<PAGE> 1
FINANCIAL STATEMENTS
PAINEWEBBER LIFE INSURANCE COMPANY
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
WITH REPORT OF INDEPENDENT AUDITORS
<PAGE> 2
PaineWebber Life Insurance Company
Financial Statements
Years ended December 31, 1997, 1996 and 1995
CONTENTS
<TABLE>
<S> <C>
Report of Independent Auditors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Audited Financial Statements
Balance Sheets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Statements of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Statements of Changes in Stockholder's Equity . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Statements of Cash Flows . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Notes to Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
</TABLE>
<PAGE> 3
Report of Independent Auditors
The Board of Directors
PaineWebber Life Insurance Company
We have audited the accompanying balance sheets of PaineWebber Life Insurance
Company as of December 31, 1997 and 1996, and the related statements of
operations, changes in stockholder's equity and cash flows for each of the
three years in the period ended December 31, 1997. 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.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of PaineWebber Life Insurance
Company at December 31, 1997 and 1996, and the results of its operations and
its cash flows for each of the three years in the period ended December 31,
1997, in conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
March 13, 1998
1
<PAGE> 4
PaineWebber Life Insurance Company
Balance Sheets
<TABLE>
<CAPTION>
DECEMBER 31
1997 1996
----------------------------------
<S> <C> <C>
ASSETS
Investments:
Fixed maturities:
Held to maturity, at amortized cost $ 7,755,294 $ 7,700,678
Available for sale, at market 70,515 74,200
Short-term investments 7,509,600 5,951,209
----------------------------------
Total investments 15,335,409 13,726,087
Cash and cash equivalents 201,621 493,662
Accrued investment income 245,607 164,540
Deferred policy acquisition costs 48,688,814 42,582,664
Goodwill, less accumulated amortization (1997 -- $600,000; 1996
-- $480,000) 600,000 720,000
Expense allowance receivable on reinsurance assumed 331,291 -
Other assets 39,857 103,446
Separate account assets 129,309,639 124,245,611
----------------------------------
Total assets $194,752,238 $182,036,010
==================================
LIABILITIES AND STOCKHOLDER'S EQUITY
Liabilities:
Net funds held on reinsurance assumed $ 27,267,752 $ 24,209,628
Expense allowance payable on reinsurance assumed - 498,500
Deferred income taxes 2,364,036 -
Other liabilities 805,870 618,757
Separate account liabilities 129,309,639 124,245,611
----------------------------------
Total liabilities 159,747,297 149,572,496
Commitments and contingencies (Note 8)
Stockholder's equity:
Common Stock, $100 par value -- 25,000 shares authorized,
issued and outstanding 2,500,000 2,500,000
Additional paid-in capital 26,757,295 26,757,295
Unrealized appreciation of available-for-sale investments 2,464 2,011
Retained earnings 5,745,182 3,204,208
----------------------------------
Total stockholder's equity 35,004,941 32,463,514
----------------------------------
Total liabilities and stockholder's equity $194,752,238 $182,036,010
==================================
</TABLE>
See accompanying notes.
2
<PAGE> 5
PaineWebber Life Insurance Company
Statements of Operations
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1997 1996 1995
---------------------------------------------
<S> <C> <C> <C>
Revenues:
Annuity product charges $11,922,506 $ 7,934,933 $ 4,442,424
Investment income, net of related expenses 687,963 797,083 1,061,015
Realized loss on investments (156) (346) (10,531)
---------------------------------------------
12,610,313 8,731,670 5,492,908
Expenses:
Commissions 8,037,598 18,631,019 10,093,301
General expenses 5,526,993 4,575,441 3,146,492
Insurance taxes 78,188 319,353 289,421
Policy acquisition costs deferred (8,482,896) (19,509,928) (10,169,946)
Amortization of deferred policy
acquisition costs 2,376,746 1,532,285 667,997
Amortization of goodwill 120,000 120,000 120,000
---------------------------------------------
7,656,629 5,668,170 4,147,265
---------------------------------------------
Income before income taxes 4,953,684 3,063,500 1,345,643
Income tax expense:
Current 50,000 - -
Deferred 2,362,710 - -
---------------------------------------------
2,412,710 - -
---------------------------------------------
Net income $ 2,540,974 $ 3,063,500 $ 1,345,643
=============================================
</TABLE>
See accompanying notes.
3
<PAGE> 6
PaineWebber Life Insurance Company
Statements of Changes in Stockholder's Equity
<TABLE>
<CAPTION>
UNREALIZED
APPRECIATION
ADDITIONAL (DEPRECIATION) OF RETAINED
COMMON PAID-IN AVAILABLE-FOR-SALE EARNINGS
STOCK CAPITAL INVESTMENTS (DEFICIT) TOTAL
----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balances at January 1, 1995 $2,500,000 $26,757,295 $(2,750) $(1,204,935) $28,049,610
Net income - - - 1,345,643 1,345,643
Unrealized appreciation of
available-for-sale
investments - - 4,684 - 4,684
----------------------------------------------------------------------------
Balances at December 31, 1995 2,500,000 26,757,295 1,934 140,708 29,399,937
Net income - - - 3,063,500 3,063,500
Unrealized appreciation of
available-for-sale
investments - - 77 - 77
----------------------------------------------------------------------------
Balances at December 31, 1996 2,500,000 26,757,295 2,011 3,204,208 32,463,514
Net income - - - 2,540,974 2,540,974
Unrealized appreciation of
available-for-sale
investments - - 453 - 453
----------------------------------------------------------------------------
Balances at December 31, 1997 $2,500,000 $26,757,295 $ 2,464 $ 5,745,182 $35,004,941
============================================================================
</TABLE>
See accompanying notes.
4
<PAGE> 7
PaineWebber Life Insurance Company
Statements of Cash Flows
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1997 1996 1995
------------------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income $ 2,540,974 $ 3,063,500 $ 1,345,643
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Amortization of goodwill 120,000 120,000 120,000
Net amortization of fixed maturities (46,082) 8,002 44,869
Deferral of policy acquisition costs (8,482,896) (19,509,928) (10,169,946)
Amortization of deferred acquisition costs 2,376,746 1,532,285 667,997
Change in expense allowance payable and net funds
held on reinsurance assumed 1,023,568 14,593,989 7,647,978
Payments to ceding companies on reinsurance assumed (1,734,647) (5,585,066) (3,569,517)
Payments received from ceding companies on reinsurance assumed 2,939,412 907,224 156,032
Provision for deferred income taxes 2,362,710 - -
Realized loss on investments 156 346 10,531
Changes in operating assets and liabilities, net of reinsurance
assumed:
Decrease (increase) in accrued investment income (81,067) (93,794) 94,400
Decrease (increase) in other assets 63,589 368,550 (255,770)
Increase (decrease) in policy and contract claims - (384,312) 263,102
Increase (decrease) in other liabilities 187,113 154,510 (1,034,844)
------------------------------------------------
Net cash provided by (used in) operating activities 1,269,576 (4,824,694) (4,679,525)
INVESTING ACTIVITIES
Proceeds from investments sold, matured or repaid:
Fixed maturities -- held to maturity 1,360,000 2,160,000 515,000
Fixed maturities -- available for sale 5,000 10,000 10,000
Short-term investments - net - 10,307,954 2,823,419
------------------------------------------------
1,365,000 12,477,954 3,348,419
Cost of investments acquired:
Fixed maturities -- held to maturity (1,368,226) (7,166,369) (662,450)
Short-term investments - net (1,558,391) - -
------------------------------------------------
(2,926,617) (7,166,369) (662,450)
------------------------------------------------
Net cash provided by (used in) investing activities (1,561,617) 5,311,585 2,685,969
------------------------------------------------
Increase (decrease) in cash and cash equivalents (292,041) 486,891 (1,993,556)
Cash and cash equivalents at beginning of year 493,662 6,771 2,000,327
------------------------------------------------
Cash and cash equivalents at end of year $ 201,621 $ 493,662 $ 6,771
================================================
</TABLE>
See accompanying notes.
5
<PAGE> 8
PaineWebber Life Insurance Company
Notes to Financial Statements
December 31, 1997
1. ORGANIZATION, NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
ORGANIZATION AND NATURE OF BUSINESS
PaineWebber Life Insurance Company (the Company) is a wholly-owned subsidiary
of PaineWebber Life Holdings, Inc., which is a wholly-owned subsidiary of
PaineWebber Group, Inc. (the Parent). The Company offers separate account
variable annuity products. These products are marketed through the Parent's
licensed brokers.
USE OF ESTIMATES
The preparation of financial statements of insurance companies requires
management to make estimates and assumptions that affect amounts reported in
the financial statements and accompanying notes. Such estimates and assumptions
could change in the future as more information becomes known, which could
impact the amounts reported and disclosed herein.
INVESTMENTS
Fixed maturity securities that the Company has the positive intent and ability
to hold to maturity are designated as "held to maturity". Held to maturity
securities are reported at cost adjusted for amortization of premiums and
discounts. Changes in the fair value of these securities, except for declines
that are other than temporary, are not reflected in the Company's financial
statements. Fixed maturity securities which may be sold are designated as
"available for sale". Available for sale securities are reported at fair value
and unrealized gains and losses on these securities are included directly in a
separate component of stockholder's equity. Securities that are determined to
have a decline in value that is other than temporary are written down to
estimated fair value, which becomes the security's new cost basis, by a charge
to realized losses in the Company's statement of operations.
Premiums and discounts are amortized utilizing the interest method which
results in a constant yield over the securities' expected life. Realized gains
and losses are determined on the basis of specific identification of
investments.
CASH AND CASH EQUIVALENTS
For purposes of the statement of cash flows, the Company considers all highly
liquid debt instruments purchased with a maturity of three months or less to be
cash equivalents.
6
<PAGE> 9
PaineWebber Life Insurance Company
Notes to Financial Statements (continued)
1. ORGANIZATION, NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (CONTINUED)
GOODWILL
Goodwill includes the costs of various insurance licenses acquired in
conjunction with the purchase of the Company. These costs are being amortized
on a straight-line basis over 10 years.
DEFERRED POLICY ACQUISITION COSTS
Commissions and other costs of acquiring new business which vary with and are
primarily related to the production of new business have been deferred. The
deferred costs are being amortized in relation to the present value of expected
gross profits. This amortization is adjusted periodically to reflect
differences in actual and assumed gross profits.
DEFERRED INCOME TAXES
The deferred tax assets or liabilities are computed based on the difference
between the financial statement and income tax basis of assets and liabilities
using the enacted marginal tax rate. Deferred income tax expense or credits are
based on the changes in the asset or liability from period to period.
DIVIDEND RESTRICTIONS
Prior approval of insurance regulatory authorities is required for payment of
dividends to the Company's parent which exceed an annual limitation. During
1998, the Company will be able to pay dividends to its parent of approximately
$1,700,000 without prior approval of statutory authorities.
SEPARATE ACCOUNT
Separate account assets and liabilities represent funds held for the exclusive
benefit of variable annuity contractholders. Fees are received for
administrative expenses and for assuming mortality, distribution and expense
risks. Operations of the separate account are not included in these financial
statements.
7
<PAGE> 10
PaineWebber Life Insurance Company
Notes to Financial Statements (continued)
2. FAIR VALUES OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards (SFAS) No. 107, Disclosures About
Fair Value of Financial Instruments, requires disclosure of fair value
information about financial instruments, whether or not recognized in the
balance sheet, for which it is practicable to estimate that value. In cases
where quoted market prices are not available, fair values are based on
estimates using present value or other valuation techniques. Those techniques
are significantly affected by the assumptions used including the discount rate
and estimates of future cash flows. In that regard, the derived fair value
estimates cannot be substantiated by comparisons to independent markets and, in
many cases, could not be realized in immediate settlement of the instrument.
SFAS 107 excludes certain financial instruments and all nonfinancial
instruments from its disclosure requirements. Accordingly, the aggregate fair
value amounts presented do not represent the underlying value of the Company.
The following methods and assumptions were used by the Company in estimating
the "fair value" disclosures for "financial instruments":
Cash, cash equivalents, short-term investments and separate account assets:
The carrying amounts reported in the balance sheet for these financial
instruments approximate their fair values.
Fixed maturities: The fair values for fixed maturities are based on quoted
market prices, where available. For fixed maturities not actively traded,
fair values are estimated using values obtained from independent pricing
services.
Separate account liabilities: Fair values for the Company's liabilities
under investment-type insurance contracts are based on cash surrender value
of the underlying contracts.
The following sets forth a comparison of the carrying amounts and fair values
of the Company's financial instruments subject to provisions of SFAS No. 107:
<TABLE>
<CAPTION>
DECEMBER 31
1997 1996
--------------------------------- ------------------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
--------------------------------- ------------------------------
<S> <C> <C> <C> <C>
Assets:
Cash and cash equivalents $ 201,621 $ 201,621 $ 493,662 $ 493,662
Short-term investments 7,509,600 7,509,600 5,951,209 5,951,209
Fixed maturities:
Held to maturity 7,755,294 7,821,060 7,700,678 7,727,700
Available for sale 70,515 70,515 74,200 74,200
--------------------------------- ------------------------------
15,537,030 15,602,796 7,774,878 7,801,900
Separate account assets 129,309,639 129,309,639 124,245,611 124,245,611
Liabilities:
Separate account liabilities 129,309,639 128,347,917 124,245,611 121,673,753
</TABLE>
8
<PAGE> 11
PaineWebber Life Insurance Company
Notes to Financial Statements (continued)
3. BASIS OF PRESENTATION
The financial statements prepared on the basis of generally accepted accounting
principles differ from those prepared on a statutory basis primarily as
follows: (a) revenues on investment products consist of policy charges for the
cost of issuance, policy administration charges, amortization of policy
initiation fees and surrender charges assessed rather than premiums received;
(b) acquisition costs such as commissions and other costs related to acquiring
new business are being deferred and amortized over the life of the policy
rather than being charged to current operations as incurred; (c) policy
reserves on investment products are based on full account values rather than
discounted methodologies utilizing statutory interest rates; (d) a portion of
fixed maturity investments is designated as "available for sale" and valued at
fair value with unrealized appreciation/depreciation credited/charged directly
to stockholder's equity rather than valued at amortized cost; (e) deferred
federal income taxes are provided for temporary differences between the
financial statements and the tax returns; (f) certain assets designated as
"non-admitted assets" have been reported as assets rather than being charged to
surplus; (g) the carrying value of investments is reduced to fair value by the
recognition of a realized loss in the statement of operations when declines in
carrying value and judged to be other than temporary rather than recording an
asset valuation reserve, in the nature of a contingency reserve which is
recorded as a liability through a charge to surplus; (h) net realized capital
gains (losses) attributable to changes in the level of market interest rates
are recognized in the statement of operations in the year of disposition rather
than being deferred and amortized over the remaining life of the bonds disposed
of; (i) assets and liabilities are restated to fair values, with provision for
goodwill and other intangible assets, when a change in ownership occurs rather
than retaining their historical value; and (j) reinsurance reserve credits are
recorded as reinsurance recoverable assets rather than recorded as a reduction
to aggregate policy reserves.
Net income (loss) for the Company as reported in accordance with statutory
accounting practices was approximately $1,679,000 in 1997, $(2,890,000) in 1996
and $(4,179,000) in 1995. Total statutory capital and surplus, as reported, was
$16,218,000 at December 31, 1997 and $14,530,000 at December 31, 1996.
The National Association of Insurance Commissioners (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 Company uses to
prepare its statutory-basis financial statements. Codification, which was
approved by the NAIC in March 1998, 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, the State of California must adopt
Codification as the prescribed basis of accounting on which domestic insurers
must report their statutory-basis results to the Insurance Division. At this
time, it is unclear whether the State of California will adopt Codification.
9
<PAGE> 12
PaineWebber Life Insurance Company
Notes to Financial Statements (continued)
4. INVESTMENT OPERATIONS
At December 31, 1997 and 1996, the amortized cost, gross unrealized gains and
losses, and estimated fair value of investments in fixed maturity securities
are as follows:
HELD FOR INVESTMENT
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------------------------------------------------------
<S> <C> <C> <C> <C>
DECEMBER 31, 1997
Bonds - United States Government and agencies $ 7,755,294 $67,363 $1,597 $ 7,821,060
Short-term investments - United States
Government and agencies 7,509,600 - - 7,509,600
---------------------------------------------------------
$15,264,894 $67,363 $1,597 $15,330,660
=========================================================
DECEMBER 31, 1996
Bonds - United States Government and agencies $ 7,700,678 $33,685 $6,663 $ 7,727,700
Short-term investments - United States
Government and agencies 5,951,209 - - 5,951,209
---------------------------------------------------------
$13,651,887 $33,685 $6,663 $13,678,909
=========================================================
</TABLE>
AVAILABLE FOR SALE
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
---------------------------------------------------------
<S> <C> <C> <C> <C>
DECEMBER 31, 1997
Bonds - state, municipal and other government $66,725 $3,790 $ - $70,515
=========================================================
DECEMBER 31, 1996
Bonds - state, municipal and other government $72,189 $2,011 $ - $74,200
=========================================================
</TABLE>
During the year ended December 31, 1997, net unrealized gains on fixed maturity
securities designated as available for sale caused an increase in stockholder's
equity of $453 (net of deferred income taxes of $1,326).
10
<PAGE> 13
PaineWebber Life Insurance Company
Notes to Financial Statements (continued)
4. INVESTMENTS OPERATIONS (CONTINUED)
The amortized cost and estimated fair value of investments in fixed maturity
securities, by contractual maturity at December 31, 1997, are shown below.
Expected maturities may differ from contractual maturities because borrowers
may have the right to call or prepay obligations with or without call or
prepayment penalties.
<TABLE>
<CAPTION>
HELD FOR INVESTMENT AVAILABLE FOR SALE
--------------------------- ------------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
--------------------------- ------------------------
<S> <C> <C> <C>
Due in one year or less $6,206,125 $6,235,000 $ - $ -
Due after one year through five years 1,549,169 1,586,060 - -
Due after five years through ten years - - 66,725 70,515
--------------------------- ------------------------
$7,755,294 $7,821,060 $66,725 $70,515
=========================== ========================
</TABLE>
Major categories of net investment income are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1997 1996 1995
------------------------------------------
<S> <C> <C> <C>
Fixed maturities:
Held for investment $265,901 $317,782 $ 146,009
Available for sale 4,534 4,383 4,500
Short-term investments 308,140 568,342 997,738
Other 3,019 924 15,828
------------------------------------------
581,594 891,431 1,164,075
Less investment expenses 106,369 94,348 103,060
------------------------------------------
$687,963 $797,083 $1,061,015
==========================================
</TABLE>
At December 31, 1997, investments with an aggregate carrying value of
$7,755,294 (1996 -- $7,650,977) were on deposit with regulatory authorities or
were restrictively held in bank custodial accounts for the benefit of such
regulatory authorities as required by statute.
11
<PAGE> 14
PaineWebber Life Insurance Company
Notes to Financial Statements (continued)
5. FEDERAL INCOME TAXES
The effective tax rate on income before taxes is different from the prevailing
federal income tax rate as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1997 1996 1995
---------------------------------------------
<S> <C> <C> <C>
Income before income taxes $4,953,684 $3,063,500 $1,345,643
=============================================
Tax effect of federal statutory rate (35%) $1,733,789 $1,072,225 $ 470,975
Tax effect (decrease) of:
Dividends received deduction, including
revisions to prior year estimates in 1997 67,857 (605,807) (185,129)
Change in valuation allowance (147,872) (401,700) (318,873)
Other, including revisions to prior year
estimates in 1997 758,936 (64,718) 33,027
---------------------------------------------
Income tax expense $2,412,710 $ - $ -
=============================================
</TABLE>
The tax effect of temporary differences giving rise to the Company's deferred
income taxes is as follows:
<TABLE>
<CAPTION>
DECEMBER 31
1997 1996
----------------------------------
<S> <C> <C>
Deferred income tax assets:
Net operating loss and credit carryovers $ 4,893,720 $ 5,477,791
Reinsurance 9,328,706 7,907,873
Other 221,573 1,299,814
----------------------------------
14,443,999 14,685,478
Deferred income tax liabilities:
Unrealized appreciation of fixed maturity 1,326 -
Deferred policy acquisition costs 16,747,970 14,491,923
Fixed maturity discounts 46,425 27,651
Other 12,314 18,032
----------------------------------
16,808,035 14,537,606
Valuation allowance - (147,872)
----------------------------------
Net deferred income tax $ 2,364,036 $ -
==================================
</TABLE>
For federal income tax purposes, the Company files a separate federal income
tax return. At December 31, 1997, the Company has net operating loss
carryforwards for income tax purposes of approximately $13,800,000, which
expire through 2011.
12
<PAGE> 15
PaineWebber Life Insurance Company
Notes to Financial Statements (continued)
6. REINSURANCE
The Company has reinsurance agreements with various insurance companies to
assume a specified percentage of their variable annuity contracts. Under these
agreements, the Company receives from the ceding company the account balances
of the reinsured contracts. The Company in return pays to the ceding companies
an expense allowance for commissions and other expenses associated with the
reinsured contracts. In addition, the Company pays or receives an amount equal
to the change in the statutory reserve held by the ceding companies on the
reinsured contracts, adjusted for investment earnings credits. For the years
ended December 31, 1997, 1996 and 1995, the Company recorded annuity product
charges of $10,361,869, $6,828,830 and $3,679,995, respectively, related to
contracts assumed under these agreements. At December 31, 1997 and 1996, the
assets on deposit with ceding companies and funds held on reinsurance assumed
are as follows:
<TABLE>
<CAPTION>
1997 1996
------------------------------------
<S> <C> <C>
Assets on deposit with ceding companies $ 703,970,716 $ 502,197,980
Funds held on reinsurance assumed (731,238,468) (526,407,608)
------------------------------------
Net funds held on reinsurance assumed $ (27,267,752) $ (24,209,628)
====================================
</TABLE>
The Company also has a reinsurance agreement with American Republic Insurance
Company (American Republic) (see Note 7) to cede a specified percentage of the
risks associated with the variable annuity contracts. Under this agreement, the
Company pays American Republic the reinsurance percentage of charges and
deductions collected on the reinsured policies. American Republic in return
pays the Company an expense allowance for certain developmental, new business
and maintenance costs on the reinsured contracts. The Company has also entered
into a separate reinsurance agreement to reinsure the enhanced death benefit
provision of the contracts. During 1997, 1996 and 1995, the Company incurred
reinsurance premiums of $1,465,655, $1,459,270 and $1,741,939, respectively,
and had benefit recoveries of $48,087, $120,199 and $198,824, respectively, in
connection with these agreements.
7. SERVICE AGREEMENTS WITH RELATED PARTIES
The Company has a third-party and corporate administrative agreements with
American Republic to provide services for new business processing and account
maintenance of the variable annuity contracts. The Company paid American
Republic $552,000, $817,000 and $724,000 for these services in 1997, 1996 and
1995, respectively.
Commissions relating to the sale of all variable annuity contacts are paid to
an affiliated company.
13
<PAGE> 16
PaineWebber Life Insurance Company
Notes to Financial Statements (continued)
8. COMMITMENTS AND CONTINGENCIES
The Company is subject to insurance guaranty laws in the states in which it
writes business. These laws provide for assessments against insurance companies
for the benefit of policyholders and claimants in the event of insolvency of
other insurance companies. Potential obligations, if any, are not presently
determinable by the Company; accordingly, no accrual has been made on these
financial statements.
9. YEAR 2000 (UNAUDITED)
Based on a study of its computer software and hardware, the Company has
determined its exposure to the Year 2000 change of the century date issue. The
Company has developed a plan to modify its information technology to be ready
for the Year 2000. Efforts began in 1996 to modify its systems. This project is
expected to be substantially completed early in 1999. While additional testing
will be conducted on its systems through the Year 2000, the Company does not
expect this project to have a significant effect on the Company's operations.
To mitigate the effect of outside influences and other dependencies relative to
the Year 2000, the Company is contacting significant customers, suppliers and
other third parties. To the extent these third parties would be unable to
transact business in the Year 2000 and thereafter, the Company's operations
could be adversely affected.
14
