaged in the United States real estate industry, including real estate
investment trusts ("REITs"). MSAM serves as the investment adviser to the
portfolio.
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 Funds 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 the Funds' 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 Funds' portfolios are
reinvested in the respective portfolios and are reflected in the unit value of
the divisions of the Separate Account.
17
<PAGE>
Separate Account II
of
National Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 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.
18
<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, 1997 and the cost of shares held
at December 31, 1997 for each division were as follows:
<TABLE>
<CAPTION>
DIVISION PURCHASES SALES COST
- -----------------------------------------------------------------------------------
<S> <C> <C> <C>
Renaissance Balanced $ 1,930,059 $ 9,736,660 $ -
Zweig Asset Allocation 611,157 1,142,383 4,853,540
Nicholas-Applegate Balanced 2,624,490 14,677,923 -
Harris Bretall Sullivan & Smith
Equity Growth 1,912,484 2,049,312 6,645,459
Zurich Kemper Value 4,527,101 3,635,507 6,638,850
Zweig Equity (Small Cap) 1,928,981 1,381,345 2,718,585
Pinnacle Fixed Income 420,103 1,916,413 -
ARM Capital Advisors Money Market 4,929,100 6,275,845 -
Morgan Stanley Asian Growth 416,438 2,695,678 -
Morgan Stanley Worldwide High Income 990,834 1,753,790 -
EAFE Equity Index 67,835 12,671 54,934
Equity 500 Index 795,546 24,082 772,016
Small Cap Index 448,702 38,968 408,556
VIP Equity-Income 672,898 26,949 646,753
VIP II Contrafund 659,731 22,726 636,401
VIP III Growth & Income 224,577 19,610 204,392
VIP III Growth Opportunities 816,687 40,637 777,610
Janus Aspen Capital Appreciation 600,617 21,718 578,428
Janus Aspen Balanced 19,434,938 1,391,616 18,053,664
Janus Aspen Worldwide Growth 204,758 4,932 199,654
Janus Aspen Money Market 2,095,037 486,377 1,608,660
JPM International Equity 60,821 341 60,459
JPM Bond 1,637,523 7,740 1,629,796
Morgan Stanley Asian Equity 1,554,285 71,739 1,481,129
Morgan Stanley Emerging Markets Debt 1,239,988 294,454 959,023
Morgan Stanley High Yield 366,976 13,347 353,530
Morgan Stanley U.S. Real Estate 93,609 2,837 90,805
------------
$ 49,372,244
------------
------------
</TABLE>
19
<PAGE>
Separate Account II
of
National Integrity Life Insurance Company
Notes to Financial Statements (continued)
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).
20
<PAGE>
Financial Statements
(Statutory Basis)
National Integrity Life
Insurance Company
YEARS ENDED DECEMBER 31, 1997 AND 1996
WITH REPORT OF INDEPENDENT AUDITORS
<PAGE>
National Integrity Life Insurance Company
Financial Statements
(Statutory Basis)
Years Ended December 31, 1997 and 1996
CONTENTS
Report of Independent Auditors . . . . . . . . . . . . . . . . . . . . . . 1
Audited Financial Statements
Balance Sheets (Statutory Basis) . . . . . . . . . . . . . . . . . . . . . 2
Statements of Income (Statutory Basis) . . . . . . . . . . . . . . . . . . 4
Statements of Changes in Capital and Surplus (Statutory Basis) . . . . . . 5
Statements of Cash Flows (Statutory Basis) . . . . . . . . . . . . . . . . 6
Notes to Financial Statements. . . . . . . . . . . . . . . . . . . . . . . 8
<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, 1997 and 1996, and the
related statutory basis statements of income, 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, 1997 and 1996, or
the results of its operations or its cash flows for the years then ended.
However, 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, 1997 and 1996, 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.
Louisville, Kentucky
February 10, 1998
1
<PAGE>
National Integrity Life Insurance Company
Balance Sheets (Statutory Basis)
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996
--------------------------------
(IN THOUSANDS)
<S> <C> <C>
ADMITTED ASSETS
Cash and invested assets:
Bonds $ 414,907 $ 451,439
Preferred stocks 21,792 50,715
Mortgage loans 3,242 3,929
Policy loans 26,396 24,981
Cash and short-term investments 12,078 14,570
Receivable for securities 1,941 4,522
Other invested assets 3,794 36
--------------------------------
Total cash and invested assets 484,150 550,192
Separate account assets 617,327 370,988
Accrued investment income 5,735 6,513
Federal income tax recoverable - 438
Other admitted assets 2,143 1,794
--------------------------------
Total admitted assets $ 1,109,355 $ 929,925
--------------------------------
--------------------------------
</TABLE>
2
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996
--------------------------------
(IN THOUSANDS)
<S> <C> <C>
LIABILITIES AND CAPITAL AND SURPLUS
Liabilities:
Policy and contract liabilities:
Life and annuity reserves $ 446,610 $ 513,639
Unpaid claims 50 124
Deposits on policies to be issued 564 645
---------------------------------
Total policy and contract liabilities 447,224 514,408
Separate account liabilities 617,327 370,988
Accounts payable and accrued expenses 151 213
Transfers to separate accounts due or accrued, net (24,362) (21,247)
Reinsurance balances payable 511 589
Federal income taxes 5,645 -
Asset valuation reserve 1,570 1,773
Interest maintenance reserve 7,240 8,914
Other liabilities 32 6,016
---------------------------------
Total liabilities 1,055,338 881,654
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 (deficit) (7,977) (13,723)
---------------------------------
Total capital and surplus 54,017 48,271
---------------------------------
Total liabilities and capital and surplus $ 1,109,355 $ 929,925
---------------------------------
---------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
3
<PAGE>
National Integrity Life Insurance Company
Statements of Income (Statutory Basis)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1997 1996
---------------------------------
(IN THOUSANDS)
<S> <C> <C>
Premiums and other revenues:
Premiums and annuity considerations $ 11,533 $ 8,640
Deposit-type funds 211,637 352,899
Net investment income 42,464 53,553
Amortization of the interest maintenance reserve 1,359 1,001
Other revenues 5,961 5,653
-------------------------------
Total premiums and other revenues 272,954 421,746
Benefits paid or provided:
Death benefits 1,268 921
Annuity benefits 12,687 19,445
Surrender benefits 123,520 101,241
Payments on supplementary contracts 1,648 1,879
Increase (decrease) in insurance and annuity reserves (66,954) 192,985
Other benefits 119 7,818
-------------------------------
Total benefits paid or provided 72,288 324,289
Insurance and other expenses:
Commissions 10,088 5,817
General expenses 11,146 8,051
Taxes, licenses and fees 794 349
Net transfers to separate accounts 163,896 69,158
Other expenses 3,542 3,110
-------------------------------
Total insurance and other expenses 189,466 86,485
-------------------------------
Gain from operations before federal income taxes
and net realized capital losses 11,200 10,972
Federal income tax expense (benefit) 3,621 (444)
-------------------------------
Gain from operations before net realized capital losses 7,579 11,416
Net realized capital losses, excluding realized
capital gains (losses) net of tax transferred to the
interest maintenance reserve (1997-($314); 1996-$2,923) (2,036) (2,500)
-------------------------------
Net income $ 5,543 $ 8,916
-------------------------------
-------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
4
<PAGE>
National Integrity Life Insurance Company
Statements of Changes in Capital and Surplus (Statutory Basis)
Years Ended December 31, 1997 and 1996
<TABLE>
<CAPTION>
SPECIAL UNASSIGNED TOTAL
COMMON PAID-IN SURPLUS SURPLUS CAPITAL AND
STOCK SURPLUS FUNDS (DEFICIT) SURPLUS
-------------------------------------------------------------------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Balance, January 1, 1996 $ 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
Net income 5,543 5,543
Decrease in asset valuation reserve 203 203
-------------------------------------------------------------------------
Balance, December 31, 1997 $ 2,000 $ 59,244 $ 750 $ (7,977) $ 54,017
-------------------------------------------------------------------------
-------------------------------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
5
<PAGE>
National Integrity Life Insurance Company
Statements of Cash Flows (Statutory Basis)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1997 1996
---------------------------------
(IN THOUSANDS)
<S> <C> <C>
OPERATIONS:
Premiums, policy proceeds, and other
considerations received $ 223,170 $ 361,539
Net investment income received 42,944 53,492
Commission and expense allowances received on
reinsurance ceded 8 644
Benefits paid (139,316) (125,238)
Insurance expenses paid (22,090) (14,170)
Other income received net of other expenses paid 2,335 5,009
Net transfers to separate accounts (167,010) (74,076)
Federal income taxes (4,479) -
---------------------------------
Net cash provided by (used in) operations (64,438) 207,200
<CAPTION>
<S> <C> <C>
INVESTMENT ACTIVITIES:
Proceeds from sales, maturities, or repayments of investments:
Bonds 368,167 455,716
Preferred stocks 55,948 19,067
Mortgage loans 687 1,389
Other invested assets - 8,826
Miscellaneous proceeds 4,254 -
---------------------------------
Total investment proceeds 429,056 484,998
Benefits received (taxes paid) on capital gains 6,921 (1,212)
---------------------------------
Net proceeds from sales, maturities, or repayments
of investments 435,977 483,786
<CAPTION>
<S> <C> <C>
Cost of investments acquired:
Bonds 337,887 626,879
Preferred stocks 26,621 55,045
Other invested assets 3,794 -
Miscellaneous applications 405 36
---------------------------------
Total cost of investments acquired 368,707 681,960
Net increase in policy loans and premium notes 1,415 2,375
---------------------------------
Net cash provided by (used in) investment activities 65,855 (200,549)
</TABLE>
6
<PAGE>
National Integrity Life Insurance Company
Statements of Cash Flows (Statutory Basis) (continued)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1997 1996
------------------------
(IN THOUSANDS)
<S> <C> <C>
FINANCING AND MISCELLANEOUS ACTIVITIES:
Other cash provided:
Other sources 2,588 3,826
------------------------
Total other cash provided 2,588 3,826
------------------------
Other cash applied:
Other applications, net 6,497 16,175
------------------------
Total other cash applied 6,497 16,175
------------------------
Net cash used in financing and miscellaneous activities (3,909) (12,349)
------------------------
Net decrease in cash and short-term investments (2,492) (5,698)
Cash and short-term investments at beginning of year 14,570 20,268
------------------------
Cash and short-term investments at end of year $ 12,078 $ 14,570
------------------------
------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
7
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis)
December 31, 1997
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, specializes in the growing asset
accumulation business with particular emphasis on retirement savings and
investment products.
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
fair value based on the National Association of Insurance Commissioners
("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 stocks are based on values specified by
the NAIC, rather than on actual or estimated fair 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
8
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
1. ORGANIZATION AND ACCOUNTING POLICIES (CONTINUED)
formula and is reported as a liability rather than unassigned surplus.
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 of 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 AND BENEFITS
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.
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.
9
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
1. ORGANIZATION AND ACCOUNTING POLICIES (CONTINUED)
FEDERAL INCOME TAXES
Deferred federal income taxes are not provided for differences between the
financial statement amounts and tax bases of assets and liabilities.
STATEMENT OF CASH FLOWS
Cash and short-term investments in the statement of cash flows represent
cash balances and investments with initial maturities of one year or less.
Under GAAP, the corresponding captions of cash and cash equivalents include
cash balances and investments with initial maturities of three months or
less.
The effects of the foregoing variances from GAAP on the accompanying statutory
basis financial statements are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1997 1996
------------------------
(IN THOUSANDS)
<S> <C> <C>
Net income as reported in the accompanying
statutory basis financial statements $ 5,543 $ 8,916
Deferred policy acquisition costs, net of amortization 10,157 5,187
Adjustments to customer deposits (5,781) (441)
Adjustments to invested asset carrying values
at acquisition date (38) (160)
Amortization of value of insurance in force (870) (1,470)
Amortization of interest maintenance reserve (1,359) (1,001)
Adjustments for realized investment gains 1,511 852
Adjustments for federal income tax expense (3,320) (2,185)
Other 166 (200)
------------------------
Net income, GAAP basis $ 6,009 $ 9,498
------------------------
------------------------
</TABLE>
10
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
1. ORGANIZATION AND ACCOUNTING POLICIES (CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1997 1996
------------------------
(IN THOUSANDS)
<S> <C> <C>
Capital and surplus as reported in the accompanying
statutory basis financial statements $ 54,017 $ 48,271
Adjustments to customer deposits (33,014) (27,233)
Adjustments to invested asset carrying values at
acquisition date (3,724) (5,197)
Asset valuation reserve and interest maintenance reserve 17,796 19,369
Value of insurance in force 13,043 13,913
Deferred policy acquisition costs 33,885 23,728
Net unrealized gains on available-for-sale securities 5,849 1,416
Other (5,793) (2,650)
------------------------
Shareholder's equity, GAAP basis $ 82,059 $ 71,617
------------------------
------------------------
</TABLE>
Other significant accounting practices are as follows:
INVESTMENTS
Bonds, preferred 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 and structured securities, 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.
11
<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 includes 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 reserve. 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.
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.
12
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
1. ORGANIZATION AND ACCOUNTING POLICIES (CONTINUED)
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 fair 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. Investments income and
interest credited on deposits held in guaranteed separate accounts are included
in the accompanying statements of income. The Company receives administrative
fees for managing the nonguaranteed separate accounts and other fees for
assuming mortality and certain expense risks. Such fees 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 1997 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 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 is in the process of codifying statutory
accounting practices ("Codification"). Codification will likely change, to some
extent, prescribed statutory accounting practices and may result in changes to
the accounting practices that the
13
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
2. PERMITTED STATUTORY ACCOUNTING PRACTICES (CONTINUED)
Company uses to prepare its statutory basis financial statements. Codification
has been approved by the NAIC in March 1998, but it will require adoption by the
various states before it becomes the prescribed statutory basis of accounting
for insurance companies domesticated within those states. Accordingly, before
Codification becomes effective for the Company, New York must adopt Codification
as the prescribed basis of accounting on which domestic insurers must report
their statutory basis results to the Insurance Department. At this time it is
unclear whether New York will adopt Codification. The Company is monitoring
developments related to codification and assessing the potential effects any
changes would have on the Company's statutory basis financial statements.
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
COST GAINS LOSSES FAIR VALUE
-------------------------------------------------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
At December 31, 1997:
Mortgage-backed securities $ 193,688 $ - $ - $ 193,688
Corporate securities 159,208 4,074 34 163,248
Asset-backed securities 27,370 - - 27,370
U.S. Treasury securities and
obligations of U.S. government
agencies 24,361 1,083 2 25,442
Foreign governments 10,280 - 437 9,843
-------------------------------------------------------
Total bonds $ 414,907 $ 5,157 $ 473 $ 419,591
-------------------------------------------------------
-------------------------------------------------------
<CAPTION>
<S> <C> <C> <C> <C>
At December 31, 1996:
Mortgage-backed securities $ 244,376 $ - $ - $ 244,376
Corporate securities 168,146 775 7,178 161,743
Asset-backed securities 10,311 - - 10,311
U.S. Treasury securities and
obligations of U.S. government
agencies 16,243 415 110 16,548
Foreign governments 12,363 643 - 13,006
-------------------------------------------------------
Total bonds $ 451,439 $ 1,833 $ 7,288 $ 445,984
-------------------------------------------------------
-------------------------------------------------------
</TABLE>
14
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
3. INVESTMENTS (CONTINUED)
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, 1997 and 1996, the fair
value of investments in bonds includes $306.8 million and $312.7 million,
respectively, of bonds that were valued at amortized cost.
A summary of the cost or amortized cost and fair value of the Company's
investments in bonds at December 31, 1997, by contractual maturity, is as
follows:
<TABLE>
<CAPTION>
COST OR
AMORTIZED
COST FAIR VALUE
------------------------------
(IN THOUSANDS)
<S> <C> <C>
Years to maturity:
One or less $ 1,304 $ 1,314
After one through five 13,493 13,513
After five through ten 39,042 39,192
After ten 140,010 144,514
Asset-backed securities 27,370 27,370
Mortgage-backed securities 193,688 193,688
------------------------------
Total $ 414,907 $ 419,591
------------------------------
------------------------------
</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 1997 and 1996 were $375.5
million and $755.7 million; gross gains of $8.6 million and $7.9 million, and
gross losses of $8.3 million and $4.5 million were realized on those sales,
respectively.
15
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
3. INVESTMENTS (CONTINUED)
At December 31, 1997 and 1996, bonds with an admitted asset value of $1,235,000
and $1,234,000, respectively, were on deposit with state insurance departments
to satisfy regulatory requirements.
The Company's mortgage loan portfolio is primarily comprised of agricultural
loans. 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 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
1997, no interest rates of outstanding mortgage loans were reduced. No amounts
have been advanced by the Company.
Major categories of the Company's net investment income are summarized as
follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1997 1996
---------------------------
(IN THOUSANDS)
<S> <C> <C>
Income:
Bonds $ 34,854 $ 47,487
Preferred stocks 4,205 4,150
Mortgage loans 291 610
Policy loans 2,072 1,886
Cash and short-term investments 1,506 1,277
Other (3) 3
---------------------------
Total investment income 42,925 55,413
Investment expenses (461) (1,860)
---------------------------
Net investment income $ 42,464 $ 53,553
---------------------------
---------------------------
</TABLE>
16
<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 is not significant to the Company's premiums, benefits
or policy and contract liabilities.
The effect of reinsurance on premiums, annuity considerations and deposit-type
funds is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1997 1996
----------------------------
(IN THOUSANDS)
<S> <C> <C>
Direct premiums and amounts assessed against
policyholders $ 210,910 $ 115,547
Reinsurance assumed 12,770 246,571
Reinsurance ceded (510) (580)
----------------------------
Net premiums, annuity considerations and
deposit-type funds $ 223,170 $ 361,538
----------------------------
----------------------------
</TABLE>
The Company sold guaranteed investment contract ("GIC") deposits totaling $358.3
million to Integrity as of June 30, 1996.
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.
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.
17
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
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's Risk-Based Capital ("RBC") requirements 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 is
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, 1997 and 1996, the adjusted capital
and surplus of the Company is substantially in excess of the minimum level of
RBC that would require regulatory response.
18
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
7. ANNUITY RESERVES
At December 31, 1997 and 1996, the Company's general and separate account
annuity reserves 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, 1997:
Subject to discretionary withdrawal (with adjustment):
With market value adjustment $ 219,464 22.9%
At book value less surrender charge of 5% or more 5,760 0.6
At market value 372,550 38.9
-------------------------
Total with adjustment or at market value 597,774 62.4
Subject to discretionary withdrawal (without adjustment)
at book value with minimal or no charge or adjustment 299,314 31.2
Not subject to discretionary withdrawal 61,448 6.4
-------------------------
Total annuity reserves and deposit fund liabilities (before
reinsurance) 958,536 100.0%
---------
---------
Less reinsurance ceded -
----------
Net annuity reserves and deposit fund liabilities $ 958,536
----------
----------
<CAPTION>
<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
----------
----------
</TABLE>
19
<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, 1997 is as follows:
<TABLE>
<CAPTION>
*NONINDEXED NONGUARANTEED
GUARANTEED SEPARATE
MORE THAN 4% ACCOUNTS TOTAL
--------------------------------------------------
(IN THOUSANDS)
<S> <C> <C> <C>
Premiums, deposits and other considerations $ 122,664 $ 89,078 $ 211,742
--------------------------------------------------
--------------------------------------------------
Reserves for separate accounts with assets
at fair value $ 219,469 $ 372,669 $ 592,138
--------------------------------------------------
--------------------------------------------------
Reserves for separate accounts by
withdrawal characteristics:
Subject to discretionary withdrawal
(with adjustment):
With market value adjustment $ 219,464 $ - $ 219,464
At book value without market value
adjustment and with current
surrender charge of 5% or more 5 - 5
At market value - 372,669 372,669
--------------------------------------------------
Total with adjustment or at market value 219,469 372,669 592,138
Not subject to discretionary withdrawal - - -
--------------------------------------------------
Total separate accounts reserves $ 219,469 $ 372,669 $ 592,138
--------------------------------------------------
--------------------------------------------------
</TABLE>
* Separate accounts with guarantees.
20
<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, 1997 and 1996 is presented below:
<TABLE>
<CAPTION>
1997 1996
-------------------------
(IN THOUSANDS)
<S> <C> <C>
Transfers as reported in the Summary of Operations
of the Separate Accounts Statement:
Transfers to separate accounts $ 211,743 $ 102,901
Transfers from separate accounts (52,365) (37,150)
-------------------------
Net transfers to separate accounts 159,378 65,751
Reconciling adjustments:
Mortality and expense charges reported as other revenues 4,417 3,194
Other revenues 101 213
-------------------------
Transfers as reported in the Summary of Operations
of the Life, Accident and Health Annual Statement $ 163,896 $ 69,158
-------------------------
-------------------------
</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.
21
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
9. FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1996
------------------------- -------------------------
CARRYING CARRYING
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
------------------------- -------------------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Assets:
Bonds $ 414,907 $ 424,642 $ 451,439 $ 457,875
Preferred stocks 21,792 22,252 50,715 50,454
Mortgage loans 3,242 3,242 3,929 3,929
Liabilities:
Life and annuity reserves for
investment-type contracts $ 367,124 $ 367,374 $ 432,013 $ 426,516
Separate accounts annuity reserves 592,018 576,877 347,503 347,072
</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 estimate
or quoted market price of comparable investments.
MORTGAGE LOANS ON REAL ESTATE
The carrying amount of mortgage loans approximates their fair value.
LIFE AND ANNUITY RESERVES FOR INVESTMENT-TYPE CONTRACTS
The fair value of single premium immediate annuity reserves are based on
discounted cash flow calculations using a market yield rate for assets with
similar durations. The fair value of deposit fund liabilities and the remaining
annuity reserves are based on the cash surrender value of the underlying
contracts.
SEPARATE ACCOUNTS ANNUITY RESERVES
The fair value of separate accounts annuity reserves for investment-type
products equals the cash surrender values.
22
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
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
1997 and 1996, the Company was charged $5.9 million and $6.1 million,
respectively, for these services in accordance with the requirements of
applicable insurance law and regulations.
11. YEAR 2000 (UNAUDITED)
The Company is currently evaluating on an ongoing basis, its computer systems
and the systems of other companies on which the Company's operations rely to
determine if they will function properly with respect to dates in the year 2000
and beyond. These activities are designed to ensure that there is no adverse
effect on the Company's core business operations. While the Company believes
its planning efforts are adequate to address its Year 2000 concerns, there can
be no guarantee that the systems of other companies on which the Company's
operations rely will be converted on a timely basis and will not have a material
effect on the Company. The cost of the Company's Year 2000 initiatives is not
expected to be material to the Company's results of operations or financial
condition.
23
