Filed with the Securities and Exchange Commission on October 15, 1999 Registration No. 333-85573 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 Form S-6 PRE-EFFECTIVE AMENDMENT NO 1 TO REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 OF SECURITIES OF UNIT INVESTMENT TRUSTS REGISTERED ON FORM N-8B-2 A. Exact name of trust: Variable Account II B. Name of depositor: AIG Life Insurance Company C. Complete address of depositor's principal executive offices: One Alico Plaza, 600 King Street, Wilmington, DE 19801 D. Name and address of agent for service: Kenneth D. Walma, Vice President and General Counsel One Alico Plaza 600 King Street Wilmington, DE 19801 COPIES TO: Michael Berenson, Esq. and Ernest T. Patrikis, Esq. Jorden Burt Boros Cicchetti American International Group, Inc. Berenson & Johnson, LLP 70 Pine Street Suite 400 East New York, NY 10270 1025 Thomas Jefferson Street, NW Washington, DC 20007-0805 E. Title and amount of securities being registered: Flexible Premium Variable Universal Life Group Insurance Policies and Certificates and Individual Insurance Policies. F. Approximate date of proposed public offering: As soon as practicable after the effective date of this Registration Statement. The Registrant hereby amends this Registration Statement on such date as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Reigstration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine. CROSS REFERENCE TO ITEMS REQUIRED BY FORM N-8B-2 N-8B-2 Item Caption in Prospectus 1 About Us and the Accounts, The Separate Account 2 About Us and the Accounts 3 Not Applicable 4 Distribution of the Policy 5 The Separate Account 6(a) Not Applicable 6(b) Not Applicable 9 Legal Proceedings 10 Purchasing a Policy 11 The Separate Account, The Investment Options 12 The Separate Account, The Investment Options 13 Expenses of the Policy 14 Purchasing a Polaris VUL Policy 15 The Separate Account 16 The Separate Account, The Investment Options 17 Purchasing a Polaris VUL Policy 18 Investing Your Account Value 19 Purchasing a Polaris VUL Policy, Investing Your Account Value 20 Not Applicable 21 Cash Benefits During the Insured's Lifetime 22 Not Applicable 23 Not Applicable 24 Not Applicable 25 About Us and the Accounts 26 Not Applicable 27 About Us and the Accounts 28 About Us and the Accounts 29 About Us and the Accounts 30 About Us and the Accounts 31 Not Applicable 32 Not Applicable 33 Not Applicable 34 Distribution of the Policy 35 About Us and the Accounts 37 Not Applicable 38 Distribution of the Policy 39 Distribution of the Policy 40 Not Applicable 41(a) Distribution of the Policy 42 Not Applicable 43 Not Applicable 44 Purchasing a Polaris VUL Policy 45 Not Applicable 46 Purchasing a Polaris VUL Policy 47 Not Applicable 48 Not Applicable 49 Not Applicable 50 Not Applicable 51 Purchasing a Polaris VUL Policy About Us and the Accounts 52 The Investment Options 53 Federal Income Tax Considerations 54 Financial Statements 55 Not Applicable Part I [Polaris VUL Logo] AIG Life Insurance Company Variable Account II One Alico Plaza 600 King Street Wilmington, Delaware 19801 1-800-340-2765 Flexible Premium Joint and Last Survivor Variable Universal Life Policy AIG Life Insurance Company ("we," "our" or "us"), is offering life insurance coverage on two individuals under the Polaris Joint and Last Survivor Variable Universal Life policy (the "Policy"). We pay the death benefit after both Insureds die. The Policy is a flexible premium joint and last survivor variable universal life policy that allows "you," the owner of the Policy, within limits, to: o Select the face amount of life insurance. You may within limits change your initial selection as your insurance needs change. o Select the amount and timing of premiums payments. You may make more premium payments than scheduled or stop making premium payments. o Allocate premium payments and your Policy's Account Value among the variable investment options and the guaranteed investment option. o Receive payments from your Policy while at least one Insured is alive through loans, partial withdrawals or a total surrender. This document contains information about the Policy. You should read this document carefully before you decide to purchase the Policy. You should also keep this document for future reference. Interest in the Policies and shares of the Portfolios are not deposits or obligations of or guaranteed by a bank, and are not federally insured by the Federal Deposit Insurance Corporation or any other governmental agency. Neither the Securities and Exchange Commission nor any state securities commission has approved of the Policy or determined that this document is accurate or complete. Any representation to the contrary is a criminal offense. Prospectus _________, 1999 Investment Options Variable Investment Options The Separate Account is divided into Subaccounts. Each Subaccount invests in shares of a specific portfolio of the Anchor Series Trust or SunAmerica Series Trust. Each portfolio is named below. The prospectuses for Anchor Series Trust and SunAmerica Series Trust contain information about each portfolio. You should read these prospectuses carefully. These prospectuses may be obtained by calling 1-800-340-2765, Anchor Series Trust Managed by Wellington Management Company, LLP o Capital Appreciation Portfolio o Government and Quality Bond Portfolio o Growth Portfolio o Natural Resources Portfolio SunAmerica Series Trust Managed by Alliance Capital Management L.P. Managed by Massachusetts o Global Equities Portfolio Financial Services Company o Alliance Growth Portfolio o MFS Growth and Income o Growth-Income Portfolio Portfolio o MFS Mid-Cap Growth Portfolio o MFS Total Return Portfolio Managed by Davis Selected Advisers, L.P. Managed by Morgan Stanley Asset o Real Estate Portfolio Management o Venture Value Portfolio o International Diversified Equities Portfolio o Worldwide High Income Portfolio Managed by Federated Investment Counseling Managed by Putnam Investment o Corporate Bond Portfolio Management, Inc. o Federated Value Portfolio o Emerging Markets Portfolio o Utility Portfolio o Putnam Growth Portfolio o International Growth and Income Portfolio Managed by Goldman Sachs Asset Managed by SunAmerica Asset Management/Goldman Sachs Asset Management Corp. Management International o Aggressive Growth Portfolio o Asset Allocation Portfolio o SunAmerica Balanced Portfolio o Global Bond Portfolio o Cash Management Portfolio o "Dogs" of Wall Street Portfolio o High-Yield Bond Portfolio Guaranteed Investment Option You may allocate your Account Value to the Guaranteed Account. The Guaranteed Account is part of our general account. We will credit interest equal to at least an effective rate of 4% per year, compounded annually on that portion of Account Value that you allocate to the Guaranteed Account. We may, in our discretion, elect to credit a higher rate of interest. This document generally describes only that portion of the Account Value allocated to the Separate Account. - -------------------------------------------------------------------------------- Table of Contents - -------------------------------------------------------------------------------- Special Terms used in this Document............................................i Summary of the Policy..........................................................1 Overview .............................................................1 Applying for a Policy.................................................1 Premium Payments......................................................2 Account Value.........................................................2 Death Benefit.........................................................3 Cash Benefits Available While the Policy is in Force..................4 Expenses of the Policy................................................5 Federal Tax Considerations............................................8 Purchasing a Polaris Joint and Last Survivor VUL Policy.......................10 Applying for a Policy................................................10 Your Right to Cancel the Policy......................................11 Premiums ............................................................11 Restrictions on Premiums.............................................11 Minimum Initial Premium..............................................12 Planned Periodic Premiums............................................12 Additional Premiums..................................................12 Effect of Premium Payments...........................................12 No Lapse Provision...................................................13 Grace Period.........................................................13 Premium Allocations..................................................14 Crediting Premiums...................................................15 The Investment Options........................................................16 Variable Investment Options..........................................16 Guaranteed Investment Option.........................................20 Investing Your Account Value..................................................22 Determining the Account Value........................................22 Transfers............................................................25 Dollar Cost Averaging (DCA)..........................................26 Automatic Rebalancing................................................28 Death Benefits................................................................29 Life Insurance Proceeds..............................................29 Death Benefit Options................................................30 Changes in Death Benefit Options.....................................31 Changes in Face Amount...............................................32 Changes in Owner or Beneficiary......................................34 Cash Benefits Available While the Policy is in Force .........................35 Policy Loans.........................................................35 Partial Withdrawals..................................................37 Systematic Withdrawal Program........................................39 Surrendering the Policy for Net Cash Surrender Value.................40 Payment Options for Benefits..................................................41 Expenses of the Policy........................................................42 Deductions From Premiums.............................................42 Monthly Deductions From Account Value................................42 Deduction From Subaccount Assets.....................................46 Deductions Upon Policy Transactions .................................47 Supplemental Benefits and Riders.............................................51 Other Policy Provisions.......................................................52 Right to Exchange....................................................52 Policy Split Option..................................................52 Limits on our Rights to Contest the Policy...........................53 Changes in the Policy or Benefits....................................54 When Proceeds Are Paid...............................................55 Reports to Owners....................................................55 Assignment...........................................................56 Reinstatement........................................................56 Performance Information.......................................................58 Federal Income Tax Considerations.............................................61 Distribution of the Policy....................................................68 About Us and the Accounts.....................................................69 The Company..........................................................69 The Separate Account.................................................70 The Guaranteed Account...............................................72 Our Directors and Executive Officers..........................................74 Other Information.............................................................76 State Regulation.....................................................76 Legal Proceedings....................................................76 Experts ............................................................76 Legal Matters........................................................76 Published Ratings....................................................77 Financial Statements..........................................................77 Appendix A - -------------------------------------------------------------------------------- Special Terms used in this Document - -------------------------------------------------------------------------------- We have capitalized some special terms we use in this document. We have defined these terms here. Accounts. The Separate Account and the Guaranteed Account of the Company. We use Account Value to determine your Policy benefits. How we determine Account Value is described on page 22. Account Value. The total amount in the Accounts credited to your Policy. If you have a request, please write to us at this address. Administrative Office. One Alico Plaza, P.O. Box 8718, Wilmington, DE 19801. Age. Each Insured's age as of his or her nearest birthday on the Policy Date. Attained Age. Each Insured's Age as of the Policy Date plus the number of full Policy years since the Policy Date. Beneficiary. The person(s) who is (are) entitled to the Life Insurance Proceeds under the Policy. How we determine the Cash Surrender Value is shown on page 24. Cash Surrender Value. The Account Value less any applicable surrender charge that would be deducted upon surrender. Code. The Internal Revenue Code of 1986, as amended. Company, we, our, us. AIG Life Insurance Company. Death Benefit. The amount of life insurance coverage which is based upon the death benefit option you select and the Face Amount. i You will specify the initial Face Amount in your Policy application. The Policy will also show the initial Face Amount. Face Amount. The amount of insurance specified by the Owner and the base for calculating the Death Benefit. Grace Period. The period of time during which your Policy will continue in force even though your Net Cash Surrender Value is insufficient. It begins on a monthly anniversary when the Net Cash Surrender Value is less than the total monthly deduction then due. Guaranteed Account. An account within our general account which consists of all of our assets other than the assets of the Separate Account and any of our other separate accounts. Insured(s). The person(s) who has (have) life insurance coverage under the Policy. We measure contestability periods from the Issue Date. Issue Date. The date the Policy is actually issued. It may be later than the Policy Date. Last Surviving Insured. The remaining Insured after the death of one of the two Insureds covered under this Policy. Life Insurance Proceeds. The amount payable to a Beneficiary if the Last Surviving Insured dies while life insurance coverage under the Policy is in force. Loan Account. The portion of the Account Value held in the Guaranteed Account as collateral for Policy loans. Monthly Anniversary. The same day as the Policy Date for each succeeding month, except that, for any month not having such a day, it is the last day of that month. We use this value to determine if your Policy is in force. Net Cash Surrender Value. The Cash Surrender Value less any Outstanding Loan. Net Premium. Any premium paid less any expense charges deducted from the premium payment. ii Outstanding Loan. The total amount of Policy loans including both principal and accrued interest. You may be an Owner even if you are not the Insured. Owner(s), you, your. The person(s) who purchased the Policy as shown in the application, unless later changed. If there is more than one Owner, then all Owners must agree to any changes regarding the Policy. Policy. The flexible premium joint and last survivor variable universal life insurance coverage we issue. We may issue coverage under an individual contract form or under a certificate issued under a group contract form. The term Policy includes the individual contract form and the certificate and group contract form. We use the Policy Date as the date coverage begins and to determine all anniversary dates. Policy Date. The date as of which we have received the initial premium and an application in good order. If a policy is issued, life insurance coverage is effective as of the Policy Date. Separate Account. Variable Account II, a separate investment account of ours. Subaccount. A division of the Separate Account established to invest in shares of a corresponding portfolio of a fund that is available for investment under the Policy. Valuation Date. Each day the New York Stock Exchange is open for trading. Valuation Period. A period commencing with the close of trading on the New York Stock Exchange (currently 4 P.M., Eastern Time) on any Valuation Date and ending as of the close of the New York Stock Exchange on the next succeeding Valuation Date. iii - -------------------------------------------------------------------------------- Summary of the Policy - -------------------------------------------------------------------------------- Because this is a summary, it does not contain all the information that may be important to you. You should read this entire document carefully before you decide to purchase a Policy. If you select any variable investment options, your Policy benefits will vary based upon the returns earned by those variable investment options. The returns may be zero or negative and you bear this risk. Overview The Policy is a flexible premium joint and last survivor variable universal life policy. Like traditional life insurance, the Policy provides an initial minimum death benefit and cash benefits that you can access through loans, partial withdrawals or a surrender. Unlike traditional life insurance, you may choose how to invest your Account Value. The Policy is a "joint and last survivor" policy because unlike a single life policy, it insures the lives of two Insureds and provides a death benefit that is payable upon the death of the Last Surviving Insured. No death benefit is payable upon the first Insured's death. The Policy allows you to make certain choices that will tailor the Policy to your needs. When you apply for the Policy, we will ask you to make some of these choices. You may also change your choices to meet your changing insurance needs. In addition, we may in the future offer several riders to the Policy. These riders provide you with the flexibility to design an insurance product that meets your specific needs. Applying for a Policy You may apply for a Policy to cover individuals, the "Insureds," who are both younger than Age 86. Amount of life insurance benefits. When you apply for a Policy, you must select the Face Amount. The Face Amount must be at least $200,000. 1 When your coverage will become effective. Your policy will become effective after: o We accept your application. o We receive an initial premium payment, in an amount we determine. o We have completed our review of your application to our satisfaction. Your right to cancel the Policy. Once you receive your Policy, you should read the Policy. You have the right to cancel the Policy for any reason no later than 10 days after you receive the Policy. If required by the state where you live, we will extend the 10 days to the number required by law. Premium Payments Minimum initial premium. Before your Policy is effective, you must pay the minimum initial premium. We will calculate the minimum initial premium based on a number of factors, such as the Age, sex and underwriting rate class of the proposed Insureds, the desired Face Amount, and any supplemental benefits or riders applied for and whether premiums will be paid by pre-authorized checking. Planned periodic premium. When you apply for a Policy you will select the amount of premium payments you plan to pay during the term of the Policy. We will establish a minimum for this amount. You will also select intervals when you plan to pay this premium amount. This may be monthly, quarterly, semiannually, or annually. Pre-authorized checking may be required for monthly payments. Flexibility in premium payments. During the term of the Policy, you may pay premiums at any time and in any amount, within limits. Thus, you are not required to pay the planned periodic premium and you may make payments in addition to the planned periodic premium. 2 Account Value We will measure your benefits under the Policy by your Account Value. Your Account Value will reflect: o the premiums you pay; o the returns earned by the Subaccounts you select; o the interest credited on amounts allocated to the Guaranteed Account; o any loans or partial withdrawals; and o the Policy charges and expenses we deduct. Death Benefit Death Benefit Selections. When you apply for a Policy, you must select: o The Face Amount. o The death benefit option, which will be the manner in which we calculate the death benefit for your Policy. o The tax qualification option, which will determine the manner in which we test your Policy under the Code for meeting the definition of life insurance. Death Benefit Options. You may select from two death benefit options. They are: Level Death Benefit Option. o Level Death Benefit Option (Option I) The basic Death Benefit will be the greater of: (1) The Face Amount on the date of the Last Surviving Insured's death; or (2) Account Value on the date of the Last Surviving Insured's death multiplied by the appropriate minimum death benefit factor on that date. Variable Death Benefit Option. o Variable Death Benefit Option (Option II) The basic Death Benefit will be the greater of: (1) The Face Amount plus the Account Value on the date of the Last Surviving Insured's death; or (2) Account Value on the date of the Last Surviving Insured's death multiplied by the appropriate minimum death benefit factor on that date. 3 The minimum death benefit factors we use are based upon the tax qualification option you select and the Policy duration. Your Policy will state the minimum death factors applicable and are determined by the Attained Age, sex and rate class of each Insured. Tax Qualification Options. You may select from two tax qualification options. They are: o Guideline Premium/Cash Value Corridor Test. The minimum death benefit factors are based upon the Code. o Cash Value Accumulation Test. The minimum death benefit factors are based upon the 1980 Commissioners Standard Ordinary Mortality Tables and a 4% effective annual interest rate. Changes You May Make. Within limits, after the first Policy anniversary, you may change the death benefit option and may make changes to the Face Amount. You may not change the tax qualification option. Cash Benefits Available While the Policy is in Force While the Policy is in force, your Policy has cash benefits that you can access within limits through loans, partial withdrawals or a surrender. o Loans -- You may borrow against your Net Cash Surrender Value at any time. If your Policy is a modified endowment contract, the loan is treated as a distribution for tax purposes, which may be taxable. o Partial Withdrawal -- You may withdraw part of your Net Cash Surrender Value after the first Policy year. We may deduct an administrative charge. If you make a partial withdrawal during the surrender charge period, we may deduct a surrender charge. A partial withdrawal may result in a decrease in the Face Amount of your Policy, depending upon your death benefit option. 4 o Surrender -- You may surrender your Policy for its Net Cash Surrender Value. If you surrender your Policy during the surrender charge period, we will deduct a surrender charge. A surrender will terminate your Policy. Expenses of the Policy Expenses reduce your returns under the Policy. Deductions from Premiums For state premium taxes, DAC taxes and other sales expenses, we currently charge 5% of each premium payment for Policy years 1- 10 which will reduce to 3% in Policy years 11+. The maximum we will charge is 8%. Account Value Charges (deducted monthly) Cost of Insurance Charge(1) Current Guaranteed Ranges from 0.00001 per Ranges from 0.00004 per $1,000 of net amount at risk $1,000 of net amount risk to 83.33333 per $1,000 of net to 83.33333 per $1,000 of net amount at risk(2) amount at risk(2) Monthly Administrative Charge Current Guaranteed Policy Years 1-5 $15.00 $15.00 Policy Years 6+ $ 7.50 $15.00 In addition, there will be a charge of $0.03 per month for each $1,000 in Face Amount until the Policy is terminated. Acquisition Charge During the first 5 Policy years or the first 5 Policy years after a Face Amount increase there will be a yearly charge for each $1,000 in Face Amount based on the Insureds' Age sex and rate class.(3) Separate Account Charges (deducted daily and shown as an annualized percentage of average net assets) 5 Mortality and Expense Risk Charge Current Guaranteed Policy Years 1-10 0.75% 0.90% Policy Years 11-20 0.15% 0.90% Policy Years 21and thereafter 0.10% 0.90% Transaction Charges Transfer Charge $25 for each transfer in excess of 12 each Policy year. Surrender Charge During the first 10 Policy years and for 10 Policy years following a Face Amount increase there will be a surrender charge based on the initial Face Amount or the increase in Face Amount. (4) Surrender Charge on Partial Withdrawal The surrender charge on a partial withdrawal is equal to the applicable surrender charge multiplied by a fraction (equal to the amount of partial withdrawal plus any administrative charge, if applicable, for the partial withdrawal, divided by the Net Cash Surrender Value immediately prior to the partial withdrawal). Surrender Charge on Decrease in Face Amount The surrender charge on a decrease in Face Amount is equal to the applicable surrender charge multiplied by a fraction (equal to the decrease in Face Amount divided by the Face Amount of the Policy prior to the decrease). Partial Withdrawal Administrative Charge Currently, four partial withdrawals are allowed per year. We may charge a $25 administrative charge per partial withdrawal. In certain states the charge may be the lesser of $25 or 2% of the amount withdrawn. Policy Split Option Charge Not to exceed $500. A surrender charge will apply if you elect the Policy Split Option during the first 10 Policy years or 10 years following a Face Amount increase. (1) The current cost of insurance charge will never exceed the guaranteed cost of insurance charge shown in the policy. If the Death Benefit is equal to the Face Amount or the Face Amount plus Account Value, the net amount at risk is the difference between the Death Benefit divided by 1.0032737 and the current Account Value. Otherwise, the net amount at risk is the difference between the Death Benefit and the Account Value. (See "Expenses of the Policy - Cost of Insurance Charge.") (2) Current and guaranteed cost of insurance rates are based on the Age (or Attained Age in the case of increase in Face Amount), sex and rate class of the Insureds, and Policy Year. 6 (3) A Policy's acquisition charge is based on the Age, sex and rate class status of both Insureds and Face Amount. For a 65 year old non-smoking male and a 65 year old non-smoking female policy with a $200,000 Face Amount, the initial acquisition charge would be $2,087. The lowest and highest acquisition charge are $0.59 and $61.71 per $1,000 of the Face Amount, respectively. (4) A Policy's surrender charge is based on the Age, sex and smoker status of both Insureds and Face Amount. For a 65 year old non-smoking male and a 65 year old non-smoking female policy with a $200,000 Face Amount, the initial surrender charge would be $6,834.00. The lowest and highest surrender charge are $10.19 and $60.00 per $1,000 of the Face Amount, respectively. Expenses of the variable investment options also reduce your returns. In addition, you will indirectly bear the costs of the investment management fees and expenses paid from the assets of the portfolios you select. The annual portfolio expenses of the variable investment options are set forth below. PORTFOLIO EXPENSES BEFORE WAIVERS AND/OR REIMBURSEMENTS As of November 30, 1998 The purpose of this table is to assist you in understanding the various costs and expenses that will be incurred, directly or indirectly. It is based on historical expenses as a percentage of net assets before waivers and/or reimbursements, if applicable, for the year ended November 30, 1998. Expenses of the portfolios are not fixed or specified under the terms of the Policy. Actual expenses may vary. Total Management Other Operating Fees Expenses(1) Expenses Anchor Series Trust Wellington Management Company, LLP Capital Appreciation Portfolio .64% .04% .68% Government and Quality Bond Portfolio .61% .06% .67% Growth Portfolio .70% .05% .75% Natural Resources Portfolio .75% .13% .88% SunAmerica Series Trust Alliance Capital Management, L.P. Global Equities Portfolio .74% .14% .88% Alliance Growth Portfolio(2) .61% .03% .64% Growth-Income Portfolio .56% .04% .60% Davis Selected Advisers, L.P. Real Estate Portfolio(3) .80% .15% .95% Venture Value Portfolio .72% .03% .75% 7 Federated Investment Counseling Corporate Bond Portfolio .65% .12% .77% Federated Value Portfolio .75% .08% .83% Utility Portfolio(3) .75% .26% 1.01% Goldman Sachs Asset Management/Goldman Sachs Asset Management International Asset Allocation Portfolio .59% .05% .64% Global Bond Portfolio .70% .15% .85% Massachusetts Financial Services Company MFS Growth and Income Portfolio(2) .70% .03% .73% MFS Mid-Cap Growth Portfolio(2)(4) .75% .40% 1.15% MFS Total Return Portfolio(2) .67% .10% .77% Morgan Stanley Asset Management International Diversified Equities Portfolio 1.00% .26% 1.26% Worldwide High Income Portfolio 1.00% .08% 1.08% Putnam Investment Management, Inc. Emerging Markets Portfolio(4) 1.25% .76% 2.01% Putnam Growth Portfolio .81% .05% .86% International Growth and Income Portfolio(3) 1.00% .46% 1.46% SunAmerica Asset Management Corp. Aggressive Growth Portfolio .74% .09% .83% SunAmerica Balanced Portfolio .68% .10% .78% Cash Management Portfolio .53% .05% .58% "Dogs" of Wall Street Portfolio(4) .60% .32% .92% High-Yield Bond Portfolio .63% .06% .69% - ------------------------------------- (1) Other expenses are based on the expenses outlined in the funds' prospectuses. (2) The expenses noted here are restated to reflect an estimate of fees for each portfolio for the current fiscal year. (3) Certain Portfolios have recoupment by the Adviser of expenses for the fiscal year ended November 30, 1998. Such recoupments are as follows: International Growth and Income Portfolio - $52,507; Real Estate Portfolio - $7,874; and Utility Portfolio - $41,753. Such recoupments have been included in the Total Operating Expenses shown above. If there had been no recoupment, the Total Operating Expenses percentages shown would be as follows: International Growth and Income Portfolio - 1.40%; Real Estate Portfolio - .93%; Utility Portfolio - .92%. With respect to any fees the Adviser waived or expenses it reimbursed after June 3, 1996, the Adviser has reserved the right to recoup the waived or reimbursed amounts for the following two years, provided that the 8 Portfolio is able to effect such payment to the Adviser and remain in compliance with the stated expense limitations. (4) The Adviser has voluntarily agreed to waive fees or reimburse expenses, if necessary, to keep annual operating expenses at or below the lesser of the following percentages of each of the following Portfolio's average net assets: Emerging Markets Portfolio - 1.90%, "Dogs" of Wall Street Portfolio - .85% and Mid-Cap Growth Portfolio -1.15%. The Adviser may terminate all such waiver and/or reimbursements at any time. For the fiscal year ended November 30, 1998, the amounts voluntarily waived or reimbursed (and reflected in the Total Operating Expenses percentage shown above) are as follows: Emerging Markets - $29,562, "Dogs" of Wall Street - $15,116. You should consider the impact of the Code. Federal Tax Considerations Your purchase of, and transactions under, your Policy may have tax consequences that you should consider before purchasing the Policy. You may wish to consult a tax adviser. In general, the Life Insurance Proceeds will not be taxable income to the Beneficiary. You will not be taxed as your Account Value increases. However, you may be taxed upon a distribution from your Policy. 9 - -------------------------------------------------------------------------------- Purchasing a Polaris Joint and Last Survivor VUL Policy - -------------------------------------------------------------------------------- Applying for a Policy To purchase a Policy, you must complete an application and submit it to us. You must specify certain information in the application, including the Face Amount, the death benefit option, tax qualification option and supplemental benefits or riders, if any. We may also require information to determine if the Insureds are an acceptable risk to us. We may require a medical examination of the Insureds and ask for additional information. Our age requirement for the Insureds. You may apply for a Policy to cover individuals who are younger than Age 86. The minimum Face Amount. The Face Amount must be at least $200,000. We require a minimum initial premium. We require that you pay a minimum initial premium before the policy is effective and we will issue the Policy. We will not issue a Policy until we have accepted the application. We will accept an application if it meets our underwriting rules. We reserve the right to reject an application for any reason or "rate" either Insured as a substandard risk. When your coverage will be effective. Your policy will become effective after: o We accept your application. o We receive an initial premium payment, in an amount we determine. o We have completed our review of your application to our satisfaction. 10 Your Right to Cancel the Policy Period to Examine and Cancel. Once you receive your Policy, you should read the Policy. You have the right to cancel the Policy for any reason no later than 10 days after you receive the Policy. If required by the state where you live, we will extend the 10 days to the number required by law. This is your "Period to Examine and Cancel." Your right to cancel also applies to the amount of any requested increase in Face Amount. This does not apply to any increase in Face Amount under the Automatic Face Amount Increase Option. How to cancel your Policy. You may cancel the Policy by returning it to our Administrative Office or to our agent within the applicable time with a written request for cancellation. We will refund you the premium paid on the Policy. Thus, the amount we return will not reflect the returns of the Subaccounts or the Guaranteed Account that you selected in your application. Premiums The Policy allows you to select the timing and amount of premium payments within limits. You should send premium payments to our Administrative Office. All your premium payments must comply with our requirements. Restrictions on Premiums. We may not accept any premium payment: o If it is less than $25 ($50 for monthly pre-authorized checking). o If the premium would cause the Policy to fail to qualify as a life insurance contract as defined in Section 7702 of the Code. We will refund any portion of any premium that causes the Policy to fail. In addition, we will monitor the Policy and will attempt to notify you on a timely basis if a Policy is in jeopardy of becoming a modified endowment contract under the Code. o If the premium would increase the amount of our risk under your Policy by an amount greater than that premium amount. In such cases, we may require satisfactory evidence of insurability of each living Insured before accepting that premium. 11 Types of premium payments. Minimum Initial Premium. We will calculate the minimum initial premium. The amount is based on a number of factors, including the Age, sex and rate class of each proposed Insured, the desired Face Amount and any supplemental benefits or riders applied for and whether premiums will be paid by pre-authorized checking. We establish a minimum planned periodic premium. Planned Periodic Premiums. When you apply for a Policy, you select a plan for paying level premiums at specified intervals. The intervals may be monthly, quarterly, semi-annually or annually, for the life of the Policy. Pre-authorized checking may be required for monthly payments. We will establish a minimum amount that may be used as the planned periodic premium. You are not required to pay premiums in accordance with this plan. Rather, you can pay more or less than the planned periodic premium or skip a planned periodic premium entirely. At any time you may request a change in the amount and frequency of planned periodic premium by sending a written notice to our Administrative Office. Additional Premiums. Additional premiums are premiums other than planned premiums. Additional premiums may be paid in any amount and at any time subject to the Code and our restrictions on premiums. Depending on the Account Value at the time of an increase in the Face Amount and the amount of the increase requested, an additional premium may be needed to prevent your Policy from terminating. Paying premiums may not ensure that your Policy remains in force. Effect of Premium Payments. In general, unless the no- lapse provision is in effect, paying all planned periodic premiums may not prevent your Policy from lapsing. In addition, if you fail to pay any planned periodic premiums, your Policy will not necessarily lapse. 12 Your Policy will lapse only when the Net Cash Surrender Value on a monthly anniversary is less than the amount of that date's monthly deduction. This could happen if the Net Cash Surrender Value has decreased because: o of the negative return or insufficient return earned by one or more of the Subaccounts or the Guaranteed Account you selected; or o of any combination of the following -- you have Outstanding Loans, you have taken partial withdrawals, we have deducted Policy expenses, or you have made insufficient premium payments to offset the monthly deduction. No lapse premium guarantee. No Lapse Provision. In general, during the no lapse period, which is currently the first five Policy years, if you pay a sufficient amount of premiums, your Policy will not lapse even if your Net Cash Surrender Value is insufficient to pay the monthly deductions then due. You will be eligible for the no lapse premium guarantee if: o Your Policy has not been reinstated. o All your premiums paid to date, reduced by any partial withdrawals and Outstanding Loans, are at least equal to the product of the minimum premium shown in your Policy Information Section multiplied by the number of months that have elapsed since the Policy Date. If you have requested a decrease in the Face Amount, we may not be able to accept any subsequent premiums if these premiums would cause the Policy to fail to qualify as a life insurance contract under the Code. In this event, the no lapse provision will end. Your Policy will not terminate immediately after your Account Value is insufficient. Grace Period. Unless the no lapse provision is in effect, in order for insurance coverage to remain in force, the Net Cash Surrender Value on each monthly anniversary must be equal to or greater than the total monthly deductions to be charged on that monthly anniversary. If it is not, you have a Grace Period of 61 days during which the Policy will continue in force. The Grace Period begins on the monthly anniversary that the Net Cash Surrender Value is less than the total monthly deductions then due. If we do not receive a sufficient premium before the end of the Grace Period, the Policy may terminate without value. 13 We will send you a written notice within 30 days of the beginning of any Grace Period. The notice will state: o A Grace Period of 61 days has begun. How much you must pay to prevent your policy from terminating. o The amount of premium required to prevent your Policy from terminating. This amount is equal to the amount needed to increase the Net Cash Surrender Value sufficiently to cover total monthly deductions for the next three (3) monthly anniversaries. If the Last Surviving Insured dies during the Grace Period, we will still pay the Life Insurance Proceeds to the Beneficiary. The amount we pay will reflect a reduction for the unpaid monthly deductions due on or before the date of the Last Surviving Insured's death. If your Policy lapses with an Outstanding Loan, you may have taxable income. Premium Allocations. In the application, you specify the percentage of Net Premiums to be allocated to each Subaccount and to the Guaranteed Account. However, until the Period to Examine and Cancel expires, we invest this amount in the Money Market Subaccount. The first business day after this period expires, we will reallocate your Account Value in the Money Market Subaccount based on the premium allocation percentages in your application. For all subsequent premiums, we will use the allocation percentages you specified in the application until you change them. You can change the allocation percentages at any time, by sending written notice to our Administrative Office. The change will apply to all premiums received with or after your notice. Allocation Rules. Your allocation instructions must meet the following requirements: o Each allocation percentage must be a whole number; and o Any allocation to a Subaccount or to the Guaranteed Account must be at least 5%; and the sum of your allocations must equal 100%. 14 Crediting Premiums. Your initial Net Premium, will be credited to your Account Value as of the Policy Date. On the first business day after the Period to Examine and Cancel expires, we will allocate it in accordance with your allocation percentages. We will credit and invest subsequent Net Premiums on the date we receive the premium or notice of deposit at our Administrative Office. If any premium requires us to accept additional risk, we may allocate this amount to the Money Market Subaccount until we complete our underwriting. 15 - -------------------------------------------------------------------------------- The Investment Options - -------------------------------------------------------------------------------- You may allocate your Account Value to: o the Subaccounts which invest in the variable investment options; or o the Guaranteed Account. Variable Investment Options Under the Policy, you may currently allocate your Account Value into any of the available Subaccounts. Each Subaccount invests in a distinct portfolio of the Anchor Series Trust or the SunAmerica Series Trust. SunAmerica Asset Management Corp., an affiliate of ours, is the investment adviser to the Anchor Series Trust and SunAmerica Series Trust. These portfolios operate similarly to a mutual fund but are only available through the purchase of certain insurance contracts. These portfolios may serve as the underlying investment vehicles for other variable insurance contracts issued by us and other affiliated/unaffiliated insurance companies. We do not believe that offering these portfolios in this manner is disadvantageous to you. The Trusts' management monitor the portfolios for any conflicts between contract owners. Anchor Series Trust Wellington Management Company, LLP serves as subadviser to the Anchor Series Trust Portfolios. Anchor Series Trust has additional portfolios which are not available for allocations under your Policy. The investment objectives of the available portfolios are set forth below. Please see the prospectus for detailed information about the available portfolios. 16 Portfolios Managed by Wellington Management Company, LLP The Capital Appreciation Portfolio seeks long-term capital appreciation. This Portfolio invests in growth equity securities which are widely diversified by industry and company. The Government and Quality Bond Portfolio seeks relatively high current income, liquidity and security of principal. This Portfolio invests in obligations issued, guaranteed or insured by the U.S. Government, its agencies or instrumentalities and in investment grade corporate debt securities. The Growth Portfolio seeks capital appreciation primarily through investments in growth equity securities. The Natural Resources Portfolio seeks a total return in excess of the U.S. rate of inflation as represented by the Consumer Price Index. This Portfolio invests primarily in equity securities of U.S. or foreign companies which are expected to provide favorable returns in periods of rising inflation. SunAmerica Series Trust Various subadvisers provide investment advice for the SunAmerica Series Trust portfolios. SunAmerica Series Trust has additional portfolios which are not available for allocations under your Policy. The available portfolios, the investment objectives of each and the subadvisers are set forth below. Please see the prospectus for detailed information about the available portfolios. Portfolios Managed by Alliance Capital Management L.P. The Global Equities Portfolio seeks long-term growth of capital by investing primarily in common stocks or securities with common stock characteristics of U.S. and foreign issuers that demonstrate the potential for appreciation and engaging in transactions in foreign currencies. The Alliance Growth Portfolio seeks long-term growth of capital by investing primarily in equity securities of a limited number of large, carefully selected high quality U.S. companies that are judged likely to achieve superior earnings. 17 The Growth-Income Portfolio seeks growth of capital and income by investing primarily in common stocks or securities which demonstrate the potential for appreciation and/or dividends. Portfolio Managed by Davis Selected Advisers, L.P. The Venture Value Portfolio seeks growth of capital by investing primarily in common stocks of companies with market capitalizations of at least $5 billion. The Real Estate Portfolio seeks total return through a combination of growth and income by investment primarily in securities in companies principally engaged in or related to the real estate industry or which own significant real estate assets or which primarily invest in real estate instruments. Portfolios Managed by Federated Investment Counseling The Corporate Bond Portfolio seeks high total return with only moderate price risk by investing primarily in investment grade fixed income securities. The Utility Portfolio seek high current income and moderate capital appreciation by investing primarily in the equity and debt securities of utility companies. The Federated Value Portfolio seeks growth of capital and income by investing primarily in the securities of high quality companies. Portfolios Managed by Goldman Sachs Asset Management/Goldman Sachs Asset Management International The Asset Allocation Portfolio seeks high total return (including income and capital gains) consistent with preservation of capital over the long-term by investing in a diversified portfolio that may include common stocks and other securities having common stock characteristics, bonds and other intermediate and long-term fixed income securities and money market instruments. The Global Bond Portfolio seeks high total return, emphasizing current income and, to a lesser extent, providing opportunities for capital appreciation, by investing in high quality fixed income securities of U.S. and foreign issuers and transactions in foreign currencies. 18 Portfolios Managed by Massachusetts Financial Services Company The MFS Growth and Income Portfolio seeks reasonable current income and long-term growth of capital and income by investing primarily in equity securities. The MFS Total Return Portfolio seeks reasonable current income, long-term capital growth and conservation of capital by investing primarily in common stocks and fixed income securities, with an emphasis on income-producing securities which appear to have some potential for capital enhancement. The MFS Mid-Cap Growth Portfolio seeks long term growth of capital by investing primarily in equity securities of medium-sized companies generally with market capitalizations between $1 billion and $5 billion, that its subadvisers believes have above-average growth potential. Portfolios Managed by Morgan Stanley Asset Management The International Diversified Equities Portfolio seeks long-term capital appreciation by investing (in accordance with country and sector weightings determined by its subadviser) in common stocks of foreign issuers that, in the aggregate, replicate broad country and sector indices. The Worldwide High Income Portfolio seeks high current income and, secondarily, capital appreciation, by investing primarily in a portfolio of high-yielding fixed income securities of issuers located throughout the world. Portfolios Managed by Putnam Investment Management, Inc. The Emerging Markets Portfolio seeks long-term capital appreciation by investing primarily in the common stocks and other equity securities of companies that its subadviser believes have above-average growth prospects primarily in emerging markets outside the United States. The Putnam Growth Portfolio seeks long-term growth of capital by investing primarily in common stocks or securities with common stock characteristics which its subadviser believes have above-average growth prospects. The International Growth and Income Portfolio seeks growth of capital with current income as a secondary objective by investing primarily in common stocks traded on markets outside the U.S. 19 Portfolios Managed by SunAmerica Asset Management Corp. The Aggressive Growth Portfolio seeks capital appreciation by investing primarily in equity securities of high growth companies including small growth companies with market capitalizations under $1 billion. The SunAmerica Balanced Portfolio seeks to conserve principal by maintaining, at all times, a balanced portfolio of stocks and bonds, with at least 25% invested in fixed income securities. The Cash Management Portfolio seeks high current yield while preserving capital by investing in a diversified selection of money market instruments. The Cash Management Portfolio does not seek to maintain a stable net asset value of $1.00. The "Dogs" of Wall Street Portfolio seeks total return (including capital appreciation and current income) by investing in thirty high dividend yielding common stocks from the Dow Jones Industrial Average and the broader market. The High-Yield Bond Portfolio seeks high current income and, secondarily seeks capital appreciation, by investing primarily in intermediate and long-term corporate obligations, with emphasis on higher-yielding, higher-risk, lower-rated or unrated securities with a primary focus on "B" rated high-yield bonds. Guaranteed Investment Option Under the Policy, you may currently allocate your Account Value to the Guaranteed Account. In addition, if you request a loan, we will allocate part of your Account Value to the Loan Account which is part of the Guaranteed Account. We treat each allocation and transfer separately for purposes of crediting interest and making deductions from the Guaranteed Account. 20 Interest Credited On the Guaranteed Account. All of your Account Value held in the Guaranteed Account will earn interest at a rate we determine, in our sole discretion. This rate will never be less than an effective rate of 4% per year compounded annually. The Loan Account portion of your Account Value may earn a different interest rate than the remaining portion of your Account Value in the Guaranteed Account. Deductions from the Guaranteed Account. We will deduct any transfers, partial withdrawals or any Policy expenses from the Guaranteed Account and the Subaccounts on a pro rata basis, unless you provide other directions. No portion of the Loan Account may be used for this purpose. We treat amounts transferred from the Loan Account to the remaining portion of the Guaranteed Account Value as a new allocation to the Guaranteed Account. We will credit this transfer with interest at the rate then in effect for Guaranteed Account allocations. Payments from the Guaranteed Account. If we must pay any part of the proceeds for a loan or partial withdrawal or surrender from the Guaranteed Account, we may defer the payment for up to six months from the date we receive the written request. If we defer payment from the Guaranteed Account for 30 days or more, we will pay interest on the amount we deferred at an effective rate of 4% per year, compounded annually, until we make payment. 21 - -------------------------------------------------------------------------------- Investing Your Account Value - -------------------------------------------------------------------------------- The Policy allows you to choose how to invest your Account Value. Your Account Value will increase or decrease based on: o The returns earned by the Subaccounts you select. o Interest credited on amounts allocated to the Guaranteed Account. We will determine your Policy benefits based upon your Account Value. If your Account Value is insufficient, your Policy may terminate, subject to any no lapse guarantee. If the Net Cash Surrender Value on a monthly anniversary is less than the amount of that date's monthly deduction, the Policy will lapse and a Grace Period will begin. Determining the Account Value On the Policy Date, your Account Value is equal to your initial Net Premium. If the Policy Date and the Issue Date are the same day, the Account Value is equal to your initial premium, less the premium expenses and monthly deduction we deduct. On each Valuation Date thereafter, your Account Value is equal to: o Your Account Value held in the Subaccounts; and o Your Account Value held in the Guaranteed Account. Your Account Value will reflect: o the premiums you pay; 22 o the returns earned by the Subaccounts you select; o the interest credited on amounts allocated to the Guaranteed Account; o any loans or partial withdrawals; and o the Policy charges and expenses we deduct. Account Value in the Subaccounts. We measure your Account Value in the Subaccounts by the value of the Subaccounts' accumulation units we credit to your Policy. When you allocate premiums or transfer part of your Account Value to a Subaccount, we credit your Policy with accumulation units in that Subaccount. The number of accumulation units equals the amount allocated to the Subaccount divided by that Subaccount's accumulation unit value for the Valuation Date when the allocation is effected. The number of Subaccount accumulation units we credit to your Policy will: o increase -- when Net Premium is allocated to the Subaccount, amounts are transferred to the Subaccount and loan repayments are credited to the Subaccount. o decrease -- when the allocated portion of the monthly deduction is taken from the Subaccount, a Policy loan is taken from the Subaccount, an amount is transferred from the Subaccount, or a partial withdrawal, including the partial withdrawal administrative and surrender charges, is taken from the Subaccount. Accumulation Unit Values. A Subaccount's accumulation unit value varies to reflect the return of the portfolio, and may increase or decrease from one Valuation Date to the next. We arbitrarily set the accumulation unit value for each Subaccount at $10 when the Subaccount was established. Thereafter, the accumulation unit value equals the accumulation unit value for the prior Valuation Period multiplied by the net investment factor for the current Valuation Period. 23 Net Investment Factor. The net investment factor is an index we use to measure the investment return earned by a Subaccount during a Valuation Period. It is based on the change in net asset value of the portfolio shares held by the Subaccount, and reflects any dividend or capital gain distributions on the portfolio shares and the deduction of the daily mortality and expense risk charge. Guaranteed Account Value. On any Valuation Date, the Guaranteed Account portion of your Policy's Account Value equals: o the total of all Net Premium, allocated to the Guaranteed Account, plus o any amounts transferred to the Guaranteed Account, plus o interest credited on the amounts allocated and transferred to the Guaranteed Account, less o the amount of any transfers from the Guaranteed Account, less o the amount of any partial withdrawals, including the partial withdrawal charges, taken from the Guaranteed Account, and less o the allocated portion of the monthly deductions, if any, deducted from the Guaranteed Account, plus o the amount of the Loan Account. If you take a Policy loan, we transfer the amount of the loan to the Loan Account held in the Guaranteed Account. The value of your Loan Account includes transfers to and from the Loan Account as you take and repay loans, and interest, charged and credited on the Loan Account. Cash Surrender Value. The Cash Surrender Value on a Valuation Date is the Account Value reduced by any surrender charge that would be assessed if the Policy were surrendered on that date. 24 The amount you would receive on a Surrender of your Policy. Net Cash Surrender Value. The Net Cash Surrender Value on a Valuation Date is equal to: o the Cash Surrender Value, less o any Outstanding Loan on that date. Transfers You may transfer Account Value among the Subaccounts and to and from the Guaranteed Account after the Period to Examine and Cancel. All transfer requests, except for those made under the Dollar Cost Averaging, Automatic Rebalancing and Systematic Withdrawal programs, must satisfy the following requirements: o Minimum amount of transfer -- You must transfer at least $250 or, the balance in the Subaccount or the Guaranteed Account, if less. o Form of transfer request -- You must make a written request unless you have established prior authorization to make telephone transfers or by other means we make available. o Transfers from the Guaranteed Account -- The maximum you may transfer in a Policy year is equal to 25% of your Guaranteed Account value that is not in the Loan Account on the most recent Policy anniversary reduced by all prior partial withdrawals and transfers taken from the Guaranteed Account during that Policy year. Date We Process Your Transfer Request. We must receive your transfer request at our Administrative Office. We process transfers on the same date we receive your transfer request subject to the NYSE being open for trading. The transfer will be made at the price next computed after we receive your transfer request. We may, however, defer transfers under the same conditions as described in "When Proceeds Are Paid." 25 Number of Allowable Transfers/Transfer Fee. We do not currently limit the number of transfers you may make. We will currently assess a $25 transfer fee, however, for each transfer in excess of 12 during a Policy year. All transfers processed on the same business day will count as one transfer for purposes of determining the number of transfers you have made in a Policy year. Transfers in connection with the Dollar Cost Averaging and Automatic Rebalancing features will not count against the 12 free transfers in a Policy year. We reserve the right to increase the number of "free" transfers allowed in any Policy year. Telephone Transfers. If you have completed an authorization form allowing telephone transfers, you may request transfers by telephone. We confirm all telephone transfers in writing. You should review all confirmations to determine if there have been any unauthorized transfers. We will use reasonable procedures to confirm that telephone transfer requests are genuine. We will not be liable for any loss due to unauthorized or fraudulent instructions. We reserve the right to suspend telephone transfer privileges at any time, for some or all Policies. Dollar Cost Averaging (DCA) Dollar Cost Averaging is a systematic method of investing at regular intervals. By investing at regular intervals, the cost of the securities is averaged over time and perhaps over various market cycles. You may request Dollar Cost Averaging. Under this program we will automatically transfer a portion of your Account Value on a monthly, quarterly, semi-annual, or annual basis, as you request. Unless you give us other instructions, we will allocate the transfer as you have specified in your most current premium allocation instructions. However, not less than 5% may be allocated to any Subaccount or to the Guaranteed Account. You may instruct us to make the transfers from any Subaccount or the Guaranteed Account so long as the Account Value in that Account is initially at least $2,000. There is no charge for this option. 26 Dollar Cost Averaging From the Guaranteed Account with Six Month Bonus Rate. We may make available a six-month bonus interest rate if you use the dollar cost averaging feature from the Guaranteed Account. For the bonus interest rate to apply, an initial premium payment of at least $2,000 made in connection with the purchase of a Policy is eligible for dollar cost averaging with a bonus rate of interest. We will credit the Net Premiums to the 6-month DCA Guaranteed Account. This dollar cost averaging option must be elected at the time of application and only applies to the initial premium payment. We will transfer monthly, one-sixth of your Account Value in the 6-month DCA Guaranteed Account over a period of six months. The sixth transfer from the 6- month DCA Guaranteed Account will include interest earnings for the six-month period. During this period, we may credit an additional interest rate over the interest rate that we are crediting on allocations or transfers to the Guaranteed Account made at that time. Additional amounts may not be allocated to the 6-month DCA Guaranteed Account. If you terminate the dollar cost averaging while your Account Value includes amounts in the 6-month DCA Guaranteed Account, we will transfer this amount to the Guaranteed Account. It will earn interest at the rate we are crediting on allocations or transfers to the Guaranteed Account made at that time. We reserve the right to establish transfer limits, to restrict the Subaccounts from which transfers may be made, and to eliminate this feature all together. When We will Process your Automatic DCA Transfers. We will begin to process your automatic transfers: o If you requested the automatic DCA transfers when you applied for your Policy -- on the first monthly anniversary following the end of the Period to Examine and Cancel. o If you elect the option after you applied for the Policy -- on the second monthly anniversary following the receipt of your request at our Administrative Office. 27 We will stop processing automatic DCA transfers if: o The funds in the transferring Subaccount or the Guaranteed Account have been depleted; o We receive your written request at our Administrative Office to cancel future transfers; o We receive notification of death of the last Surviving Insured; or o Your Policy goes into a Grace Period. Dollar Cost Averaging may lessen the impact of market fluctuations on your investment. Using Dollar Cost Averaging does not guarantee investment gains or protect against loss in a declining market. Automatic Rebalancing We may offer an Automatic Rebalancing program to rebalance your Account Value to match your allocation instructions. This program is offered because the Account Value in the Guaranteed Account and the Subaccounts will accumulate at different rates as a result of different investment returns. Automatic Rebalancing will restate the Account Value of the Guaranteed Account and the Subaccounts to your most recent allocation instructions. You may elect the frequency (monthly, quarterly, semi-annually, or annually) as measured from the Policy anniversary. On each date elected, we will rebalance the Account Value by generating transfers to reallocate the Account Values according to your most recent allocation instructions. Transfers resulting from Automatic Rebalancing will not be counted against the total number of transfers allowed before a charge is applied. We reserve the right to suspend or modify Automatic Rebalancing or to charge an administrative fee for excessive election or allocation changes. Automatic Rebalancing is not available if the grace period has commenced. 28 - -------------------------------------------------------------------------------- Death Benefits - -------------------------------------------------------------------------------- Life Insurance Proceeds During the Policy term, we will pay the Life Insurance Proceeds to the Beneficiary after both Insureds die. To make payment, we must receive at our Administrative Office: o satisfactory proof of the Last Surviving Insured's death while the Policy was in force; o return of the Policy; and o all other requirements we deem necessary. The Beneficiary may receive the Life Insurance Proceeds in one lump sum or under any other payment option available. Payment of Life Insurance Proceeds. We will pay the Life Insurance Proceeds generally within seven days after we receive the information we require. We will pay the Life Insurance Proceeds to the Beneficiary in one lump sum or, if elected, under an available payment option. Payment of the Life Insurance Proceeds may also be affected by other provisions of the Policy. We will pay interest on the Life Insurance Proceeds from the date of the Last Surviving Insured's death to the date of payment as required by applicable state law. Amount of Life Insurance Proceeds. We will determine the Life Insurance Proceeds as of the date of the Last Surviving Insured's death. The Life Insurance Proceeds will depend on the death benefit option and tax qualification option in effect on the date of death of the Last Surviving Insured and will equal: o the Death Benefit amount determined according to the death benefit option selected; plus 29 o any other benefits then due from riders to the Policy; minus o the Outstanding Loan, if any, minus o any overdue monthly deductions if the Last Surviving Insured dies during a Grace Period. Death Benefit Options You may select from two death benefit options. They are: Level Death Benefit Option. o Level Death Benefit Option (Option I) The basic Death Benefit will be the greater of: (1) The Face Amount at date of the Last Surviving Insured's death; or (2) Account Value at date of the Last Surviving Insured's death multiplied by the appropriate minimum death benefit factor on that date. This death benefit option should be considered if you want to minimize your cost of insurance. Variable Death Benefit Option. o Variable Death Benefit Option (Option II) The basic Death Benefit will be the greater of: (1) The Face Amount plus the Account Value at date of the Last Surviving Insured's death; or (2) Account Value at date of the Last Surviving Insured's death multiplied by the appropriate minimum death benefit factor on that date. This death benefit option should be considered if you want your Death Benefit to vary with your Policy's Account Value. 30 Tax Qualification Options. Section 7702 of the Code provides alternative testing procedures for meeting the definition of life insurance. Each Policy must qualify under one of these two tests and you may select the test we use for ensuring your Policy meets the definition of life insurance. For both tests under Section 7702, there is a minimum Death Benefit required at all times. This is equal to the Account Value multiplied by the appropriate minimum death benefit factor. These factors depend on the tax qualification option and will be based on the Attained Ages, sex and rate classes of the Insureds. A table of the applicable factors is located in the Policy. The two tax qualification options are: Guideline Premium/Cash Value Corridor Test. o Guideline Premium/Cash Value Corridor Test. Cash Value Accumulation Test. o Cash Value Accumulation Test. This tax qualification option should be considered if you want to maximize the premiums permitted for your Policy. Once you have selected the tax qualification option for your Policy, it may not be changed. Changes in Death Benefit Options At any time after the first Policy anniversary while your Policy is in force, you may request a change in death benefit option. If you have selected the Level Death Benefit Option, you may change to the Variable Death Benefit Option. You may also change from the Variable Death Benefit Option to the Level Death Benefit Option. How to request a change. You may change your death benefit option by providing your Agent with a written request or by writing us at our Administrative Office. We may require that you submit satisfactory evidence of insurability of both Insureds to us. 31 If you request a change from the Level Death Benefit Option to the Variable Death Benefit Option, we will decrease the Face Amount by an amount equal to Your Account Value on the date the change takes effect. However, we will not allow such a change if it would reduce the Face Amount below the minimum Face Amount. This change will also cancel all future Face Amount increases under the Automatic Face Amount Increase Option. If you request a change from the Variable Death Benefit Option to the Level Death Benefit Option, we will increase the Face Amount by an amount equal to your Account Value on the date the change takes effect. Such decreases and increases in the Face Amount are made so that the Death Benefit remains the same on the date the change takes effect. Once a change is approved, we will issue new Policy information pages and attach a copy of your application for change. The change will take effect at the beginning of the Policy month that coincides with or next follows the date we approve your request. We reserve the right to decline to make any changes that we determine would cause the Policy to fail to qualify as life insurance under our interpretation of the Code. Changes in Face Amount When you apply for a Policy, you may select the Automatic Face Amount Increase Option. In addition, you may request a change in the Face Amount at any time after the first Policy anniversary while the Policy is in force. We will not make a change in Face Amount that causes your Policy to fail to qualify as life insurance under the Code. Automatic Face Amount Increase Option. Under the Automatic Face Amount Increase Option, the Face Amount will be automatically increased on specified Policy anniversaries, up to a maximum total for all increases that is twice the initial Face Amount. You may select the Automatic Face Amount Increase Option only if you also select the Level Death Benefit Option. When you select this option, you must specify: o the Policy anniversaries on which the Face Amount increase will begin. The increase must begin no later than the tenth Policy anniversary. 32 o the amount of increase, which may be no less than 1% and no more than 6% of the initial Face Amount. You may elect to cancel the automatic increase. If you do so, we will cancel all future increases. We require written notice of at least 30 days before the effective date of an increase. In addition, any request to change the Face Amount, any change in Face Amount as a result of a partial withdrawal or a change from the Level Death Benefit Option to the Variable Death Benefit Option, will cancel all future automatic increases. Requested Increases in Face Amount. Any request for an increase: o Must be made after the first Policy anniversary. o Must be for at least $10,000. o May not be requested more than once each Policy year. o May not be requested after the oldest living Insured reaches Attained Age 90. How to request a change. A written application must be submitted to our Administration Office along with satisfactory evidence of insurability for each living Insured. You must return the Policy so we can amend the Policy to reflect the increase. The requested increase in Face Amount will become effective on the monthly anniversary on or next following the date the increase is approved, and the Account Value will be adjusted to the extent necessary to reflect a monthly deduction as of the effective date of the increase in Face Amount. Decreases in Face Amount. Any request for a decrease: o Must be at least $5,000. o Must not cause the Face Amount after the decrease to be less than the minimum Face Amount at which we would issue a Policy. 33 o We do not allow a decrease in the first Policy year. During the second through the fifth Policy years, you may decrease the Face Amount by up to 25% of the initial Face Amount each Policy year. The decreases may be cumulative. If the Face Amount is decreased during the first 10 Policy years or within 10 Policy years of an increase in Face Amount, a surrender charge will be applicable. Decrease will first be applied against the most recent increase in Face Amount. Consequences of a Change in Face Amount. An increase or decrease in Face Amount will change the net amount at risk for your Policy. This will affect the monthly deduction related to the cost of insurance charge. Both requested increases and decreases in Face Amount may impact the surrender charge. We will charge an acquisition charge for the first five years following a requested increase in Face Amount. In addition, a requested increase or decrease in Face Amount may impact the status of the Policy as a modified endowment contract. A decrease in Face Amount, will cause the termination of the Policy's no-lapse provision. A requested change in the Face Amount will also cancel the Automatic Face Amount Increase Option. Changes in Owner or Beneficiary While either Insured is living, you may request a change in the Owner or Beneficiary. The change will take effect on the date you sign the notice, but will not apply to any payment we make or other action we take before we receive the notice. Changes in Owner Due to Death. More than one person may own the Policy. Unless otherwise provided, if a joint Owner dies, ownership passes to any surviving joint Owner(s). Unless otherwise provided, when the Owner, or the last surviving joint Owner dies, ownership passes to that person's estate. 34 - -------------------------------------------------------------------------------- Cash Benefits Available While the Policy is in Force - -------------------------------------------------------------------------------- While the Policy is in force, your Policy has cash benefits which you may access within limits by taking loans, partial withdrawals or a surrender. Policy Loans You may request a loan against your Policy at any time while the Policy has a Net Cash Surrender Value. We limit the minimum and maximum amount of a loan you may take as follows: o Maximum Loan Amount During the first Policy year, you may take a loan so long as the total Outstanding Loan after taking into account the loan does not exceed 50% of the Cash Surrender Value. After the first Policy Year, the maximum loan amount you may take is: * Your Net Cash Surrender Value, less * Loan interest to the next Policy anniversary on the loan amount , less * The amount we calculate for the monthly deductions for each monthly anniversary up to the next Policy anniversary. o Minimum Loan Amount -- $500. How to request a loan. You must submit a written request for a loan to the Administrative Office. Policy loans will be processed as of the date we receive the request at our Administrative Office. Loan proceeds generally will be sent to you within seven days. 35 Interest. We charge interest daily on any Outstanding Loan at a declared annual rate not in excess of 8%. The maximum net cost (the difference between the rate of interest we charge on Policy loans and the amount we credit on the equivalent amount held in the Loan Account) of a loan is 2% per year . Currently, after the tenth Policy anniversary, the net cost is 0.25%. While we believe such loans after the tenth Policy anniversary will be treated as valid indebtedness for tax purposes, there is some risk they would be treated as distributions. Interest is due and payable at the end of each Policy year while a Policy loan is outstanding. If interest is not paid when due, the amount of the interest is added to the loan and becomes part of the Outstanding Loan. Loan Account. You may direct us to take an amount equal to the loan proceeds and any amount attributed to unpaid interest from any Subaccount or from the Guaranteed Account. Otherwise, we will withdraw this amount from each Subaccount and Guaranteed Account on a pro rata basis. We transfer this amount to the Loan Account in the Guaranteed Account. When a loan is repaid, an amount equal to the repayment will be transferred from the Loan Account to the Subaccounts and Guaranteed Account in accordance with your premium allocation percentages in effect at the time of repayment. Effect of Policy Loan. A Policy loan, whether or not repaid, will have a permanent effect on the Life Insurance Proceeds and Account Value because the investment results of the Subaccounts and current interest rates credited in the Guaranteed Account will apply only to the non-loaned portion of the Account Value. The longer the loan is outstanding, the greater this effect is likely to be. Depending on the investment results of the Subaccounts or credited interest rates for the Guaranteed Account while the Policy loan is outstanding, the effect could be favorable or unfavorable. In addition, loans from modified endowment contracts are treated for tax purposes as distributions, which may be taxable. If the Life Insurance Proceeds become payable while a Policy loan is outstanding, the Outstanding Loan will be deducted in calculating the Life Insurance Proceeds. 36 If the Outstanding Loan exceeds the Net Cash Surrender Value on any monthly anniversary, the Policy will lapse. We will send you, and any assignee of record, notice of the lapse. You will have a 61-day Grace Period to submit a sufficient payment to avoid termination. The notice will specify the amount that must be repaid to prevent termination. Outstanding Loan. The Outstanding Loan on a Valuation Date equals: o All Policy loans that have not been repaid (including past due unpaid interest added to the loan), plus o accrued interest not yet due. Loan Repayment. You may repay all or part of your Outstanding Loan at any time while the Policy is in force. Loan repayments must be sent to our Administrative Office and will be credited as of the date received. You must indicate that the amount paid is for a loan repayment. Partial Withdrawals Requirements for Partial Withdrawals. You may request a partial withdrawal at any time after the first Policy anniversary while the Policy is in force. Currently, we limit the number of partial withdrawals to four each Policy year unless made under the systematic withdrawal program. We may limit the minimum and maximum amount of withdrawals. o Maximum Partial Withdrawal Amount -- Your Policy's Net Cash Surrender Value except that the withdrawal may not cause the Policy Face Amount to be less than the required minimum Face Amount. o Minimum Partial Withdrawal Amount -- $250. This limit is waived for withdrawals under the systematic withdrawal program. 37 o Maximum Partial Withdrawal from the Guaranteed Account -- during any Policy year you may only withdraw from the Guaranteed Account 25% of your Guaranteed Account value that is not in the Loan Account on the most recent Policy anniversary reduced by all prior partial withdrawals and transfers from the Guaranteed Account during that Policy year. o The Maximum Partial Withdrawal from the Guaranteed Account if you are a participant in the systematic withdrawal program -- under this circumstance during any Policy year you may only withdraw the greater of: * 25% of your Guaranteed Account value that is not in the Loan Account on the most recent Policy anniversary; or * The maximum amount you may have withdrawn from the Guaranteed Account in any of the prior Policy years. How to request a partial withdrawal. You must submit a written request to our Administrative Office. We will reduce your Account Value by the partial withdrawal amount plus any applicable charges. When you request a partial withdrawal, you may direct us to take the requested amount from any Subaccount or from the Guaranteed Account. If you do not direct us or if the Guaranteed Account or Subaccount value is insufficient to withdraw the amount requested, we will withdraw all or the difference from the remaining Accounts on a pro rata basis. We will process partial withdrawal requests at the price next computed after we receive your written request at our Administrative Office. We will generally pay partial withdrawals within seven days. Expenses for Partial Withdrawal. During the first ten Policy years or for the ten Policy years following a requested increase in Face Amount, we will deduct the applicable surrender charge on a partial withdrawal. This charge will be deducted from your Account Value along with the amount requested to be surrendered and will be considered part of the partial withdrawal (together, the "partial withdrawal amount"). Currently, we do not assess a processing fee for partial withdrawals. However, we reserve the right to assess a $25 processing charge for each withdrawal. 38 Effect of Partial Withdrawal on your Face Amount. The Face Amount of your Policy will be reduced by the partial withdrawal amount if you selected the Level Death Benefit Option. We will reduce the Face Amount by the amount of the partial withdrawal in the following order: 1. The most recent increase in the Face Amount, if any, will be reduced first. 2. The next most recent increases in the Face Amount, if any, will then be successively decreased. 3. The initial Face Amount will then be decreased. No partial withdrawal may be made that would reduce the Face Amount below the minimum Face Amount. If a Variable Death Benefit Option is in effect a partial withdrawal does not affect the Face Amount. Partial withdrawals from your Policy may have tax consequences. Systematic Withdrawal Program You may request the systematic withdrawal program at any time after the first Policy anniversary. You may access your Account Value by electing the systematic withdrawal program. This program allows you to automatically receive payments on a monthly, quarterly, semi-annual or annual basis. You have the option to switch to borrowing from your Account Value once a specified amount of withdrawals has been reached. You may also elect to borrow the interest due on your outstanding loan balance in order to continue to receive a steady stream of income. Loans taken under this program are not subject to the minimum loan amount. Some withdrawals may be taxable. 39 Surrendering the Policy for Net Cash Surrender Value You may surrender your Policy at any time while the Policy is in force for its Net Cash Surrender Value by submitting a written request to our Administrative Office. We will require the return of the Policy. A surrender charge may apply. We will process a surrender request as of the date we receive your written request and all required documents. Your surrender request generally will be paid within seven days. The Net Cash Surrender Value may be taken in one sum or it may be applied to a payment option. Your Policy will terminate and cease to be in force if it is surrendered and no life insurance proceeds will be payable. It cannot later be reinstated. 40 - -------------------------------------------------------------------------------- Payment Options for Benefits - -------------------------------------------------------------------------------- We offer a wide variety of optional ways of receiving proceeds payable under the Policy, such as on a surrender or death, other than in a lump sum. Any agent authorized to sell this Policy can explain these options upon request. None of these options vary with the investment performance of a separate account because they are all forms of guaranteed benefit payments. 41 - -------------------------------------------------------------------------------- Expenses of the Policy - -------------------------------------------------------------------------------- Periodically, we will deduct expenses related to your Policy. We will deduct these: o from premiums, Account Value and from Subaccount assets; and o upon certain transactions. The amount of these expenses are described in your Policy as either guaranteed or current. We will never charge more than the guaranteed amount. We may in our discretion deduct expenses on a current basis that is less than the guaranteed amount. Deductions From Premiums We will deduct up to a maximum of 8% from each premium payment. This charge is intended to provide for state premium taxes, DAC taxes and for other expenses associated with acquiring and servicing a Policy. Currently, the deduction is 5% for the first ten Policy years and 3% thereafter. Monthly Deductions From Account Value On the Policy Date and each monthly anniversary thereafter, we make a deduction from the Account Value. The amount deducted on the Issue Date is for the Policy Date and any monthly anniversaries that have elapsed since the Policy Date. For this purpose, the Policy Date is treated as a monthly anniversary. We will deduct on each monthly anniversary charges for: o The administration of your Policy. 42 o The acquisition and underwriting costs of your Policy. o The cost of insurance for your Policy. o The cost of any supplemental benefits or riders. Subject to our approval, you may request us to take the monthly deductions from your un-loaned Account Value allocated to the Money Market Subaccount, Guaranteed Account or a specified Subaccounts. Otherwise, we will take the monthly deductions from each Subaccount and the Guaranteed Account on a pro rata basis. Administrative Charge. This charge compensates us for administrative expenses associated with the Policy and the Separate Account. These expenses relate to premium billing and collection, record keeping, processing claims, Policy loans, Policy changes, reporting and overhead costs, processing applications and establishing Policy records. This charge will be no more than $15 per month for all Policy years. Currently, after the fifth Policy year the charge is $7.50 per month. In addition, there will be a charge of $.03 per $1,000 of Face Amount per month until the Policy is terminated. Acquisition Charge. We will make a deduction from your Policy Account Value for expenses associated with the acquisition and underwriting costs to issue your Policy. This charge will vary based on the Insured's Age, sex and rate class. The charge is assessed for the first five Policy years and if you request an increase in the Face Amount, for the first five years following that increased Face Amount the term of the Policy. The lowest and highest acquisition charge are $0.59 and $61.71 per $1,000 of Face Amount, respectively. The amount of the acquisition charge for your Policy is specified in the Policy Information section of your Policy. 43 Cost of Insurance Charge. This charge compensates us for providing insurance coverage. The charge depends on a number of factors, such as Attained Age, sex and rate class of each Insured and reflects the fact that the Death Benefit is not payable until the death of the Last Surviving Insured. Therefore this charge will vary from Policy to Policy and from month to month. For any Policy the cost of insurance on a monthly anniversary is calculated by multiplying the applicable cost of insurance rate by the Net Amount at Risk under the Policy on that monthly anniversary. Net Amount at Risk. If the Death Benefit is equal to the Face Amount, or the Face Amount plus the Account Value, then the Net Amount at Risk is calculated as (a) minus (b) where: (a) is the current Death Benefit at the beginning of the Policy month divided by 1.0032737; and (b) is the current total Account Value. If the Death Benefit is equal to the Account Value multiplied by the appropriate minimum death benefit factor, then the Net Amount at Risk is calculated as (a) minus (b) where: (a) is the current Death Benefit at the beginning of the Policy month; and (b) is the current total Account Value Rate Classes for Insureds. We currently rate Insureds in one of following basic rate classifications, based on our underwriting: o preferred nonsmoker; o standard plus nonsmoker; o standard nonsmoker; o smoker; o substandard for those involving a higher mortality risk. 44 We place each Insured in a rate class when we issue the Policy based on our underwriting determination. This original rate class applies to the initial Face Amount, as well as subsequent automatic increases in Face Amount under the Automatic Face Amount Increase Option under the Policy. When an increase in Face Amount is requested, we conduct underwriting before approving the increase (except as noted below) to determine whether a different rate class will apply to the increase. If the rate class for the increase has lower guaranteed cost of insurance rates than the original rate class, the rate class for the increase also will be applied to the initial Face Amount. If the rate class for the increase has higher guaranteed cost of insurance rates than the original rate class, the rate class for the increase will apply only to the increase in Face Amount, and the original rate class will continue to apply to the initial Face Amount and to automatic increases in the Face Amount. If there have been requested increases in the Face Amount, we may use different cost of insurance rates for the requested increased portions of the Face Amount. For purposes of calculating the cost of insurance charge after the Face Amount has been increased, the Account Value will be applied to the initial Face Amount first and then to any subsequent requested increases in Face Amount. If at the time an increase is requested, the Account Value exceeds the initial Face Amount (or any subsequently increased Face Amount) divided by 1.0032737, the excess will then be applied to the subsequent increase in Face Amount in the sequence of the increases. In order to maintain the Policy in compliance with Section 7702 of the Code, under certain circumstances an increase in Account Value will cause an automatic increase in the Death Benefit. The Attained Age and rate class for such requested increase will be the same as that used for the most recent increase in Face Amount (that has not been eliminated through a subsequent decrease in Face Amount). The guaranteed cost of insurance charges at any given time for a substandard policy with flat extra charges will be based on the guaranteed maximum cost of insurance rate for the Policy (including table rating multiples, if applicable), the then current Net Amount at Risk, plus the actual dollar amount of the flat extra charge. 45 Our current cost of insurance rates may be less than the guaranteed rates. Our current cost of insurance rates will be determined based on our expectations as to future mortality, investment, expense and persistency experience. These rates may change from time to time. In our discretion, the current charge may be increased in any amount up to the maximum guaranteed charge shown in the table. Cost of insurance rates (whether guaranteed or current) for an Insured in a nonsmoker rate class are generally lower than rates for an Insured of the same age and sex in a smoker rate class. Cost of insurance rates (whether guaranteed or current) for an Insured in a nonsmoker or smoker rate class are generally lower than rates for an Insured of the same age and sex and smoking status in a substandard rate class. Legal Considerations Relating to Sex-Distinct Premiums and Benefits. Mortality tables for the Policy generally distinguish between males and females. Thus, premiums and benefits under the Policy covering two males, two females or one male and one female of the same age will differ. We may also offer the Policy based on unisex mortality tables if required by state law. Employers and employee organizations considering the purchase of a Policy should consult their legal advisers to determine whether purchase of a Policy based on sex- distinct actuarial tables is consistent with Title VII of the Civil Rights Act of 1964 or other applicable law. Upon request, we may offer the Policy with unisex mortality tables to such prospective purchasers. Deduction From Subaccount Assets Mortality and Expense Risk Charge. We deduct a daily charge from the net assets in the Subaccounts for assuming certain mortality and expense risks under the Policy. This charge does not apply to the amounts you allocate to the Guaranteed Account. Currently, we charge an annual rate of 0.75% of the Subaccount assets for the first 10 Policy years and 0.15% for Policy years 11-20 and 0.10% thereafter. The guaranteed charge is at an annual rate of 0.90%. Although the charge may be increased or decreased in our sole discretion, it is guaranteed not to exceed an annual rate of 0.90% of your Account Value in the Subaccounts for the duration of a Policy. 46 The mortality risk we assume is that the Insureds under a Policy may die sooner than anticipated, and therefore we will pay an aggregate amount of Life Insurance Proceeds greater than anticipated. The expense risk we assume is that expenses incurred in issuing and administering all Policies and the Separate Account will exceed the amounts realized from the administrative charges assessed against all Policies. Deductions Upon Policy Transactions Transfer Charge. We currently impose a $25 transfer charge on any transfer of Account Value among the Subaccounts and the Guaranteed Account in excess of the 12 free transfers permitted each Policy year. If the charge is imposed, we will deduct it from the amount requested to be transferred before allocation to the new Subaccount(s) or Guaranteed Account and shown in the confirmation of the transaction. Surrender Charge. If the Policy is surrendered or there is a decrease in Face Amount during the first 10 Policy years, we will deduct a surrender charge based on the initial Face Amount. If a Policy is surrendered or there is a decrease in Face Amount within 10 years after a requested increase in Face Amount, we will deduct a surrender charge based on the increase in Face Amount. The surrender charge will be deducted before any surrender proceeds are paid. Surrender Charge Calculation. In general, the surrender charge is based on the Face Amount. The Surrender Charge will be no greater than the product of (1) times (2) times (3) where: (1) is equal to the Face Amount divided by $1,000; (2) is equal to a surrender charge factor per $1,000 based on the Insureds' Age, sex and smoker status; and (3) is equal to the factor based upon the number of years that has elapsed since the Policy Date or requested increase in Face Amount, as described in the following table: 47 Year Factor 1...................... 100% 2...................... 90% 3...................... 80% 4...................... 70% 5...................... 60% 6...................... 50% 7...................... 40% 8...................... 30% 9...................... 20% 10...................... 10% 11+...................... 0% The product of (1) and (2) will be capped at a level not to exceed a maximum surrender charge based on a rate per $1,000 of Face Amount. The lowest and highest surrender charge are $10.19 and $60.00 per $1,000 of Face Amount, respectively. The surrender charge for your Policy is specified in the Policy Information section of your Policy. Surrender Charge Based On An Increase Or Decrease In Face Amount. A requested increase in Face Amount of the Policy will result in an additional surrender charge during the 10 Policy years immediately following the requested increase. The additional surrender charge period will begin on the effective date of the requested increase. If the Face Amount of the Policy is reduced before the end of the 10th Policy year or within 10 years immediately following a Face Amount increase, we may also deduct a pro rata share of any applicable surrender charge from your Account Value. Decreases in Face Amount will first be applied against the most recent increase in the Face Amount of the Policy. They will then be applied to prior increases in Face Amount of the Policy in the reverse order in which such increases took place, and then to the initial Face Amount of the Policy. 48 Surrender Charges Upon Partial Withdrawal. During the surrender charge period we will deduct a surrender charge: o Upon a partial withdrawal; and o If you decrease your Policy Face Amount. We deduct the surrender charge from the Subaccounts or the Guaranteed Account in the same proportion as we deduct the amounts for your partial withdrawal. Surrender Charge Due to Partial Withdrawal. We deduct an amount equal to the applicable surrender charge multiplied by a fraction (equal to the amount of partial withdrawal plus any administrative charge, if applicable, for the partial withdrawal, divided by the Net Cash Surrender Value immediately prior to the partial withdrawal). Surrender Charge Due to A Decrease in Face Amount. We deduct an amount equal to the applicable surrender charge multiplied by a fraction (equal to the decrease in Face Amount divided by the Face Amount of the Policy prior to the decrease). Partial Withdrawal Administrative Charge. We reserve the right to deduct an administrative charge upon a partial withdrawal of up to $25 per partial withdrawal. Currently, we do not assess an administrative charge for partial withdrawals. In certain states the charge may be the lesser of $25 or 2% of the amount withdrawn. Policy Split Option Charge. If you elect to surrender your Policy in exchange for separate individual permanent life insurance policies under the Policy Split Option, we reserve the right to deduct a charge of up to $500. A surrender charge will apply if you elect the Policy Split Option during the first 10 Policy years or 10 years following a Face Amount increase. 49 Discount Purchase Programs The amount of the surrender charge and other charges under the Policy may be reduced or eliminated when sales of the Policy are made to individuals or to groups of individuals in a manner that in our opinion results in expense savings. For purchases made by officers, directors and employees of the Company, an affiliate, or any individual, firm, or a company that has executed the necessary agreements to sell the Policy, and members of the immediate families of such officers, directors, and employees, we may reduce or eliminate the surrender charge. Any variation in charges under the Policy, including the surrender charge, administrative charge or mortality and expense risk charge, will reflect differences in costs or services and will not be unfairly discriminatory. 50 - -------------------------------------------------------------------------------- Supplemental Benefits and Riders - -------------------------------------------------------------------------------- We intend to make available certain supplemental benefits and riders which may in the future be issued with the Policy. Any monthly charges for these supplemental benefits and riders, as listed below, will be deducted from the Policy Account Value. The addition of riders may affect the cost of insurance. Automatic Face Amount Increase Option (AFAIO) Renewable No Lapse Rider (RNLR) Joint and Last Survivor Renewable Term Rider (JLSRTR) Joint and Last Survivor Term Insurance Rider (Estate Preservation Term Rider Waiver of Monthly Deduction Rider (WMDR) Waiver of Specified Premium Rider (WSPR) 51 - -------------------------------------------------------------------------------- Other Policy Provisions - -------------------------------------------------------------------------------- Right to Exchange You may exchange this Policy to a flexible premium fixed benefit life insurance policy on the lives of the Insureds, without evidence of insurability. While the Policy is in force this exchange may be made: (a) within 24 months after the Issue Date while the Policy is in force; (b) within 24 months of any increase in Face Amount of the Policy, other than under the Automatic Face Amount Increase Option and other than increase due to a Death Benefit Option change; or (c) within 60 days of the effective date of a material change in the investment policy of a Subaccount, or within 60 days of the notification of such change, if later. In the event of such a change, we will notify you and give you information on the options available. When an exchange is requested, we accomplish the exchange by transferring all of the Account Value to the Guaranteed Account. There is no charge for this transfer. Once this option is exercised, the entire Account Value must remain in the Guaranteed Account for the remaining life of the policy. The Face Amount in effect at the time of the exchange will remain unchanged. The Effective Date, Issue Date and Age of each Insured will remain unchanged. The Owner and Beneficiary are the same as were recorded immediately before the exchange. 52 Policy Split Option In certain cases, you may elect to surrender Policy in exchange for separate individual permanent life insurance policies on the life of both Insureds. The Policy may be split if: o The Insureds were married on the policy date and a final annulment or divorce decree dissolving the Insureds' marriage has been issued. We must receive your written request to split the Policy not earlier than 180 days, or later than 360 days, after the date a decree of annulment or divorce becomes final. We must also receive a copy of the final decree. o a change to the Federal Estate Tax Law has occurred which results in either: * the repeal of the unlimited marital deduction provided by the Internal Revenue Code of 1986, as amended; or * a change to the Internal Revenue Code of 1986, as amended, which reduces the maximum Federal Estate Tax rate to 25% or less. We must receive your written request to split the Policy within 180 days of the date of a change in the Federal Estate Tax Law. We will require evidence satisfactory to us of the insurability of both Insureds and we will also require evidence satisfactory to us of insurable interest of the new owner(s) in both Insureds on the date the Policy is split. We will also require that any Outstanding Loan be repaid on the date of exchange. Before the Policy is split and the new policies are issued, we must receive the initial premium due on each of the new policies and any fee we charge to process the exchange. The fee to process the exchange will not exceed $500.00. A surrender charge will apply if you elect the Policy Split Option during the first 10 Policy years or the 10 years following a Face Amount increase. The date of the Policy split will be the Policy anniversary after we receive all the requirements for a Policy split. The features of the new policies are described in the Policy. The surrender of the Policy in exchange for separate individual permanent life insurance on the life of both Insureds will be subject to tax. 53 Limits on our Rights to Contest the Policy Incontestability. We will not contest the Policy after it has been in force during both Insureds' lifetime for two years from the Issue Date. Any increase in the Face Amount will be incontestable with respect to statements made in the evidence of insurability for that increase after the increase has been in force during the life of both Insureds for two years after the effective date of the increase. Suicide Exclusion. If either Insured commits suicide (while sane or insane) within two years (unless otherwise specified by state law) after the Issue Date, the Policy will terminate on the date of the death. Our liability will be limited to the payment of a single sum equal to the premiums paid, minus any Outstanding Loan and minus any partial withdrawal and minus the cost of any riders attached to the Policy. If either Insured commits suicide (while sane or insane) within two years (unless otherwise specified by state law) after the effective date of a requested increase in the Face Amount, then the additional insurance coverage provided by the requested increase in Face Amount will terminate on the date of the death. Our liability as to the increase in amount will be limited to the payment of a single sum equal to the monthly cost of insurance deductions made for such increase plus the expense charge deducted for the increase. Changes in the Policy or Benefits Misstatement of Age or Sex. If either Insured's Age or sex has been misstated in the Policy, the Death Benefit and any benefits provided by riders shall be those which would be purchased at the most recent monthly deduction for the cost of insurance charge for the correct Ages and sexes. Other Changes. At any time we may make such changes in the Policy as are necessary to assure compliance at all times with the definition of life insurance prescribed by the Code or to make the Policy conform with any law or regulation issued by any government agency to which it is subject. 54 When Proceeds Are Paid We will ordinarily pay any Life Insurance Proceeds, loan proceeds or partial or full surrender proceeds within seven days after receipt at our Administrative Office of all the required documents. Other than the Life Insurance Proceeds, which is determined as of the date of death of the Last Surviving Insured, the amount will be determined as of the date of receipt of required documents. However, we may delay making a payment or processing a transfer request if: (1) the disposal or valuation of the Separate Account's assets is not reasonably practicable because the New York Stock Exchange is closed for other than a regular holiday or weekend, trading is restricted by the SEC, or the SEC declares that an emergency exists; or (2) the SEC by order permits postponement of payment for your protection. In addition we may delay making deductions from the Guaranteed Account for up to 6 months after we receive your request. Reports to Owners You will receive a confirmation within seven days of the transaction of: o the receipt of any unplanned premium (and any premium received before the Issue Date); o any change of allocation of premiums; o any transfer between Subaccounts; o any loan, interest repayment, or loan repayment; 55 o any partial withdrawal; o any return of premium necessary to comply with applicable maximum receipt of any premium payment; o any exercise of your right to cancel; o an exchange of the Policy; o full surrender of the Policy; or o payment of the Life Insurance Proceeds under the Policy. Within 30 days after each Policy anniversary we will send you an annual statement. The statement will show the Death Benefit currently payable, and the current Account Value, Cash Surrender Value, and the Outstanding Loan. The statement will also show premiums paid, all charges deducted during the Policy year, and all transactions. We will also send to you annual and semi-annual reports of the Separate Account. Assignment You may assign the Policy, if we agree, in accordance with its terms on a form provided by us. We will not be deemed to know of an assignment unless we receive a copy of this assignment form at our Administrative Office. We assume no responsibility for the validity or sufficiency of any assignment. Any assignment or pledge of a modified endowment contract as collateral for a loan may result in a taxable event. Reinstatement If the Policy has ended without value, you may reinstate Policy benefits while at least one Insured is alive if you: 1. Request in writing a reinstatement of Policy benefits within three (3) years (unless otherwise specified by state law) from the end of the Grace Period; 56 2. Provide evidence of insurability satisfactory for each Insured who is alive at the end of the Grace Period to us; 3. Make a payment of an amount sufficient to cover (i) total monthly deductions for three (3) months, calculated from the effective date of reinstatement; and (ii) the premium expense charge. We will determine the amount of this required payment as if no interest or investment performance were credited to or charged against your Account Value; and 4. Repay or reinstate any Outstanding Loan which existed on the date the Policy ended. The effective date of the reinstatement of Policy benefits will be the next monthly anniversary which coincides with or next follows the date we approve your request. From the required payment we will deduct the premium expenses. The monthly expense charges, Account Value, Outstanding Loan and surrender charges that will apply upon reinstatement will be those that were in effect on the date the Policy lapsed. We will start to make monthly deductions again as of the effective date of reinstatement. 57 - -------------------------------------------------------------------------------- Performance Information - -------------------------------------------------------------------------------- From time to time we may advertise the "total return" and the "average annual total return" of the Subaccounts and the Funds. Both total return and average total return figures are based on historical earnings and are not intended to indicate future performance. "Total Return" for a portfolio refers to the total of the income generated by the portfolio net of total portfolio operating expenses plus capital gains and losses, realized or unrealized. "Total Return" for the Subaccounts refers to the total of the income generated by the portfolio net of total portfolio operating expenses plus capital gains and losses, realized or unrealized, and the mortality and expense risk charge. "Average Annual Total Return" reflects the hypothetical annually compounded return that would have produced the same cumulative return if a Fund's portfolio's or Subaccount's performance had been constant over the entire period. Because average annual total returns tend to smooth out variations in the return of the portfolio, they are not the same as actual year-by-year results. The performance information set forth in Appendix A reflects the total of the income generated by the portfolio net of the total portfolio operating expenses (i.e., management fees and other portfolio expenses), plus capital gains and losses, realized or unrealized. The performance results do not reflect charges deducted from premiums, contract values or separate account assets, including, mortality and expense risk deductions, monthly deductions, cost of insurance, surrender charges, sales loads, DAC taxes, and any state or local premium taxes. If these charges were included, the total return figures would be lower. 58 Performance information may be compared, in reports and promotional literature, to: (i) the Standard & Poor's 500 Stock Index ("S&P 500"), Dow Jones Industrial Average ("DJIA"), Shearson Lehman Aggregate Bond Index or other unmanaged indices so that investors may compare the Subaccount results with those of a group of unmanaged securities widely regarded by investors as representative of the securities markets in general; (ii) other groups of variable life separate accounts or other investment products tracked by Lipper Analytical Services, a widely used independent research firm which ranks mutual funds and other investment products by overall performance, investment objectives, and assets, or tracked by other services, companies, publications, or persons, such as Morningstar, Inc., who rank such investment products on overall performance or other criteria; or (iii) the Consumer Price Index (a measure for inflation) to assess the real rate of return from an investment in the Subaccount. Unmanaged indices may assume the reinvestment of dividends but generally do not reflect deductions for administrative and management costs and expenses. We may provide in advertising, sales literature, periodic publications or other materials information on various topics of interest to Owners and prospective Owners. These topics may include the relationship between sectors of the economy and the economy as a whole and its effect on various securities markets, investment strategies and techniques (such as value investing, market timing, dollar cost averaging, asset allocation, constant ratio transfer and account rebalancing), the advantages and disadvantages of investing in tax-deferred and taxable investments, customer profiles and hypothetical purchase and investment scenarios, financial management and tax and retirement planning, and investment alternatives to certificates of deposit and other financial instruments, including comparisons between the Policy and the characteristics of and market for such financial instruments. 59 Total return data may be advertised based on the period of time that the portfolios have been in existence. The results for any period prior to the Policy being offered will be calculated as if the Policy had been offered during that period of time, with all charges assumed to be those applicable to the Policy. Performance information for any Subaccount in any advertising will reflect only the performance of a hypothetical investment in the Subaccount during the particular time period on which the calculations are based. Performance information should be considered in light of the investment objectives and policies, characteristics and quality of the portfolio in which the Subaccount invests and the market conditions during the given time period, and should not be considered as a representation of what may be achieved in the future. Actual returns may be more or less than those shown in any advertising and will depend on a number of factors, including the investment allocations by an Owner and the different investment rates of return for the portfolios. 60 - -------------------------------------------------------------------------------- Federal Income Tax Considerations - -------------------------------------------------------------------------------- The following summarizes the current federal income tax law that applies to life insurance in general. No attempt is made to consider any applicable state or other tax laws. This summary does not cover all situations. This summary is based upon our understanding of the current federal income tax laws and current interpretations by the Internal Revenue Service. We cannot predict whether the Code will change. You should speak to a competent tax adviser to discuss how the purchase of a Policy and the transactions you make under the Policy will impact your federal tax liability. Tax Status of the Policy A Policy has certain tax advantages when it is treated as a "life insurance contract" under the Code. We believe that the Policy meets the definition of a life insurance contract under Section 7702 of the Code. You bear the risk that the Policy may not meet the definition of a life insurance contract. You should consult your own tax advisers to discuss these risks. The Company We are taxed as a life insurance company under the Code. For federal tax purposes, the Separate Account and its operations are considered to be part of our operations and are not taxed separately. Diversification and Investor Control The Code requires that we diversify the investments underlying variable insurance contracts. If the investments are not properly diversified and any remedial period has passed, Section 817(h) of the Code provides in general the contract is immediately disqualified from treatment as a life insurance contract for federal income tax purposes. Disqualification of the Policy as a life insurance contract would result in taxable income to you for prior and current earnings, and future earnings if not corrected, even though you have not received any payments under the Policy. 61 To the extent that any segregated asset account with respect to a variable life insurance contract invests exclusively in securities issued by the U.S. Treasury, the diversification standard is satisfied. A segregated asset account underlying life insurance contracts such as the Policy will also meet the diversification requirements if, as of the close of each quarter: o the assets of the account are diversified in accordance with the diversification rules applicable to regulated investment companies; and o not more than 55 percent of the value of the assets of the account are attributable to cash and cash items (including receivables), Government securities and securities of other regulated investment companies. The diversification requirements may also be met for each if: o no more than 55% of the value of the total assets of the portfolio is represented by any one investment; o no more than 70% of the value of the total assets of the portfolio is represented by any two investments; o no more than 80% of the value of the total assets of the portfolio is represented by any three investments; and o no more than 90% of the value of the total assets of the portfolio is represented by any four investments. Generally, each United States government agency or instrumentality is treated as a separate issuer under these rules. All securities of the same issuer are generally treated as a single investment. We intend that each portfolio in which the Subaccounts invest will be managed by its investment adviser in compliance with these diversification requirements. 62 A variable life insurance policy could fail to be treated as a life insurance contract for tax purposes if the owner of the policy has such control over the investments underlying the policy (e.g., by being able to transfer values among many subaccounts with only limited restrictions) so as to be considered the owner of the underlying investments. There is some uncertainty on this point because no guidelines have been issued by the Treasury Department. If and when guidelines are issued, we may be required to impose limitations on your rights to control investment designations under the Policy. We do not know whether any such guidelines will be issued or whether any such guidelines would have retroactive effect. We, therefore, reserve the right to make changes that we deem necessary to insure that the Policy qualifies as a life insurance contract. Tax Treatment of the Policy Section 7702 of the Code sets forth a detailed definition of a life insurance contract for federal tax purposes. The Treasury Department has not issued final regulations so that the extent of the official guidance as to how Section 7702 is to be applied is quite limited. If a Policy were determined not to be a life insurance contract for purposes of Section 7702, that Policy would not qualify for the favorable tax treatment normally provided to a life insurance contract. With respect to a Policy issued on the basis of a standard rate class, the Company believes that such a Policy should meet the Section 7702 definition of a life insurance contract. With respect to a Policy that is issued on a substandard basis (i.e., a premium class involving higher than standard mortality risk), there is less certainty, in particular as to how the mortality and other expense requirements of Section 7702 are to be applied in determining whether such a Policy meets the definition of a life insurance contract set forth in section 7702. Thus, it is not clear that such a Policy would satisfy Section 7702, particularly if you pay the full amount of premiums permitted under the Policy. 63 If subsequent guidance issued under Section 7702 leads us to conclude that a Policy does not (or may not) satisfy Section 7702, we will take appropriate and necessary steps for the purpose of bringing the Policy into compliance, but we can give no assurance that it will be possible to achieve that result. We expressly reserve the right to restrict Policy transactions if we determine such action to be necessary to qualify the Policy as a life insurance contracts under Section 7702. Tax Treatment of Policy Benefits In General This discussion assumes that each Policy will qualify as a life insurance contract for federal income tax purposes under Section 7702. The Life Insurance Proceeds under the Policy should be excluded from the gross income of the Beneficiary. In addition, the increases in a Policy's Account Value should not be taxed until there has been a distribution from the Policy such as a surrender, partial surrender or lapse with outstanding loan. Pre-Death Distribution The tax treatment of any distribution you receive before the Last Surviving Insured's death depends on whether the Policy is classified as a modified endowment contract. Policies Not Classified as Modified Endowment Contracts o If you surrender the Policy or allow it to lapse, you will be taxed to the extent the amount you receive is in excess of the premiums you paid less the untaxed portion of any prior withdrawals. For this purpose, you will be treated as receiving any portion of the cash surrender value used to repay Policy debt. The tax consequences of a surrender may differ if you take the proceeds under an income payment settlement option. o Generally, you will be taxed on a withdrawal to the extent the amount you receive exceeds the premiums you paid for the Policy less the untaxed portion of any prior withdrawals. However, under some limited circumstances, in the first 15 Policy years, all or a portion of a withdrawal may be taxed even if total withdrawals do not exceed total premiums paid. 64 o Extra premiums for optional benefits and riders generally do not count in computing the premiums paid for the Policy for the purposes of determining whether a withdrawal is taxable. o Loans you take against the Policy are ordinarily treated as debt and are not considered distributions subject to tax. Modified Endowment Contracts o The rules change if the Policy is classified as a modified endowment contract (or "MEC"). The Policy could be classified as a MEC if premiums substantially in excess of scheduled premiums are paid or a decrease in the face amount of insurance is made (or a rider removed). The addition of a rider or an increase in the face amount of insurance may also cause the Policy to be classified as a MEC. The rules on whether a Policy will be treated as a MEC are very complex and cannot be fully described in this summary. You should consult a qualified tax adviser to determine whether a Policy transaction will cause the Policy to be classified as a MEC. We will monitor your Policy and will take steps reasonably necessary to notify you on a timely basis if your Policy is in jeopardy of becoming a MEC. o If the Policy is classified as a MEC, and you fully surrender the policy, you will be taxed to the extent the amount you receive, including any portion of the cash surrender value used to repay Policy debt, in excess of the premiums you paid for the Policy increased by the amount of any loan previously included in income and reduced by untaxed amounts previously received other than the amount of any loans excludable from income. Other amounts you receive under the Policy before the Last Surviving Insured's death, including loans and withdrawals, are included in income to the extent that the cash value before surrender charges exceeds the premiums paid for the Policy increased by the amount of any loans previously included in income and reduced by any untaxed amounts previously received other than the amount of any loans excludable from income. An assignment of a MEC is taxable in the same way. These rules also apply to pre-death distributions, including loans, made during the two-year period before the time that the Policy became a MEC. 65 o Any taxable income on pre-death distributions (including full surrenders) is subject to a penalty of 10% unless the amount is received on or after age 59 1/2, on account of your becoming disabled or as a life annuity. It is presently unclear how the penalty tax provisions apply to the Policies owned by businesses. o All MECs issued by us to you during the same calendar year are treated as a single Policy for purposes of applying these rules. Interest on Policy Loans. Except in special circumstances, interest paid on a loan under a Policy which is owned by an individual is treated as personal interest under the Code and thus will not be tax deductible. In addition, the deduction of interest that is incurred on any loan under a Policy owned by a taxpayer and covering the life of any individual who is an officer or employee of or who is financially interested in the business carried on by that taxpayer may also be subject to certain restrictions set forth in Section 264 of the Code. Before taking a Policy loan, you should consult a tax adviser as to the tax consequences of such a loan. (Also Section 264 of the Code may preclude business Owners from deducting premium payments.) Policy Exchanges and Modifications. Depending on the circumstances, the exchange of a Policy, a change in the Policy's death benefit option, a Policy loan, a partial surrender, a surrender, a change in ownership, or an assignment of the Policy may have federal income tax consequences. In addition, the federal, state and local transfer, and other tax consequences of ownership or receipt of Policy proceeds will depend on the circumstances of each Owner or Beneficiary. Withholding. We are required to withhold federal income taxes on the taxable portion of any amounts received under the Policy unless you elect to not have any withholding or in certain other circumstances. You are not permitted to elect out of withholding if you do not provide a social security number or other taxpayer identification number. Special withholding rules apply to payments made to non-resident aliens. You are liable for payment of federal income taxes on the taxable portion of any amounts received under the Policy. You may be subject to penalties under the estimated tax rules if your withholding and estimated tax payments are not sufficient. 66 Generation Skipping Transfer Tax. A transfer of the Policy or the designation of a beneficiary who is either 37 1/2 years younger than the Owner or a grandchild of the Owner may have generation skipping transfer tax consequences. Possible Charge for the Company's Taxes At the present time, we do not deduct any charges for any federal, state or local income taxes. However, we do currently deduct charges for state and federal premium based taxes and the federal DAC tax. We reserve the right in the future to deduct a charge for any such tax or other economic burden resulting from the application of the tax laws that we determine to be properly attributable to the Separate Account or to the Policy. 67 - -------------------------------------------------------------------------------- Distribution of the Policy - -------------------------------------------------------------------------------- The Policy is sold by licensed insurance agents, where the Policy may be lawfully sold, who are registered representatives of broker-dealers which are registered under the Securities Exchange Act of 1934 and are members of the National Association of Securities Dealers, Inc. The Policy will be distributed through the principal underwriter for the Separate Account, AIG Equity Sales Corp. (AIGESC) 80 Pine Street, New York, New York, an affiliate of ours. AIGESC may also enter into selling agreements with other broker dealers that will offer the policy. Commissions may be paid to registered representatives based on premiums paid for Policies sold. Other expense reimbursements, allowances, and overrides may also be paid. Registered representatives who meet certain productivity and profitability standards may be eligible for additional compensation. Additional payments may be made for administrative or other services not directly related to the sale of the Policies. Other Policies Issued by the Company The Company may offer other policies similar to those offered herein. 68 - -------------------------------------------------------------------------------- About Us and the Accounts - -------------------------------------------------------------------------------- The Company We are a member of the American International Group, Inc. AIG Life Insurance Company is a stock life insurance company operating under the laws of the State of Delaware. It was incorporated in 1962. We provide a full range of individual and group life, disability, accidental death and dismemberment policies and annuities. We are a subsidiary of American International Group, Inc., which is a holding company for a number of companies engaged in the international insurance business, both life and general, in approximately 130 countries and jurisdictions around the world. Year 2000. The Year 2000 issue arises from computer programs being written using two digits rather than four digits to define the applicable year. This could result in a failure of the information technology systems (IT systems) and other equipment containing imbedded technology (non-IT systems) in the year 2000, causing disruption of our operations and of our lessees, vendors, or business partners. We have developed a plan to address the Year 2000 issue as it affects our internal IT and non-IT systems, and to assess Year 2000 issues relating to third parties with whom we have critical relationships. Our plan for addressing internal systems includes: o an assessment of internal IT and non-IT systems and equipment affected by the Year 2000 issue; o definition of strategies to address affected systems and equipment; o remediation of identified affected systems and equipment; and o internal certification that each internal system is Year 2000 compliant. 69 We have remediated, tested and returned to production substantially all of our internal IT systems. We continue to remediate and test internal non-IT systems and expect to complete our remediation in 1999. We have also initiated formal communications with respect to the Year 2000 issue to those third parties which have significant interaction with us. Currently, we are unable to ascertain whether all such third parties will successfully address the Year 2000 issue, particularly those third parties outside the United States where it is believed that remediation efforts relating to the Year 2000 issue may be less advanced. While we expect to have no interruption of operations as a result of internal IT and non-IT systems, significant uncertainties remain about the effect on us of third parties who are not Year 2000 compliant. We will continue to monitor third party Year 2000 issue readiness to determine whether additional or alternative measures may be necessary. Such measures may include selecting alternate third parties or other actions designed to mitigate the effects of a third party's lack of preparedness. There can be no assurance that unresolved Year 2000 issues of third parties will not have a material adverse impact on our results of operations, financial condition or liquidity. We are considering the effects of Year 2000 related failures on our business and, as the most reasonably likely worst case scenarios become more clearly identified, we will develop appropriate contingency plans. The Separate Account We established the Separate Account as a separate investment account on June 5, 1986. It may be used to support the Policy and other variable life insurance policies, and used for other permitted purposes. The Separate Account is registered with the Securities and Exchange Commission as a unit investment trust under the federal securities laws and qualifies as a "separate account" within the meaning of these laws. Although you may have allocated your Account Values to the Subaccounts, you do not own these assets. You only own your Policy. We own the assets in the Separate Account. The Separate Account is divided into Subaccounts. The Subaccounts available under the Policy invest in shares of a specific portfolio of the Anchor Series Trust or SunAmerica Trust. The Separate Account may include other Subaccounts which are not currently available under the Policy. 70 Income, gains and losses, realized or unrealized, of a Subaccount are credited to or charged against the Subaccount without regard to any of our other income, gains or losses. Assets equal to the reserves and other contract liabilities with respect to each Subaccount are not chargeable with liabilities arising out of any of our other businesses or separate accounts. If the assets exceed the required reserves and other liabilities, we may transfer the excess to our general account. We are obligated to pay all benefits provided under the Policy. Rights we have reserved. We have reserved certain rights regarding the Separate Account. We will exercise these rights only in compliance with all applicable regulatory requirements. We have the right to: o Change, add or delete designated investment options. o Add or remove Subaccounts. o Withdraw assets of a class of policies to which the Policy belongs from a Subaccount and put them in another Subaccount. o Combine any two or more Subaccounts. o Register other separate accounts or deregister the Separate Account with the Securities and Exchange Commission. o Run the Separate Account under the direction of a committee, and discharge such committee at any time. o Restrict or eliminate any voting rights of Owners, or other persons who have voting rights as to the Separate Account. o Operate the Separate Account or one or more of the Subaccounts by making direct investments or in any other form. If we do so, we may invest the assets of the Separate Account or one or more of the Subaccounts in any investments that are legal, as determined by our own or outside counsel. 71 We will not change any investment policy of a Subaccount of our Separate Account unless approved by the Commissioner of Insurance of the State of Delaware or deemed approved in accordance with such law or regulation. Any approval process is on file with the insurance supervisory official of the jurisdiction in which this Policy is delivered. If any change we make results in a material change in the underlying investments of a Subaccount, we will notify you of such change. If you have value in that Subaccount: o We will transfer it at your written direction from that Subaccount (without charge) to another Subaccount or to the Guaranteed Account, and o You may then change your premium allocation percentages. Voting Rights We are the legal owner of shares held by the Subaccounts and as such have the right to vote on all matters submitted to shareholders of the portfolios. However, as required by law, we will vote shares held in the Subaccounts at regular and special meetings of shareholders of the portfolios in accordance with instructions we receive from Owners with Account Value in the Subaccounts. If allowed by law or required by law we may vote shares of the portfolios without obtaining instructions or in disregard to instructions we have received. If we ever disregard voting instructions, we will advise you of that action and our reasons for such action in the next semiannual report. The Guaranteed Account The Guaranteed Account is an account within the general account of the Company. Our general account assets are used to support our insurance and annuity obligations other than those funded by separate accounts. Subject to applicable law, we have sole discretion over the investment of the assets of the general account. 72 We have not registered: o Interests in the Guaranteed Account under the Securities Act of 1933, and o the Guaranteed Account as an investment company. The staff of the Securities and Exchange Commission has not reviewed our disclosure on the Guaranteed Account. Our disclosure regarding the Guaranteed Account must comply with generally applicable provisions of the federal securities laws relating to the accuracy and completeness of statements made in a prospectus. 73 - ------------------------------------------------------------------------------ Our Directors and Executive Officers - ------------------------------------------------------------------------------ The directors and principal officers of the Company are listed below with their current principal business affiliation and their principal occupations during the past five (5) years. All officers have been affiliated with the Company during the past five (5) years unless otherwise indicated. Principal Business Affiliations and Principal Occupations Name and Address Office During Past Five Years Michele L. Abruzzo Director, Senior Senior Vice President of 80 Pine Street Executive American International New York, NY 10005 Vice President Life Assurance Company of New York Paul S. Bell Director, Sr. Vice Sr. Vice President and One Alico Plaza President and Chief Actuary of American 600 King Street Actuary International Life Wilmington, DE 19801 Assurance Company of New York Maurice R. Greenberg Director Director, Chairman and 70 Pine Street Chief Executive Officer New York, NY 10270 AIG, Inc. Howard E. Gunton, Jr. Chief Financial Officer, Sr. Vice President and One Alico Plaza Senior Vice President Comptroller of American 600 King Street International Life Wilmington, DE 19801 Assurance Company of New York Edward Easton Matthews Director, Senior Vice Vice Chairman of 70 Pine Street President Investments and Financial New York, NY 10270 Services of AIG, Inc. Jerome T. Muldowney Director, Senior Vice Senior Vice President of 175 Water Street President American International New York, NY 10038 Life Assurance Company of New York, Senior Managing Director of AIG Global Investment Corp. 74 Principal Business Affiliations and Principal Occupations Name and Address Office During Past Five Years Robinson K. Nottingham Director, Chairman of the Chairman of the Board and 70 Pine Street Board Chief Executive Officer New York, NY 10270 of American International Life Insurance Company (ALICO) Nicholas A. O'Kulich Director, Vice Chairman, Vice President, Sr. Vice 70 Pine Street Treasurer President of AIG, Inc. New York, NY 10270 Howard Ian Smith Director Director, Executive Vice 70 Pine Street President,Chief Financial New York, NY 10270 Officer and Comptroller of AIG, Inc. Edmund Sze-Wing Tse Director Vice Chairman of AIG, 70 Pine Street Inc. New York, NY 10270 Elizabeth M. Tuck Secretary Secretary and Assistant 70 Pine Street Secretary of AIG, Inc., New York, NY 10270 and certain affiliates Gerald Walter Wyndorf Director, Chief Executive Executive Vice President 80 Pine Street Officer and President of American International New York, NY 10038 Life Assurance Company of New York 75 - ------------------------------------------------------------------------------- Other Information - ------------------------------------------------------------------------------- State Regulation We are subject to the laws of Delaware governing insurance companies and to regulation by the Delaware Insurance Department. We file an annual statement in a prescribed form with the Insurance Department each year covering our operation for the preceding year and our final condition as of the end of such year. Regulation by the Insurance Department includes periodic examinations to determine our Policy liabilities and reserves so that the Insurance Department may certify the items are correct. Our books and accounts are subject to review by the Insurance Department at all times and a full examination of its operations is conducted periodically by the staff of the Insurance Department pursuant to the National Association of Insurance Commissioners. Such regulation does not, however, involve any supervision of management or investment practices or policies. In addition, we are subject to regulation under the insurance laws of other jurisdictions in which we may operate. Legal Proceedings There are no legal proceedings to which the Separate Account or the principal underwriter is a party. We are engaged in various kinds of routine litigation which, in our opinion, are not of material importance in relation to our total capital and surplus. Experts Our financial statements (AIG Life Insurance Company as of December 31, 1998 and 1997 and for the years ended December 31, 1998, 1997 and 1996; and AIG Life Insurance Company Variable Account II as of December 31, 1998 and for the years ended December 31, 1998 and 1997)which appear in this Prospectus have been audited by PricewaterhouseCoopers LLP, independent certified public accountants, as stated in their reports, and have been included in reliance upon the authority of such firm as experts in accounting and auditing. 76 Legal Matters Legal matters relating to the federal securities laws are being passed upon by the firm of Jorden Burt Boros Cicchetti Berenson & Johnson LLP of Washington, D.C. Published Ratings We may occasionally publish in advertisements, sales literature and reports the ratings and other information assigned to us by one or more independent rating organizations such as A.M. Best Company, Moody's and Standard & Poor's . The purpose of the ratings is to reflect the rating organization's opinion of our financial strength and should not be considered as bearing on the investment performance of assets held in the Separate Account. The ratings are not recommendations to purchase our life insurance or annuity products or to hold or sell these products, and the ratings do not comment on the suitability of such products for a particular investor. There can be no assurance that any rating will remain in effect for any given period of time or that any rating will not be lowered or withdrawn entirely by a rating organization if, in such organization's judgment, future circumstances so warrant. The ratings do not reflect the investment performance of the Separate Account or the degree of risk associated with an investment in the Separate Account. - -------------------------------------------------------------------------------- Financial Statements - -------------------------------------------------------------------------------- 77 AIG LIFE INSURANCE COMPANY (a wholly-owned subsidiary of American International Group, Inc.) REPORT ON AUDITS OF FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 Report of Independent Accountants To the Stockholders and Board of Directors AIG Life Insurance Company In our opinion, the accompanying balance sheets and the related statements of income, capital funds, cash flows, and comprehensive income present fairly, in all material respects, the financial position of AIG Life Insurance Company (a wholly-owned subsidiary of American International Group, Inc.) at December 31, 1998 and 1997, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. 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 of these statements in accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. February 5, 1999 AIG LIFE INSURANCE COMPANY BALANCE SHEETS (in thousands) December31, December 31, 1998 1997 Assets Investments and cash: Fixed maturities: Bonds available for sale, at market value $ 4,238,045 $ 2,984,255 (cost: 1998 - $4,081,008: 1997 - $2,826,088) Equity securities: Common stock (cost: 1998 - $901: 1997 - $1,381) 2,410 2,775 Preferred stock (cost: 1998 - $18,250 : 1997 - $250) 19,338 250 Mortgage loans on real estate, net 468,342 350,823 Real estate, net of accumulated depreciation of $4,351 in 1998; and $4,740 in 1997 13,002 15,940 Policy loans 1,010,969 1,496,837 Other invested assets 81,916 56,219 Short-term investments 163,704 667,912 Cash 4,788 5,132 -------------- ------------- Total investments and cash 6,002,514 5,580,143 Amounts due from related parties 17,330 11,446 Investment income due and accrued 94,029 85,135 Premium and insurance balances receivable-net 56,583 46,937 Reinsurance assets 72,044 60,744 Deferred policy acquisition costs 167,840 118,535 Federal income tax receivable 4,207 - Separate and variable accounts 1,971,280 1,204,643 Other assets 6,228 4,855 -------------- ------------- Total assets $ 8,392,055 $ 7,112,438 ========== ========== See accompanying notes to financial statements. AIG LIFE INSURANCE COMPANY BALANCE SHEETS (in thousands, except share amounts) December 31, December 31, 1998 1997 Liabilities Policyholders' funds on deposit $ 4,472,854 $ 3,745,902 Future policy benefits 1,002,244 749,918 Reserve for unearned premiums 21,468 24,108 Policy and contract claims 200,193 199,069 Reserve for commissions, expenses and taxes 25,702 16,103 Insurance balances payable 56,263 47,372 Amounts due to related parties 4,119 3,945 Federal income tax payable - 1,684 Deferred income taxes 56,519 37,498 Separate and variable accounts 1,971,280 1,204,643 Minority interest 5,987 6,067 Other liabilities 59,189 621,585 ------------- ------------ Total liabilities 7,875,818 6,657,894 ----------- ----------- Capital funds Common stock, $5 par value; 1,000,000 shares authorized; 976,703 shares issued and outstanding 4,884 4,884 Additional paid-in capital 153,283 153,283 Retained earnings 236,521 181,887 Accumulated other comprehensive income 121,549 114,490 ------------ ------------- Total capital funds 516,237 454,544 ------------ ------------ Total liabilities and capital funds $ 8,392,055 $ 7,112,438 ========== ========== See accompanying notes to financial statements. AIG LIFE INSURANCE COMPANY STATEMENTS OF INCOME (in thousands) Years ended December 31, 1998 1997 1996 --------- -------------- ------------- Revenues: Premiums $ 616,964 $ 437,650 $ 394,480 Net investment income 457,148 381,868 504,661 Realized capital (losses) (334) (3,025) (51) ------------- ------------- ------------- Total revenues 1,073,778 816,493 899,090 --------- ----------- ---------- Benefits and expenses: Benefits to policyholders 272,368 188,969 189,933 Increase in future policy benefits and policyholders' funds on deposit 547,100 397,481 495,529 Acquisition and insurance expenses 168,075 163,533 161,841 ---------- ----------- ---------- Total benefits and expenses 987,543 749,983 847,303 ---------- ----------- ---------- Income before income taxes 86,235 66,510 51,787 ----------- ------------ ---------- Income taxes (benefits): Current 16,218 20,059 25,087 Deferred 15,220 3,964 (5,486) ----------- ------------- ----------- Total income taxes 31,438 24,023 19,601 ----------- ----------- ---------- Net income before minority interest 54,797 42,487 32,186 Minority interest income (loss) (163) (128) 154 ------------ ------------- ------------ Net income $ 54,634 $ 42,359 $ 32,340 ========== ========== ========== See accompanying notes to financial statements. AIG LIFE INSURANCE COMPANY STATEMENTS OF CAPITAL FUNDS (in thousands) Years ended December 31, 1998 1997 1996 ------------ ------------ ------------- Common Stock Balance at beginning of year $ 4,884 $ 4,884 $ 4,884 ------------ ----------- ----------- Balance at end of year 4,884 4,884 4,884 ------------ ----------- ----------- Additional paid-in capital Balance at beginning of year: 153,283 123,283 123,283 Capital contribution - 30,000 - --------------- ---------- -------------- Balance at end of year 153,283 153,283 123,283 --------- --------- --------- Retained earnings Balance at beginning of year 181,887 139,528 107,188 Net income 54,634 42,359 32,340 ---------- ---------- ----------- Balance at end of year 236,521 181,887 139,528 --------- --------- ---------- Accumulated other comprehensive income Balance at beginning of year 114,490 62,814 87,673 Unrealized appreciation (depreciation) of investments - net of reclassification adjustments 10,860 79,497 (50,245) Deferred income tax (expense) benefit on changes (3,801) (27,821) 25,386 ----------- ---------- ---------- Balance at end of year 121,549 114,490 62,814 --------- --------- ---------- Total capital funds $ 516,237 $ 454,544 $ 330,509 ========= ========= ========== See accompanying notes to financial statements. AIG LIFE INSURANCE COMPANY STATEMENTS OF CASH FLOWS (in thousands) Years ended December 31, 1998 1997 1996 ----------- ---------- ------------ Cash flows from operating activities: Net income $ 54,634 $ 42,359 $ 32,340 --------- ----------- ------------ Adjustments to reconcile net income to net cash provided by operating activities: Non-cash revenues, expenses, gains and losses included in income: Change in insurance reserves 250,810 121,325 72,151 Change in premiums and insurance balances receivable and payable -net (753) (5,346) 11,782 Change in reinsurance assets (11,301) 157,710 (10,627) Change in deferred policy acquisition costs (49,305) (34,248) (23,662) Change in investment income due and accrued (8,894) 22,133 135,480 Realized capital losses 334 3,025 51 Change in current and deferred income taxes -net 9,330 2,689 (7,133) Change in reserves for commissions, expenses and taxes 9,599 13,243 (21,274) Change in other assets and liabilities - net (61,575) 69,582 12,733 ----------- ----------- ------------ Total adjustments 138,245 350,113 169,501 --------- ---------- ----------- Net cash provided by operating activities 192,879 392,472 201,841 --------- ---------- ----------- Cash flows from investing activities: Cost of fixed maturities at market, sold 282,756 23,816 40,098 Cost of fixed maturities at market, matured or redeemed 340,435 153,963 124,621 Cost of equity securities sold 1,039 3,676 2,607 Cost of real estate sold 2,585 - - Realized capital gains 1,666 1,975 (51) Purchase of fixed maturities (1,865,768) (804,262) (524,245) Purchase of equity securities (18,559) (1,750) (1,678) Purchase of real estate (341) (413) (881) Mortgage loans granted (202,484) (87,690) (74,590) Repayments of mortgage loans 83,035 29,298 16,416 Change in policy loans 485,868 377,124 1,087,765 Change in short-term investments 504,208 (567,876) 102,616 Change in other invested assets (11,706) 6,294 11,002 Other - net (27,908) 11,917 (38) ---------- ----------- -------------- Net cash (used in) provided by investing activities (425,174) (853,928) 783,642 ---------- ----------- ---------- Cash flows from financing activities: Change in policyholders' funds on deposit 231,951 430,808 (980,835) Proceeds from capital contribution - 30,000 - --------------- ----------- ----------------- Net cash provided by (used in) financing activities 231,951 460,808 (980,835) --------- ---------- ------------ Change in cash (344) (648) 4,648 Cash at beginning of year 5,132 5,780 1,132 ------------ ------------ ------------- Cash at end of year $ 4,788 $ 5,132 $ 5,780 =========== ============ ============= See accompanying notes to financial statements. AIG LIFE INSURANCE COMPANY STATEMENTS OF COMPREHENSIVE INCOME (in thousands) Years ended December 31, 1998 1997 1996 ------------ ------------ ------------- Comprehensive income Net income $ 54,634 $ 42,359 $ 32,340 ------------ ------------ ----------- Other comprehensive income Unrealized appreciation (depreciation) of investments - net of reclassification adjustments 10,860 79,497 (50,245) Changes due to deferred income tax benefit (expense) on changes and future policy benefits (3,801) (27,821) 25,386 ------------ ------------- ----------- Other comprehensive income 7,059 51,676 (24,859) ------------ ------------ ----------- Comprehensive income $ 61,693 $ 94,035 $ 7,481 =========== =========== ============ See accompanying notes to financial statements. AIG LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS 1. Summary of Significant Accounting Policies (a) Basis of Presentation: AIG Life Insurance Company (the Company) is a wholly owned subsidiary of American International Group, Inc. (the Parent). The financial statements of the Company have been prepared on the basis of generally accepted accounting principles (GAAP). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. The Company is licensed to sell life and accident and health insurance in the District of Columbia and all states except for Maine and New York. The Company also files financial statements prepared in accordance with statutory practices prescribed or permitted by the Insurance Department of the State of Delaware. Financial statements prepared in accordance with generally accepted accounting principles differ in certain respects from the practices prescribed or permitted by regulatory authorities. The significant differences are: (1) statutory financial statements do not reflect fixed maturities available for sale at market value; (2) policy acquisition costs, charged against operations as incurred for regulatory purposes, have been deferred and are being amortized over the anticipated life of the contracts; (3) individual life and annuity policy reserves based on statutory requirements have been adjusted based upon mortality, lapse and interest assumptions applicable to these coverages, including provisions for reasonable adverse deviations; these assumptions reflect the Company's experience and industry standards; (4) deferred income taxes not recognized for regulatory purposes have been provided for temporary differences between the bases of assets and liabilities for financial reporting purposes and tax purposes; (5) for regulatory purposes, future policy benefits, policyholders' funds on deposit, policy and contract claims and reserve for unearned premiums are presented net of ceded reinsurance; and (6) an asset valuation reserve and interest maintenance reserve using National Association of Insurance Commissioners (NAIC) formulas are set up for regulatory purposes. (b) Investments: Fixed maturities available for sale, where the company may not have the ability or positive intent to hold these securities until maturity, are carried at market value. Interest income with respect to fixed maturity securities is accrued currently. Included in fixed maturities available for sale are collateralized mortgage obligations (CMOs). Premiums and discounts arising from the purchase of CMOs are treated as yield adjustments over their estimated life. Common and non-redeemable preferred stocks are carried at current market value. Dividend income is generally recognized when receivable. Short-term investments are carried at cost, which approximates market. Unrealized gains and losses from investments in equity securities and fixed maturities available for sale are reflected as a separate component of comprehensive income, net of deferred income taxes and future policy benefits in capital funds currently. Realized capital gains and losses are determined principally by specific identification. Where declines in values of securities below cost or amortized cost are considered to be other than temporary, a charge is reflected in income for the difference between cost or amortized cost and estimated net realizable value. Mortgage loans on real estate are carried at unpaid principal balance less unamortized loan origination fees and costs less an allowance for uncollectible loans. Interest income on such loans is accrued currently. 1. Summary of Significant Accounting Policies - (continued) (b) Investments: (continued) Real estate is carried at depreciated cost and is depreciated on a straight-line basis over 31.5 years. Expenditures for maintenance and repairs are charged to income as incurred; expenditures for betterments are capitalized and depreciated over their estimated lives. Policy loans are carried at the aggregate unpaid principal balance. Other invested assets consist primarily of limited partnership interests which are carried at market value. Unrealized gains and losses from the revaluation of these investments are reflected as a separate component of comprehensive income, net of deferred income taxes in capital funds currently. (c) Income Taxes: The Company joins in a consolidated federal income tax return with the Parent and its domestic subsidiaries. The Company and the Parent have a written tax allocation agreement whereby the Parent agrees not to charge the Company a greater portion of the consolidated tax liability than would have been paid by the Company if it had filed a separate return. Additionally, the Parent agrees to reimburse the Company for any tax benefits arising out of its net losses within ninety days after the filing of that consolidated tax return for the year in which these losses are utilized. Deferred federal income taxes are provided for temporary differences related to the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. (d) Premium Recognition and Related Benefits and Expenses: Premiums on traditional life insurance and life contingent annuity contracts are recognized when due. Revenues for universal life and investment-type products consist of policy charges for the cost of insurance, administration, and surrenders during the period. Premiums on accident and health insurance are reported as earned over the contract term. The portion of accident and health premiums which is not earned at the end of a reporting period is recorded as unearned premiums. Estimates of premiums due but not yet collected are accrued. Policy benefits and expenses are associated with earned premiums on long-duration contracts resulting in a level recognition of profits over the anticipated life of the contracts. Policy acquisition costs for traditional life insurance products are generally deferred and amortized over the premium paying period of the policy. Deferred policy acquisition costs and policy initiation costs related to universal life and investment-type products are amortized in relation to expected gross profits over the life of the policies (see Note 3). The liability for future policy benefits and policyholders' contract deposits is established using assumptions described in Note 4. (e) Policy and Contract Claims: Policy and contract claims include amounts representing: (1) the actual in-force amounts for reported life claims and an estimate of incurred but unreported claims; and (2) an estimate, based upon prior experience, for accident and health reported and incurred but unreported losses. The methods of making such estimates and establishing the resulting reserves are continually reviewed and updated and any adjustments resulting therefrom are reflected in income currently. (f) Separate and Variable Accounts: These accounts represent funds for which investment income and investment gains and losses accrue directly to the policyholders. Each account has specific investment objectives, and the assets are carried at market value. The assets of each account are legally segregated and are not subject to claims which arise out of any other business of the Company. 1. Summary of Significant Accounting Policies - (continued) (g) Reinsurance Assets: Reinsurance assets include the balances due from both reinsurance and insurance companies under the terms of the Company's reinsurance arrangements for ceded unearned premiums, future policy benefits for life and accident and health insurance contracts, policyholders' funds on deposit and policy and contract claims. It also includes funds held under reinsurance treaties. (h) Accounting Standards: In June 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 130 "Reporting Comprehensive Income" (FASB 130) and Statement of Financial Accounting Standards No. 131 "Disclosure about Segments of an Enterprise and Related Information" (FASB 131). FASB 130 establishes standards for reporting comprehensive income and its components in a full set of general purpose financial statements. FASB 130 was effective for the Company as of January 1, 1998. FASB 130 had no impact on the Company's results of operations, financial condition or liquidity. FASB 131 establishes standards for the way companies are required to disclose information about their operating segments in annual financial statements and in interim financial statements. FASB 131 establishes, where practicable, standards with respect to geographic areas, among other things. Certain descriptive information is also required. FASB 131 has been adopted for the year ended December 31, 1998 by the Parent, whose operations are conducted principally through three business segments: General Insurance, Life Insurance and Financial Services. All operations of the Company fall within the Life Insurance segment. In February 1998, FASB issued Statement of Financial Accounting Standards No. 132 "Employers' Disclosures about Pensions and Other Postretirement Benefits" (FASB 132). This statement requires revised disclosures about pension and other postretirement benefit plans and does not change the measurement or recognition of these plans. Also, FASB 132 requires additional information on changes in the benefit obligations and fair values of plan assets. FASB 132 was effective for the year ended December 31, 1998 and has been adopted by the Parent. Information regarding the pension and postretirement benefit plans is not computed on a subsidiary basis, but rather on a consolidated basis for all subsidiaries of the Parent and, accordingly, is not presented herein. In June 1998, FASB issued Statement of Financial Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities" (FASB 133). This statement requires the Company to recognize all derivatives in the consolidated balance sheet measuring these derivatives at fair value. The recognition of the change in the fair value of a derivative depends on a number of factors, including the intended use of the derivative. The Company believes that the impact of FASB 133 on its results of operations, financial condition or liquidity will not be significant. FASB 133 is effective for the year commencing January 1, 2000. In December 1997, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants (AcSEC) issued Statement of Position (SOP) 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments." This statement provides guidance for the recording of a liability for insurance-related assessments. The statement requires that a liability be recognized in certain defined circumstances. The Company believes that the impact of this statement on its results of operations, financial condition or liquidity will not be significant. This statement is effective for the year commencing January 1, 1999. 1. Summary of Significant Accounting Policies - (continued) (h) Accounting Standards - (continued): In October 1998, AcSEC issued SOP 98-7, "Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk." This statement identifies several methods of deposit accounting and provides guidance on the application of each method. This statement classifies insurance and reinsurance contracts for which the deposit method is appropriate as contracts that (i) transfer only significant timing risk, (ii) transfer only significant underwriting risk, (iii) transfer neither significant timing nor underwriting risk, and (iv) have an indeterminate risk. The Company believes that the impact of this statement on its results of operations, financial condition or liquidity will not be significant. This statement is effective for the year commencing January 1, 2000. Restatement of previously issued financial statements is not permitted. (i) The financial statements for 1997 and 1996 have been reclassified to conform to the 1998 presentation. 2. Investment Information (a) Statutory Deposits: Securities with a carrying value of $2,448,000 and $2,454,000 were deposited by the Company under requirements of regulatory authorities as of December 31, 1998 and 1997, respectively. (b) Net Investment Income: An analysis of net investment income is as follows (in thousands): Years ended December 31, 1998 1997 1996 Fixed maturities $284,267 $200,097 $164,548 Equity securities 622 58 219 Mortgage loans 36,464 28,714 22,797 Real estate 2,406 2,254 2,125 Policy loans 120,927 148,555 314,020 Cash and short-term investments 9,346 3,582 2,924 Other invested assets 8,015 2,380 2,549 --------- --------- --------- Total investment income 462,047 385,640 509,182 Investment expenses 4,899 3,772 4,521 --------- --------- --------- Net investment income $457,148 $381,868 $504,661 ======= ======= ======= 2. Investment Information - (continued) (c) Investment Gains and Losses: The net realized capital gains (losses) and change in unrealized appreciation (depreciation) of investments for 1998, 1997 and 1996 are summarized below (in thousands): Years ended December 31, 1998 1997 1996 Net realized (losses) gains on investments: Fixed maturities $ - $ - $ (79) Equity securities 84 1,975 28 Mortgage loans (2,000) (5,000) - Real estate 1,561 - - Other invested assets 21 - - --------- ----------- ------------ Net realized gains $ (334) $ (3,025) $ (51) ======= ======= ========== Change in unrealized appreciation (depreciation) of investments: Fixed maturities $ (1,131) $77,422 $(58,659) Equity securities 1,203 (626) 1,517 Other invested assets 10,788 2,701 6,897 --------- ------- --------- Net change in unrealized appreciation (depreciation) of investments $ 10,860 $79,497 $(50,245) ======== ====== ======= Proceeds from the sale of investments in fixed maturities during 1998, 1997 and 1996 were $282,756,000, $23,816,000, and $40,098,000, respectively. During 1998, 1997 and 1996, gross gains of $0, $0, and $176,000, respectively, and gross losses of $0, $0, and $255,000, respectively, were realized on dispositions of fixed maturity investments. During 1998, 1997 and 1996, gross gains of $84,000, $1,975,000, and $28,000, respectively, were realized on disposition of equity securities. (d) Market Value of Fixed Maturities and Unrealized Appreciation of Investments: At December 31, 1998 and 1997, unrealized appreciation of investments in equity securities (before applicable taxes) included gross gains of $2,854,000 and $1,530,000 and gross losses of $257,000 and $136,000, respectively. The amortized cost and estimated market values of investments in fixed maturities at December 31, 1998 and 1997 are as follows (in thousands): Gross Gross 1998 Amortized Unrealized Unrealized Market ---- Cost Gains Losses Value Fixed maturities: U.S. Government and government agencies and authorities $ 50,617 $ 19,220 $ 10 $ 69,827 States, municipalities and political subdivisions 370,790 23,962 4,961 389,791 Foreign governments 30,431 7,201 - 37,632 All other corporate 3,629,170 156,316 44,691 3,740,795 --------- ---------- --------- --------- Total fixed maturities $4,081,008 $ 206,699 $ 49,662 $4,238,045 ========= ========== ========= ========= 2. Investment Information - (continued) Gross Gross 1997 Amortized Unrealized Unrealized Market ---- Cost Gains Losses Value Fixed maturities: U.S. Government and government agencies and authorities $ 42,866 $ 14,667 $ - $ 57,533 States, municipalities and political subdivisions 371,477 21,481 252 392,706 Foreign governments 30,168 4,887 - 35,055 All other corporate 2,381,577 125,382 7,998 2,498,961 --------- ---------- ---------- --------- Total fixed maturities $2,826,088 $ 166,417 $ 8,250 $2,984,255 ========= ========== ========== ========= The amortized cost and estimated market value of fixed maturities, available for sale at December 31, 1998, by contractual maturity, are shown below (in thousands). Actual maturities could differ from contractual maturities because certain borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Estimated Amortized Market Cost Value Due in one year or less $ 139,701 $ 144,918 Due after one year through five years 1,097,111 1,136,468 Due after five years through ten years 1,538,510 1,586,346 Due after ten years 1,305,686 1,370,313 ---------- --------- $ 4,081,008 $4,238,045 ========= ========= (e) CMOs: CMOs are U.S. Government and Government agency backed and triple A-rated securities. CMOs are included in other corporate fixed maturities. At December 31, 1998 and 1997, the market value of the CMO portfolio was $522,844,000 and $445,739,000, respectively; the estimated amortized cost was approximately $504,077,000 in 1998 and $426,760,000 in 1997. The Company's CMO portfolio is readily marketable. There were no derivative (high risk) CMO securities contained in the portfolio at December 31, 1998. (f) Fixed Maturities Below Investment Grade: At December 31, 1998 and 1997, the fixed maturities held by the Company that were below investment grade had an aggregate amortized cost of $344,609,000 and $242,573,000, respectively, and an aggregate market value of $327,217,000 and $244,417,000, respectively. (g) Non-income Producing Assets: Non-income producing assets were insignificant. (h) Investments Greater than 10% Equity: The market value of investments in the following company exceeded 10% of the Company's total capital funds at December 31, 1998 (in thousands): Other Invested Assets: Equity Linked Investors II, L.P. $ 60,271 3. Deferred Policy Acquisition Costs The following reflects the policy acquisition costs deferred (commissions, direct solicitation and other costs) which will be amortized against future income and the related current amortization charged to income, excluding certain amounts deferred and amortized in the same period (in thousands). Years ended December 31, 1998 1997 1996 Balance at beginning of year $118,535 $84,287 $60,625 Acquisition costs deferred 71,430 50,927 43,534 Amortization charged to income (22,125) (16,679) (19,872) -------- -------- ------ Balance at end of year $167,840 $118,535 $84,287 ======= ======= ====== 4. Future Policy Benefits and Policyholders' Funds on Deposit (a) The analysis of the future policy benefits and policyholders' funds on deposit at December 31, 1998 and 1997 follows (in thousands): 1998 1997 ----------- ---------- Future Policy Benefits: Long duration contracts $ 987,503 $ 740,969 Short duration contracts 14,741 8,949 ----------- ------------ $1,002,244 $ 749,918 ========= ========== Policyholders' funds on deposit: Annuities $ 1,385,203 $ 1,265,490 Universal life 184,460 149,202 Guaranteed investment contracts (GICs) 669,035 379,049 Corporate owned life insurance 2,229,843 1,948,558 Other investment contracts 4,313 3,603 ------------ ------------ $ 4,472,854 $ 3,745,902 ============ ============ (b) Long duration contract liabilities included in future policy benefits, as presented in the table above, result from traditional life products. Short duration contract liabilities are primarily accident and health products. The liability for future policy benefits has been established based upon the following assumptions: (i) Interest rates (exclusive of immediate/terminal funding annuities), which vary by year of issuance and products, range from 3.0 percent to 10.0 percent within the first 20 years. Interest rates on immediate/terminal funding annuities are at a maximum of 12.2 percent and grade to not greater than 7.5 percent. (ii) Mortality and surrender rates are based upon actual experience modified to allow for variations in policy form. The weighted average lapse rate, including surrenders, for individual life approximated 10.1 percent. 4. Future Policy Benefits and Policyholders' Funds on Deposit - (continued) (c) The liability for policyholders' funds on deposit has been established based on the following assumptions: (i) Interest rates credited on deferred annuities vary by year of issuance and range from 3.0 percent to 7.1 percent. Credited interest rate guarantees are generally for a period of one year. Withdrawal charges generally range from 3.0 percent to 10.0 percent grading to zero over a period of 5 to 10 years. (ii) GICs have market value withdrawal provisions for any funds withdrawn other than benefit responsive payments. Interest rates credited generally range from 4.7 percent to 8.1 percent and maturities range from 1 to 20 years. (iii)Interest rates on corporate-owned life insurance business are guaranteed at 4.0 percent and the weighted average rate credited in 1998 was 7.0 percent. (iv) The universal life funds, exclusive of corporate owned life insurance business, have credited interest rates of 5.6 percent to 7.5 percent and guarantees ranging from 3.5 percent to 5.5 percent depending on the year of issue. Additionally, universal life funds are subject to surrender charges that amount to 11.0 percent of the fund balance and grade to zero over a period not longer than 20 years. 5. Income Taxes (a) The Federal income tax rate applicable to ordinary income is 35% for 1998, 1997 and 1996. Actual tax expense on income from operations differs from the "expected" amount computed by applying the Federal income tax rate because of the following (in thousands except percentages): Years ended December 31, ------------------------------------------------------------------------------------- 1998 1997 1996 ----------------------- ----------------------- ------------------------ Percent Percent Percent of of of pre-tax pre-tax pre-tax operating operating operating Amount Income Amount Income Amount Income "Expected" income tax expense $ 30,183 35.0% $ 23,279 35.0% $ 18,125 35.0% Prior year federal income tax benefit 268 0.3 (6) - (51) (0.1) State income tax 599 0.7 673 1.0 850 1.6 Other 388 0.5 77 0.1 677 1.3 -------- ------- ---------- ----- --------- ----- Actual income tax expense $31,438 36.5% $ 24,023 36.1% $ 19,601 37.8% ====== ====== ======= ==== ======= ==== 5. Income Taxes - (continued) (b) The components of the net deferred tax liability were as follows (in thousands): Years ended December 31, 1998 1997 Deferred tax assets: Adjustment to life reserves $ 59,903 $ 51,992 Adjustments to mortgage loans and investment income due and accrued 4,913 4,250 Adjustment to policy and contract claims 5,456 8,816 Other 2,406 4,292 ---------- --------- 72,678 69,350 --------- -------- Deferred tax liabilities: Deferred policy acquisition costs $ 55,308 $ 37,559 Unrealized appreciation on investments 65,445 61,644 Bond discount 4,911 4,843 Other 3,533 2,802 ---------- ----------- 129,197 106,848 -------- --------- Net deferred tax liability $ 56,519 $ 37,498 ========= ========= (c) At December 31, 1998, accumulated earnings of the Company for Federal income tax purposes include approximately $2,204,000 of "Policyholders' Surplus" as defined under the Code. Under provisions of the Code, "Policyholders' Surplus" has not been currently taxed but would be taxed at current rates if distributed to the Parent. There is no present intention to make cash distributions from "Policyholders' Surplus" and accordingly, no provision has been made for taxes on this amount. (d) Income taxes paid in 1998, 1997, and 1996 amounted to $21,184,000, $20,311,000, and $25,412,000, respectively. 6. Commitments and Contingencies The Company, in common with the insurance industry in general, is subject to litigation, including claims for punitive damages, in the normal course of their business. The Company does not believe that such litigation will have a material effect on its operating results and financial condition. During 1997, the Company entered into a partnership agreement with Private Equity Investors III, L.P. The agreement requires the Company to make capital contributions totaling $50,000,000. Contributions totaling $10,963,000 have been made through December 31, 1998. During 1998, the Company entered into a partnership agreement with Sankaty High Yield Asset Partners, L.P. The agreement requires the Company to make capital contributions totaling $2,500,000. Contributions totaling $1,868,000 have been made through December 31, 1998. 7. Fair Value of Financial Instruments (a) Statement of Financial Accounting Standards No. 107 "Disclosures about Fair Value of Financial Instruments" (FASB 107) requires disclosure of fair value information about financial instruments for which it is practicable to estimate such fair value. These financial instruments may or may not be recognized in the balance sheet. In the measurement of the fair value of certain of the financial instruments, quoted market prices were not available and other valuation techniques were utilized. These derived fair value estimates are significantly affected by the assumptions used. FASB 107 excludes certain financial instruments, including those related to insurance contracts. The following methods and assumptions were used by the Company in estimating the fair value of the financial instruments presented: Cash and short term investments: The carrying amounts reported in the balance sheet for these instruments approximate fair values. Fixed maturities: Fair values for fixed maturity securities carried at market value are generally based upon quoted market prices. For certain fixed maturities for which market prices were not readily available, fair values were estimated using values obtained from independent pricing services. Equity securities: Fair values for equity securities were based upon quoted market prices. Mortgage and policy loans: Where practical, the fair values of loans on real estate were estimated using discounted cash flow calculations based upon the Company's current incremental lending rates for similar type loans. The fair value of the policy loans were not calculated as the Company believes it would have to expend excessive costs for the benefits derived. Therefore, the fair value of policy loans was estimated at carrying value. Policyholders' funds on deposit: Fair value of policyholder contract deposits were estimated using discounted cash flow calculations based upon interest rates currently being offered for similar contracts consistent with those remaining for the contracts being valued. (b) The fair value and carrying amounts of financial instruments is as follows (in thousands): 1998 Fair Carrying Value Amount Cash and short-term investments $ 168,492 $ 168,492 Fixed maturities 4,238,045 4,238,045 Equity securities 21,748 21,748 Mortgage and policy loans 1,500,447 1,479,311 Policyholders' funds on deposit $ 4,554,644 $ 4,472,854 1997 Fair Carrying Value Amount Cash and short-term investments $ 673,044 $ 673,044 Fixed maturities 2,984,255 2,984,255 Equity securities 3,025 3,025 Mortgage and policy loans 1,868,449 1,847,660 Interest rate cap - 19 Policyholders' funds on deposit $ 3,777,435 $ 3,745,902 8. Capital Funds (a) The maximum stockholder dividend which can be paid without prior regulatory approval is subject to restrictions relating to statutory surplus and statutory net gain from operations. These restrictions limited payment of dividends to $35,350,000 during 1998, however, no dividends were paid during the year. (b) The Company's capital funds as determined in accordance with statutory accounting practices was $298,047,000 at December 31, 1998 and $285,350,000 at December 31, 1997. Statutory net income amounted to $28,789,000, $35,350,000 and $47,074,000 for 1998, 1997 and 1996, respectively. (c) During 1997, the Company received a $30,000,000 surplus contribution from American International Group Inc., the parent. (d) Statement of Accounting Standards No. 130 "Comprehensive Income" (FASB 130) was adopted by the Company effective January 1, 1998. FASB 130 establishes standards for reporting comprehensive income and its components as part of capital funds. The reclassification adjustments with respect to available for sale securities were $(334,000), $(3,025,000) and $(51,000) for December 31, 1998, 1997 and 1996, respectively. 9. Employee Benefits (a) The Company participates with its affiliates in a qualified, non-contributory, defined benefit pension plan which is administered by the Parent. All qualified employees who have attained age 21 and completed twelve months of continuous service are eligible to participate in this plan. An employee with 5 or more years of service is entitled to pension benefits beginning at normal retirement age 65. Benefits are based upon a percentage of average final compensation multiplied by years of credited service limited to 44 years of credited service. The average final compensation is subject to certain limitations. Annual funding requirements are determined based on the "projected unit credit" cost method which attributes a pro rata portion of the total projected benefit payable at normal retirement to each year of credited service. Pension expense for current service costs, retirement and termination benefits for the years ended December 31, 1998, 1997 and 1996 were approximately $272,000, $373,000, and $400,000, respectively. The Parent's plans do not separately identify projected benefit obligations and plan assets attributable to employees of participating affiliates. The projected benefit obligations exceeded the plan assets at December 31, 1998 by $100,000,000. The Parent has adopted a Supplemental Executive Retirement Program (Supplemental Plan) to provide additional retirement benefits to designated executives and key employees. Under the Supplemental Plan, the annual benefit, not to exceed 60 percent of average final compensation, accrues at a percentage of average final pay multiplied for each year of credited service reduced by any benefits from the current and any predecessor retirement plans, Social Security, if any, and from any qualified pension plan of prior employers. The Supplemental Plan also provides a benefit equal to the reduction in benefits payable under the AIG retirement plan as a result of Federal limitations on benefits payable thereunder. Currently, the Supplemental Plan is unfunded. (b) The Parent also sponsors a voluntary savings plan for domestic employees (a 401(k) plan), which, during the three years ended December 31, 1998, provided for salary reduction contributions by employees and matching contributions by the Parent of up to 6 percent of annual salary depending on the employees' years of service. 9. Employee Benefits - (continued) (c) In addition to the Parent's defined benefit pension plan, the Parent and its subsidiaries provide a post-retirement benefit program for medical care and life insurance. Eligibility in the various plans is generally based upon completion of a specified period of eligible service and reaching a specified age. (d) The Parent applies APB Opinion 25 "Accounting for Stock issued to Employees" and related interpretations in accounting for its stock based compensation plans. Employees of the Company participate in certain stock option and stock purchase plans of the Parent. In general, under the stock option plan, officers and other key employees are granted options to purchase AIG common stock at a price not less than fair market value at the date of grant. In general, the stock purchase plan provide for eligible employees to receive privileges to purchase AIG common stock at a price equal to 85% of the fair market value on the date of grant of the purchase privilege. The Parent has not recognized compensation costs for either plan. The effect of the compensation costs, as determined consistent with FASB 123, was not computed on a subsidiary basis, but rather on a consolidated basis for all subsidiaries of the Parent and therefore are not presented herein. 10. Leases (a) The Company occupies leased space in many locations under various long-term leases and has entered into various leases covering the long-term use of data processing equipment. At December 31, 1998, the future minimum lease payments under operating leases were as follows (in thousands): Year Payment 1999 $ 4,251 2000 2,980 2001 2,530 2002 2,380 2003 1,870 Remaining years after 2003 1,571 ------- Total $ 15,582 Rent expense approximated $4,450,000, $3,881,000, and $4,263,000 for the years ended December 31, 1998, 1997 and 1996, respectively. (b) Sublease Income - The Company does not participate in sublease agreements. 11. Reinsurance (a) The Company reinsures portions of its life and accident and health insurance risks with unaffiliated companies. Life insurance risks are reinsured primarily under coinsurance and yearly renewable term treaties. Accident and health insurance risks are reinsured primarily under coinsurance, excess of loss and quota share treaties. Amounts recoverable from reinsurers are estimated in a manner consistent with the assumptions used for the underlying policy benefits and are presented as a component of reinsurance assets. A contingent liability exists with respect to reinsurance ceded to the extent that any reinsurer is unable to meet the obligations assumed under the reinsurance agreements. 11. Reinsurance - (continued) The Company also reinsures portions of its life and accident and health insurance risks with affiliated companies (see Note 12). The effect of all reinsurance contracts, including reinsurance assumed, is as follows (in thousands, except percentages): Percentage December 31, 1998 of Amount Assumed Gross Ceded Assumed Net to Net Life Insurance in Force $53,884,853 $19,921,930 $ 896,285 $34,859,208 2.6% ============= ========== ======== ========== Premiums: Life 184,487 54,134 2,022 132,375 1.5% Accident and Health 155,199 82,614 142,878 215,463 66.3% Annuity 269,126 - - 269,126 - ------------ ----------------- -------------- ------------ Total Premiums $ 608,812 $ 136,748 $ 144,900 $ 616,964 23.5% ============ =========== ======== ============ Percentage of Amount December 31, 1997 Assumed Gross Ceded Assumed Net to Net Life Insurance in Force $52,183,971 $18,779,228 $ 935,975 $34,340,718 2.7% ============= ========== ======== ========== Premiums: Life 200,926 67,350 2,389 135,965 1.8% Accident and Health 118,663 59,550 115,573 174,686 66.2% Annuity 126,999 - - 126,999 - ------------ ----------------- -------------- ------------ Total Premiums $ 446,588 $ 126,900 $ 117,962 $ 437,650 27.0% ============ =========== ======== ============ Percentage of Amount December 31, 1996 Assumed Gross Ceded Assumed Net to Net Life Insurance in Force $53,854,456 $17,392,184 $ 605,831 $37,068,103 1.6% ============= ========== ======== ========== Premiums: Life 187,886 49,150 327 139,063 - Accident and Health 97,971 28,359 107,447 177,059 60.7% Annuity 78,358 - - 78,358 - ------------- ------------------- -------------- ------------- Total Premiums $ 364,215 $ 77,509 $ 107,774 $ 394,480 27.3% ============ ============== ======== ============ (b) The maximum amount retained on any one life by the Company is $1,000,000. (c) Reinsurance recoveries, which reduced death and other benefits, approximated $111,580,000, $100,029,000, and $54,456,000, respectively, for each of the years ended December 31, 1998, 1997 and 1996. The Company's reinsurance arrangements do not relieve the Company from its direct obligation to its insureds. 12. Transactions with Related Parties (a) The Company is party to several reinsurance agreements with its affiliates covering certain life and accident and health insurance risks. Premium income and commission ceded for 1998 amounted to $1,237,000 and $1,000, respectively. Premium income and commission ceded for 1997 amounted to $1,251,000 and $1,000, respectively. Premium income and commission ceded to affiliates amounted to $1,345,000 and $0 for the year ended December 31, 1996. Premium income and ceding commission expense assumed from affiliates aggregated $131,771,000 and $31,584,000, respectively, for 1998, compared to $110,529,000 and $24,853,000, respectively, for 1997, and $103,885,000 and $27,609,000, respectively for 1996. (b) The Company is party to several cost sharing agreements with its affiliates. Generally, these agreements provide for the allocation of costs upon either the specific identification basis or a proportional cost allocation basis which management believes to be reasonable. For the years ended December 31, 1998, 1997 and 1996, the Company was charged $40,417,000, $37,846,000 and $28,277,000, respectively, for expenses attributed to the Company but incurred by affiliates. During the same period, the Company received reimbursements from affiliates aggregating $23,132,000, $18,134,000 and $17,598,000, respectively, for costs incurred by the Company but attributable to affiliates. (c) During 1997, a reinsurance agreement covering certain annuity policies was terminated. Upon cancellation, assets totaling $164,895,000 were transferred to the Company from Delaware American Life Insurance Company. (d) During 1996, the Company purchased 1,500,000 shares of AIG Life Ireland, LTD., a subsidiary. AIG LIFE INSURANCE COMPANY BALANCE SHEETS (in thousands) June 30, December 31, 1999 1998 (unaudited) Assets Investments and cash: Fixed maturities: Bonds available for sale, at market value $ 4,539,466 $ 4,238,045 (cost: 1999 - $4,563,445: 1998 - $4,081,008) Equity securities: Common stock (cost: 1999-$2,608: 1998 - $901) 2,608 2,410 Preferred stock (cost: 1999 - $20,252 : 1998 - $18,250) 20,416 19,338 Mortgage loans on real estate, net 435,517 468,342 Real estate, net of accumulated depreciation of $4,683 in 1999; and $4,351 in 1998 12,860 13,002 Policy loans 635,774 1,010,969 Other invested assets 87,916 81,916 Short-term investments 70,814 163,704 Cash 4,191 4,788 -------------- ------------- Total investments and cash 5,809,562 6,002,514 Amounts due from related parties 7,575 17,330 Investment income due and accrued 107,353 94,029 Premium and insurance balances receivable-net 70,564 56,583 Reinsurance assets 115,276 72,044 Deferred policy acquisition costs 192,311 167,840 Federal income tax receivable 936 4,207 Deferred income taxes 7,231 - Separate and variable accounts 2,599,917 1,971,280 Other assets 5,751 6,228 -------------- ------------- Total assets $ 8,916,476 $ 8,392,055 ========== ========== See accompanying notes to financial statements. AIG LIFE INSURANCE COMPANY BALANCE SHEETS (in thousands, except share amounts) June 30, December 31, 1999 1998 (unaudited) Liabilities Policyholders' funds on deposit $ 4,377,132 $ 4,472,854 Future policy benefits 1,098,017 1,002,244 Reserve for unearned premiums 19,018 21,468 Policy and contract claims 189,467 200,193 Reserve for commissions, expenses and taxes 12,338 25,702 Insurance balances payable 59,998 56,263 Amounts due to related parties 8,378 4,119 Deferred income taxes - 56,519 Separate and variable accounts 2,599,917 1,971,280 Minority interest 5,996 5,987 Other liabilities 127,408 59,189 ------------ ----------- Total liabilities 8,497,669 7,875,818 ----------- ----------- Capital Funds Common stock, $5 par value; 1,000,000 shares authorized; 976,703 shares issued and outstanding 4,884 4,884 Additional paid-in capital 153,283 153,283 Retained earnings 262,392 236,521 Accumulated other comprehensive income (1,752) 121,549 -------------- ------------ Total capital funds 418,807 516,237 ------------ ------------ Total liabilities and capital funds $ 8,916,476 $ 8,392,055 ========== ========== See accompanying notes to financial statements. AIG LIFE INSURANCE COMPANY STATEMENTS OF INCOME (in thousands) (unaudited) For the six months ended June 30, 1999 1998 Revenues: Premiums $ 301,096 $ 309,585 Net investment income 219,644 230,579 Realized capital (losses) (1,837) - ----------- ------------- Total revenues 518,903 540,164 -------- -------- Benefits and expenses: Benefits to policyholders 154,238 122,614 Increase in future policy benefits and policyholders' funds on deposit 225,875 294,553 Acquisition and insurance expenses 98,771 81,806 --------- -------- Total benefits and expenses 478,884 498,973 -------- -------- Income before income taxes 40,019 41,191 --------- --------- Income taxes (benefits): Current 11,409 11,934 Deferred 2,643 2,976 ---------- ---------- Total income taxes 14,152 14,910 --------- --------- Net income before minority interest 25,967 26,281 Minority interest income 96 87 ------------ ------------ Net income $ 25,871 $ 26,194 ========= ========= See accompanying notes to financial statements AIG LIFE INSURANCE COMPANY STATEMENTS OF CAPITAL FUNDS (in thousands) June 30, December 31, 1999 1998 --------- ------------------ (unaudited) Common Stock Balance at beginning of year $ 4,884 $ 4,884 ----------- ----------- Balance at end of year 4,884 4,884 ----------- ----------- Additional paid-in capital Balance at beginning of year: 153,283 153,283 --------- --------- Balance at end of year 153,283 153,283 --------- --------- Retained earnings Balance at beginning of year 236,521 181,887 Net income 25,871 54,634 ---------- ---------- Balance at end of year 262,392 236,521 --------- --------- Accumulated other comprehensive income Balance at beginning of year 121,549 114,490 Unrealized appreciation (depreciation) of investments - net of reclassification adjustments (189,694) 10,860 Deferred income tax benefit (expense) on changes 66,393 (3,801) ---------- ---------- Balance at end of year (1,752) 121,549 ----------- --------- Total capital funds $ 418,807 $ 516,237 ========= ========= See accompanying notes to financial statements AIG LIFE INSURANCE COMPANY STATEMENTS OF CASH FLOWS (in thousands) (unaudited) For six months ended June 30, 1999 1998 Cash flows from operating activities: Net income $ 25,871 $ 26,194 Adjustments to reconcile net income to net cash provided by operating activities: Non-cash revenues, expenses, gains and losses included in income: Change in insurance reserves 82,598 160,672 Change in premiums and insurance balances receivable and payable -net (10,246) (6,301) Change in reinsurance assets (43,233) 3,816 Change in deferred policy acquisition costs (24,471) (28,584) Change in investment income due and accrued (13,324) (61,375) Realized capital gains 1,837 - Change in current and deferred income taxes -net 5,913 1,330 Change in reserves for commissions, expenses and taxes (13,364) 12,002 Change in other assets and liabilities - net 45,704 (72,158) ------- ------------ Total adjustments 31,414 9,402 -------- ------------- Net cash provided by operating activities 57,285 35,596 -------- ------------ Cash flows from investing activities: Cost of fixed maturities, at market sold 401,435 105,330 Cost of fixed maturities, at market matured or redeemed 212,993 213,083 Cost of equity securities sold 1,020 579 Realized capital gains (1,837) - Purchase of fixed maturities (1,092,475) (1,202,140) Purchase of equity securities (3,023) (10,579) Mortgage loans granted (49,000) (40,477) Repayments of mortgage loans 81,865 32,912 Change in policy loans 375,195 (23,658) Change in short-term investments 92,889 505,795 Change in other invested assets (13,930) (5,556) Other - net 32,708 (8,597) ---------- ------------- Net cash provided by (used in) investing activities 37,840 (433,308) ---------- ----------- Cash flows from financing activities: Change in policyholders' funds on deposit (95,722) 401,502 ------------ ----------- Net cash (used in) provided by financing activities (95,722) 401,502 ------------ ---------- Change in cash (597) 3,790 Cash at beginning of year 4,788 5,132 ------------ ------------ Cash at end of year $ 4,191 $ 8,922 =========== ============ See accompanying notes to financial statements AIG LIFE INSURANCE COMPANY STATEMENTS OF COMPREHENSIVE INCOME (in thousands) (unaudited) June 30, December 31, 1999 1998 (unaudited) Comprehensive income Net income $ 25,871 $ 54,634 ------------ ------------ Other comprehensive income Unrealized appreciation (depreciation) of investments - net of reclassification adjustments (189,694) 10,860 Changes due to deferred income tax benefit (expense) on changes 66,393 (3,801) ----------- ------------- Other comprehensive income (123,301) 7,059 ---------- ------------- Comprehensive income $ (97,430) $ 61,693 ===========- =========== See accompanying notes to financial statements AIG LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS 1. Summary of Significant Accounting Policies Basis of Presentation: The year-end balance sheet data was derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles. REPORT OF INDEPENDENT ACCOUNTANTS To the Contract Owners of AIG Life Insurance Company Variable Account II In our opinion, the accompanying statements of assets and liabilities of AIG Life Insurance Company Variable Account II (comprising twenty-seven subaccounts, hereafter collectively referred to as "Variable Account II") and the related statements of operations and changes in net assets present fairly, in all material respects, the financial position of Variable Account II at December 31, 1998, and the results of its operations for the year then ended and the changes in its net assets for each of the two years in the period then ended, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the management of Variable Account II; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. March 12, 1999 AIG LIFE INSURANCE COMPANY (AIG LIFE) VARIABLE ACCOUNT II STATEMENT OF ASSETS AND LIABILITIES DECEMBER 31, 1998 - -------------------------------------------------------------------------------------------------------------------------- ASSETS: Investments at Market Value: Shares Cost Market Value ------------------------------------------------------------------------ ------------------------------------------------------------------------ Aim Capital Appreciation Portfolio 7,967.361 $ 174,945 $ 200,777 International Equity Portfolio 12,467.656 236,877 244,616 Alliance Conservative Investors Portfolio 2,351.573 31,263 32,995 Global Bond Portfolio 688.066 8,257 8,547 Global Dollar Government Portfolio 21.880 212 222 Growth Portfolio 103,752.036 2,269,574 2,827,243 Growth & Income Portfolio 114,967.436 2,371,168 2,510,891 Growth Investors Portfolio 11,980.789 170,031 195,648 Money Market Portfolio 20,485.370 20,484 20,484 Premier Growth Portfolio 4,897.459 135,406 151,967 Technology Portfolio 42,154.382 625,961 808,100 Total Return Portfolio 140.114 2,418 2,530 Quasar Portfolio 29,073.531 378,222 323,880 U.S. Government High Grade Portfolio 78.903 967 968 Utility Income Portfolio 53.953 967 1,020 Dreyfus Small Company Stock Portfolio 16,436.564 244,881 248,028 Stock Index Portfolio 83,498.512 2,317,307 2,715,365 Zero Coupon 2000 Portfolio 1,086.434 13,465 13,579 Fidelity Asset Manager Portfolio 43,714.023 749,687 793,844 Contrafund Portfolio 12,145.716 259,365 296,842 Growth Portfolio 67,940.819 2,451,577 3,048,504 High Income Portfolio 22,836.942 281,130 263,309 Investment Grade Bond Portfolio 16,104.772 202,456 208,718 Money Market Portfolio 2,748,418.390 2,748,419 2,748,419 Overseas Portfolio 18,964.028 376,478 380,231 Van Eck Worldwide Emerging Markets Portfolio 4,148.930 26,887 29,539 Worldwide Hard Assets Portfolio 3,756.723 47,156 34,560 Weiss,Peck & Greer Tomorrow Long Term Portfolio 6,383.661 54,490 58,921 Tomorrow MediumTerm Portfolio 509.549 4,670 4,805 Tomorrow Short Term Portfolio 638.247 6,677 6,727 ---------------------- ----------------------- Total Investments $ 16,211,397 18,181,279 Total Assets $ 18,181,279 ======================= Contract Owners' Equity $ 18,181,279 ----------------------- Total Equity $ 18,181,279 ======================= See Accompanying Notes to Financial Statements AIG LIFE INSURANCE COMPANY (AIG LIFE) VARIABLE ACCOUNT II STATEMENT OF OPERATIONS For The Year Ended December 31, 1998 Aim Aim Capital International Appreciation Equity Total Portfolio Portfolio Investment Income (Loss): Dividends $733,252 $5,326 $1,878 Expenses: Mortality & Expense Risk Fees 106,392 694 1,405 --------------- ---------------- ---------------- Net Investment Income (Loss) 626,860 4,632 473 --------------- ---------------- ---------------- Realized & Unrealized Gain (Loss) on Investments: Realized Gain (Loss) on Investment Activity 519,608 (371) (22,044) Change in Unrealized Appreciation (Depreciation) 1,519,964 25,833 7,738 --------------- ---------------- ---------------- Net Gain (Loss) on Investments 2,039,572 25,462 (14,306) --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations $2,666,432 $30,094 ($13,833) =============== ================ ================ Alliance Alliance Alliance Global Conservative Global Dollar Investors Bond Government Portfolio Portfolio Portfolio Investment Income (Loss): Dividends $2,086 $18 $0 Expenses: Mortality & Expense Risk Fees 263 20 0 --------------- ---------------- ---------------- Net Investment Income (Loss) 1,823 (2) 0 --------------- ---------------- ---------------- Realized & Unrealized Gain (Loss) on Investments: Realized Gain (Loss) on Investment Activity 1,083 19 2 Change in Unrealized Appreciation (Depreciation) 691 289 10 --------------- ---------------- ---------------- Net Gain (Loss) on Investments 1,774 308 12 --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations $3,597 $306 $12 =============== ================ ================ Alliance Growth Alliance Alliance & Growth Growth Income Investors Portfolio Portfolio Portfolio Investment Income (Loss): Dividends $110,505 $111,284 $14,073 Expenses: Mortality & Expense Risk Fees 16,449 10,688 1,473 --------------- ---------------- ---------------- Net Investment Income (Loss) 94,056 100,596 12,600 --------------- ---------------- ---------------- Realized & Unrealized Gain (Loss) on Investments: Realized Gain (Loss) on Investment Activity 36,650 55,743 3,763 Change in Unrealized Appreciation (Depreciation) 394,461 63,586 17,434 --------------- ---------------- ---------------- Net Gain (Loss) on Investments 431,111 119,329 21,197 --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations $525,167 $219,925 $33,797 =============== ================ ================ Alliance Alliance Alliance Money Premier International Market Growth Portfolio Portfolio Portfolio Investment Income (Loss): Dividends $0 $2,482 $233 Expenses: Mortality & Expense Risk Fees 334 482 2,105 --------------- ---------------- ---------------- Net Investment Income (Loss) (334) 2,000 (1,872) --------------- ---------------- ---------------- Realized & Unrealized Gain (Loss) on Investments: Realized Gain (Loss) on Investment Activity 54,637 0 30,881 Change in Unrealized Appreciation (Depreciation) 0 0 16,562 --------------- ---------------- ---------------- Net Gain (Loss) on Investments 54,637 0 47,443 --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations $54,303 $2,000 $45,571 =============== ================ ================ Alliance Alliance Total Alliance Technology Return Quasar Portfolio Portfolio Portfolio Investment Income (Loss): Dividends $715 $0 $31,614 Expenses: Mortality & Expense Risk Fees 5,537 1 3,978 --------------- ---------------- ---------------- Net Investment Income (Loss) (4,822) (1) 27,636 --------------- ---------------- ---------------- Realized & Unrealized Gain (Loss) on Investments: Realized Gain (Loss) on Investment Activity 171,268 0 31,274 Change in Unrealized Appreciation (Depreciation) 197,601 112 (66,300) --------------- ---------------- ---------------- Net Gain (Loss) on Investments 368,869 112 (35,026) --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations $364,047 $111 ($7,390) =============== ================ ================ Alliance U.S. Dreyfus Government Small High Alliance Company Grade Utility Stock Portfolio Portfolio Portfolio Investment Income (Loss): Dividends $0 $0 $1,151 Expenses: Mortality & Expense Risk Fees 0 0 1,653 --------------- ---------------- ---------------- Net Investment Income (Loss) 0 0 (502) --------------- ---------------- ---------------- Realized & Unrealized Gain (Loss) on Investments: Realized Gain (Loss) on Investment Activity 0 0 (2,481) Change in Unrealized Appreciation (Depreciation) 0 52 8,859 --------------- ---------------- ---------------- Net Gain (Loss) on Investments 0 52 6,378 --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations $0 $52 $5,876 =============== ================ ================ Dreyfus Dreyfus Zero Fidelity Stock Coupon Asset Index 2000 Manager Portfolio Portfolio Portfolio Investment Income (Loss): Dividends $30,188 $705 $60,993 Expenses: Mortality & Expense Risk Fees 16,095 116 5,125 --------------- ---------------- ---------------- Net Investment Income (Loss) 14,093 589 55,868 --------------- ---------------- ---------------- Realized & Unrealized Gain (Loss) on Investments: Realized Gain (Loss) on Investment Activity 90,160 117 10,634 Change in Unrealized Appreciation (Depreciation) 348,632 37 18,503 --------------- ---------------- ---------------- Net Gain (Loss) on Investments 438,792 154 29,137 --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations $452,885 $743 $85,005 =============== ================ ================ Fidelity Fidelity Fidelity High Contrafund Growth Income Portfolio Portfolio Portfolio Investment Income (Loss): Dividends $1,859 $181,333 $33,968 Expenses: Mortality & Expense Risk Fees 1,067 17,992 2,593 --------------- ---------------- ---------------- Net Investment Income (Loss) 792 163,341 31,375 --------------- ---------------- ---------------- Realized & Unrealized Gain (Loss) on Investments: Realized Gain (Loss) on Investment Activity 3,199 52,384 (5,310) Change in Unrealized Appreciation (Depreciation) 37,476 484,390 (31,433) --------------- ---------------- ---------------- Net Gain (Loss) on Investments 40,675 536,774 (36,743) --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations $41,467 $700,115 ($5,368) =============== ================ ================ Fidelity Investment Fidelity Grade Money Fidelity Bond Market Overseas Portfolio Portfolio Portfolio Investment Income (Loss): Dividends $9,614 $72,672 $29,556 Expenses: Mortality & Expense Risk Fees 1,360 12,336 3,291 --------------- ---------------- ---------------- Net Investment Income (Loss) 8,254 60,336 26,265 --------------- ---------------- ---------------- Realized & Unrealized Gain (Loss) on Investments: Realized Gain (Loss) on Investment Activity (104) 0 22,548 Change in Unrealized Appreciation (Depreciation) 2,966 0 1,403 --------------- ---------------- ---------------- Net Gain (Loss) on Investments 2,862 0 23,951 --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations $11,116 $60,336 $50,216 =============== ================ ================ VanEck VanEck VanEck Worldwide Worldwide Worldwide Emerging Hard Balanced Markets Assets Portfolio Portfolio Portfolio Investment Income (Loss): Dividends $24,879 $0 $4,567 Expenses: Mortality & Expense Risk Fees 466 80 292 --------------- ---------------- ---------------- Net Investment Income (Loss) 24,413 (80) 4,275 --------------- ---------------- ---------------- Realized & Unrealized Gain (Loss) on Investments: Realized Gain (Loss) on Investment Activity (10,944) (238) (4,776) Change in Unrealized Appreciation (Depreciation) (4,930) 2,653 (11,854) --------------- ---------------- ---------------- Net Gain (Loss) on Investments (15,874) 2,415 (16,630) --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations $8,539 $2,335 ($12,355) =============== ================ ================ WP&G WP&G WP&G Tomorrow Tomorrow Tomorrow Long Medium Short Term Term Term Portfolio Portfolio Portfolio Investment Income (Loss): Dividends $948 $287 $318 Expenses: Mortality & Expense Risk Fees 423 41 33 --------------- ---------------- ---------------- Net Investment Income (Loss) 525 246 285 --------------- ---------------- ---------------- Realized & Unrealized Gain (Loss) on Investments: Realized Gain (Loss) on Investment Activity 1,436 31 47 Change in Unrealized Appreciation (Depreciation) 4,736 390 67 --------------- ---------------- ---------------- Net Gain (Loss) on Investments 6,172 421 114 --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations $6,697 $667 $399 =============== ================ ================ See Accompanying Notes to Financial Statements AIG LIFE INSURANCE COMPANY (AIG LIFE) VARIABLE ACCOUNT II STATEMENT OF CHANGES IN NET ASSETS For The Years Ended December 31, 1998 and December 31, 1997 1998 Aim Aim Capital International Appreciation Equity Total Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $626,860 $4,632 $473 Realized Gain (Loss) on Investment Activity 519,608 (371) (22,044) Change in Unrealized Appreciation (Depreciation) of Investments 1,519,964 25,833 7,738 --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations 2,666,432 30,094 (13,833) --------------- ---------------- ---------------- Capital Transactions: Contract Deposits 10,210,370 185,128 275,137 Cost Of Insurance Charge (1,571,906) (12,343) (20,406) Policy Loans (212,191) 0 0 Transfers Between Funds 18,740 (1,665) 4,554 Contract Withdrawals (202,369) (437) (836) --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 8,242,644 170,683 258,449 --------------- ---------------- ---------------- Total Increase (Decrease) in Net Assets 10,909,076 200,777 244,616 Net Assets, at Beginning of Year 7,272,203 0 0 --------------- ---------------- ---------------- Net Assets, at End of Year $18,181,279 $200,777 $244,616 =============== ================ ================ Alliance Alliance Alliance Global Conservative Global Dollar Investors Bond Government Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $1,823 ($2) $0 Realized Gain (Loss) on Investment Activity 1,083 19 2 Change in Unrealized Appreciation (Depreciation) of Investments 691 289 10 --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations 3,597 306 12 --------------- ---------------- ---------------- Capital Transactions: Contract Deposits 9,551 8,736 241 Cost Of Insurance Charge (2,651) (507) (31) Policy Loans 0 0 0 Transfers Between Funds (834) 12 0 Contract Withdrawals (740) 0 0 --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 5,326 8,241 210 --------------- ---------------- ---------------- Total Increase (Decrease) in Net Assets 8,923 8,547 222 Net Assets, at Beginning of Year 24,072 0 0 --------------- ---------------- ---------------- Net Assets, at End of Year $32,995 $8,547 $222 =============== ================ ================ Alliance Growth Alliance Alliance & Growth Growth Income Investors Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $94,056 $100,596 $12,600 Realized Gain (Loss) on Investment Activity 36,650 55,743 3,763 Change in Unrealized Appreciation (Depreciation) of Investments 394,461 63,586 17,434 --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations 525,167 219,925 33,797 --------------- ---------------- ---------------- Capital Transactions: Contract Deposits 1,469,752 1,709,454 67,574 Cost Of Insurance Charge (210,721) (152,262) (18,064) Policy Loans (30,640) (25,729) (2,299) Transfers Between Funds (4,391) 16,628 97 Contract Withdrawals (44,972) (21,460) (2,915) --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 1,179,028 1,526,631 44,393 --------------- ---------------- ---------------- Total Increase (Decrease) in Net Assets 1,704,195 1,746,556 78,190 Net Assets, at Beginning of Year 1,123,048 764,335 117,458 --------------- ---------------- ---------------- Net Assets, at End of Year $2,827,243 $2,510,891 $195,648 =============== ================ ================ Alliance Alliance Alliance Money Premier International Market Growth Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) ($334) $2,000 ($1,872) Realized Gain (Loss) on Investment Activity 54,637 0 30,881 Change in Unrealized Appreciation (Depreciation) of Investments 0 0 16,562 --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations 54,303 2,000 45,571 --------------- ---------------- ---------------- Capital Transactions: Contract Deposits (48,815) 30,048 122,585 Cost Of Insurance Charge (7,879) (11,766) (19,989) Policy Loans 0 0 (267) Transfers Between Funds 2,391 202 4,628 Contract Withdrawals 0 0 (561) --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions (54,303) 18,484 106,396 --------------- ---------------- ---------------- Total Increase (Decrease) in Net Assets 0 20,484 151,967 Net Assets, at Beginning of Year 0 0 0 --------------- ---------------- ---------------- Net Assets, at End of Year $0 $20,484 $151,967 =============== ================ ================ Alliance Alliance Total Alliance Technology Return Quasar Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) ($4,822) ($1) $27,636 Realized Gain (Loss) on Investment Activity 171,268 0 31,274 Change in Unrealized Appreciation (Depreciation) of Investments 197,601 112 (66,300) --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations 364,047 111 (7,390) --------------- ---------------- ---------------- Capital Transactions: Contract Deposits 274,264 2,477 152,103 Cost Of Insurance Charge (66,804) (58) (36,287) Policy Loans (12,128) 0 (10,340) Transfers Between Funds 6,050 0 (7,597) Contract Withdrawals (12,390) 0 (8,285) --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 188,992 2,419 89,594 --------------- ---------------- ---------------- Total Increase (Decrease) in Net Assets 553,039 2,530 82,204 Net Assets, at Beginning of Year 255,061 0 241,676 --------------- ---------------- ---------------- Net Assets, at End of Year $808,100 $2,530 $323,880 =============== ================ ================ Alliance U.S. Dreyfus Government Small High Alliance Company Grade Utility Stock Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $0 $0 ($502) Realized Gain (Loss) on Investment Activity 0 0 (2,481) Change in Unrealized Appreciation (Depreciation) of Investments 0 52 8,859 --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations 0 52 5,876 --------------- ---------------- ---------------- Capital Transactions: Contract Deposits 991 991 139,298 Cost Of Insurance Charge (23) (23) (22,440) Policy Loans 0 0 (1,455) Transfers Between Funds 0 0 2,014 Contract Withdrawals 0 0 (2,646) --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 968 968 114,771 --------------- ---------------- ---------------- Total Increase (Decrease) in Net Assets 968 1,020 120,647 Net Assets, at Beginning of Year 0 0 127,381 --------------- ---------------- ---------------- Net Assets, at End of Year $968 $1,020 $248,028 =============== ================ ================ Dreyfus Dreyfus Zero Fidelity Stock Coupon Asset Index 2000 Manager Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $14,093 $589 $55,868 Realized Gain (Loss) on Investment Activity 90,160 117 10,634 Change in Unrealized Appreciation (Depreciation) of Investments 348,632 37 18,503 --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations 452,885 743 85,005 --------------- ---------------- ---------------- Capital Transactions: Contract Deposits 1,652,138 4,327 384,610 Cost Of Insurance Charge (264,577) (2,247) (60,284) Policy Loans (35,221) 0 (1,634) Transfers Between Funds (3,827) (10) 1,319 Contract Withdrawals (30,468) 0 (3,078) --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 1,318,045 2,070 320,933 --------------- ---------------- ---------------- Total Increase (Decrease) in Net Assets 1,770,930 2,813 405,938 Net Assets, at Beginning of Year 944,435 10,766 387,906 --------------- ---------------- ---------------- Net Assets, at End of Year $2,715,365 $13,579 $793,844 =============== ================ ================ Fidelity Fidelity Fidelity High Contrafund Growth Income Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $792 $163,341 $31,375 Realized Gain (Loss) on Investment Activity 3,199 52,384 (5,310) Change in Unrealized Appreciation (Depreciation) of Investments 37,476 484,390 (31,433) --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations 41,467 700,115 (5,368) --------------- ---------------- ---------------- Capital Transactions: Contract Deposits 274,009 1,511,553 20,065 Cost Of Insurance Charge (18,289) (264,617) (31,215) Policy Loans 0 (38,305) (541) Transfers Between Funds (301) 8,334 (1,103) Contract Withdrawals (44) (32,651) (5,710) --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 255,375 1,184,314 (18,504) --------------- ---------------- ---------------- Total Increase (Decrease) in Net Assets 296,842 1,884,429 (23,872) Net Assets, at Beginning of Year 0 1,164,075 287,181 --------------- ---------------- ---------------- Net Assets, at End of Year $296,842 $3,048,504 $263,309 =============== ================ ================ Fidelity Investment Fidelity Grade Money Fidelity Bond Market Overseas Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $8,254 $60,336 $26,265 Realized Gain (Loss) on Investment Activity (104) 0 22,548 Change in Unrealized Appreciation (Depreciation) of Investments 2,966 0 1,403 --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations 11,116 60,336 50,216 --------------- ---------------- ---------------- Capital Transactions: Contract Deposits 133,257 1,798,436 25,198 Cost Of Insurance Charge (15,077) (262,012) (46,489) Policy Loans 0 (47,336) (4,988) Transfers Between Funds 372 (3,849) (3,101) Contract Withdrawals (446) (23,046) (8,945) --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 118,106 1,462,193 (38,325) --------------- ---------------- ---------------- Total Increase (Decrease) in Net Assets 129,222 1,522,529 11,891 Net Assets, at Beginning of Year 79,496 1,225,890 368,340 --------------- ---------------- ---------------- Net Assets, at End of Year $208,718 $2,748,419 $380,231 =============== ================ ================ VanEck VanEck VanEck Worldwide Worldwide Worldwide Emerging Hard Balanced Markets Assets Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $24,413 ($80) $4,275 Realized Gain (Loss) on Investment Activity (10,944) (238) (4,776) Change in Unrealized Appreciation (Depreciation) of Investments (4,930) 2,653 (11,854) --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations 8,539 2,335 (12,355) --------------- ---------------- ---------------- Capital Transactions: Contract Deposits (87,825) 28,761 22,441 Cost Of Insurance Charge (7,250) (1,673) (5,001) Policy Loans 0 0 0 Transfers Between Funds (1,323) 116 (79) Contract Withdrawals (456) 0 (666) --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions (96,854) 27,204 16,695 --------------- ---------------- ---------------- Total Increase (Decrease) in Net Assets (88,315) 29,539 4,340 Net Assets, at Beginning of Year 88,315 0 30,220 --------------- ---------------- ---------------- Net Assets, at End of Year $0 $29,539 $34,560 =============== ================ ================ WP&G WP&G WP&G Tomorrow Tomorrow Tomorrow Long Medium Short Term Term Term Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $525 $246 $285 Realized Gain (Loss) on Investment Activity 1,436 31 47 Change in Unrealized Appreciation (Depreciation) of Investments 4,736 390 67 --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations 6,697 667 399 --------------- ---------------- ---------------- Capital Transactions: Contract Deposits 38,701 534 4,650 Cost Of Insurance Charge (9,742) (536) (643) Policy Loans (1,308) 0 0 Transfers Between Funds 103 0 0 Contract Withdrawals (1,420) 0 (197) --------------- ---------------- ---------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 26,334 (2) 3,810 --------------- ---------------- ---------------- Total Increase (Decrease) in Net Assets 33,031 665 4,209 Net Assets, at Beginning of Year 25,890 4,140 2,518 --------------- ---------------- ---------------- Net Assets, at End of Year $58,921 $4,805 $6,727 =============== ================ ================ See Accompanying Notes to Financial Statements AIG LIFE INSURANCE COMPANY (AIG LIFE) VARIABLE ACCOUNT II STATEMENT OF CHANGES IN NET ASSETS For The Years Ended December 31, 1998 and December 31, 1997 1997 Aim Aim Capital International Appreciation Equity Total Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $166,746 $0 $0 Realized Gain (Loss) on Investment Activity 206,207 0 0 Change in Unrealized Appreciation (Depreciation) of Investments 366,321 0 0 ---------------- ----------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations 739,274 0 0 ---------------- ----------------- --------------- Capital Transactions: Contract Deposits 5,544,641 0 0 Cost Of Insurance Charge (775,349) 0 0 Policy Loans (94,631) 0 0 Transfers Between Funds 18,850 0 0 Contract Withdrawals (82,467) 0 0 ---------------- ----------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 4,611,044 0 0 ---------------- ----------------- --------------- Total Increase (Decrease) in Net Assets 5,350,318 0 0 Net Assets, at Beginning of Year 1,921,885 0 0 ---------------- ----------------- --------------- Net Assets, at End of Year $7,272,203 $0 $0 ================ ================= =============== Alliance Alliance Alliance Global Conservative Global Dollar Investors Bond Government Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $167 $0 $0 Realized Gain (Loss) on Investment Activity 600 0 0 Change in Unrealized Appreciation (Depreciation) of Investments 586 0 0 ---------------- ----------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations 1,353 0 0 ---------------- ----------------- --------------- Capital Transactions: Contract Deposits 15,627 0 0 Cost Of Insurance Charge (2,705) 0 0 Policy Loans 0 0 0 Transfers Between Funds 20 0 0 Contract Withdrawals (239) 0 0 ---------------- ----------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 12,703 0 0 ---------------- ----------------- --------------- Total Increase (Decrease) in Net Assets 14,056 0 0 Net Assets, at Beginning of Year 10,016 0 0 ---------------- ----------------- --------------- Net Assets, at End of Year $24,072 $0 $0 ================ ================= =============== Alliance Growth Alliance Alliance & Growth Growth Income Investors Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $21,469 $22,999 $1,477 Realized Gain (Loss) on Investment Activity 37,620 18,395 3,687 Change in Unrealized Appreciation (Depreciation) of Investments 138,629 68,190 5,513 ---------------- ----------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations 197,718 109,584 10,677 ---------------- ----------------- --------------- Capital Transactions: Contract Deposits 814,495 571,454 61,194 Cost Of Insurance Charge (117,612) (74,918) (11,672) Policy Loans (6,689) (5,180) 0 Transfers Between Funds 1,673 2,565 3,415 Contract Withdrawals (19,879) (5,967) (2,220) ---------------- ----------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 671,988 487,954 50,717 ---------------- ----------------- --------------- Total Increase (Decrease) in Net Assets 869,706 597,538 61,394 Net Assets, at Beginning of Year 253,342 166,797 56,064 ---------------- ----------------- --------------- Net Assets, at End of Year $1,123,048 $764,335 $117,458 ================ ================= =============== Alliance Alliance Alliance Money Premier International Market Growth Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $0 $0 $0 Realized Gain (Loss) on Investment Activity 0 0 0 Change in Unrealized Appreciation (Depreciation) of Investments 0 0 0 ---------------- ----------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations 0 0 0 ---------------- ----------------- --------------- Capital Transactions: Contract Deposits 0 0 0 Cost Of Insurance Charge 0 0 0 Policy Loans 0 0 0 Transfers Between Funds 0 0 0 Contract Withdrawals 0 0 0 ---------------- ----------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 0 0 0 ---------------- ----------------- --------------- Total Increase (Decrease) in Net Assets 0 0 0 Net Assets, at Beginning of Year 0 0 0 ---------------- ----------------- --------------- Net Assets, at End of Year $0 $0 $0 ================ ================= =============== Alliance Alliance Total Alliance Technology Return Quasar Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) ($1,115) $0 ($1,464) Realized Gain (Loss) on Investment Activity 16,995 0 9,057 Change in Unrealized Appreciation (Depreciation) of Investments (15,270) 0 11,871 ---------------- ----------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations 610 0 19,464 ---------------- ----------------- --------------- Capital Transactions: Contract Deposits 270,239 0 232,934 Cost Of Insurance Charge (19,431) 0 (17,506) Policy Loans (101) 0 (387) Transfers Between Funds 4,396 0 3,524 Contract Withdrawals (8,527) 0 (1,093) ---------------- ----------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 246,576 0 217,472 ---------------- ----------------- --------------- Total Increase (Decrease) in Net Assets 247,186 0 236,936 Net Assets, at Beginning of Year 7,875 0 4,740 ---------------- ----------------- --------------- Net Assets, at End of Year $255,061 $0 $241,676 ================ ================= =============== Alliance U.S. Dreyfus Government Small High Alliance Company Grade Utility Stock Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $0 $0 $2,102 Realized Gain (Loss) on Investment Activity 0 0 (107) Change in Unrealized Appreciation (Depreciation) of Investments 0 0 (5,712) ---------------- ----------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations 0 0 (3,717) ---------------- ----------------- --------------- Capital Transactions: Contract Deposits 0 0 135,191 Cost Of Insurance Charge 0 0 (2,314) Policy Loans 0 0 0 Transfers Between Funds 0 0 (1,779) Contract Withdrawals 0 0 0 ---------------- ----------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 0 0 131,098 ---------------- ----------------- --------------- Total Increase (Decrease) in Net Assets 0 0 127,381 Net Assets, at Beginning of Year 0 0 0 ---------------- ----------------- --------------- Net Assets, at End of Year $0 $0 $127,381 ================ ================= =============== Dreyfus Dreyfus Zero Fidelity Stock Coupon Asset Index 2000 Manager Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $26,687 $511 $21,546 Realized Gain (Loss) on Investment Activity 41,444 (71) 8,600 Change in Unrealized Appreciation (Depreciation) of Investments 41,726 83 19,239 ---------------- ----------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations 109,857 523 49,385 ---------------- ----------------- --------------- Capital Transactions: Contract Deposits 778,061 11,713 287,927 Cost Of Insurance Charge (90,065) (4,235) (42,651) Policy Loans (1,032) 0 (167) Transfers Between Funds 2,970 25 664 Contract Withdrawals (7,423) (171) (9,859) ---------------- ----------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 682,511 7,332 235,914 ---------------- ----------------- --------------- Total Increase (Decrease) in Net Assets 792,368 7,855 285,299 Net Assets, at Beginning of Year 152,067 2,911 102,607 ---------------- ----------------- --------------- Net Assets, at End of Year $944,435 $10,766 $387,906 ================ ================= =============== Fidelity Fidelity Fidelity High Contrafund Growth Income Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $0 $21,466 $3,283 Realized Gain (Loss) on Investment Activity 0 55,366 11,481 Change in Unrealized Appreciation (Depreciation) of Investments 0 90,042 11,697 ---------------- ----------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations 0 166,874 26,461 ---------------- ----------------- --------------- Capital Transactions: Contract Deposits 0 492,521 226,949 Cost Of Insurance Charge 0 (148,843) (23,779) Policy Loans 0 (24,473) 0 Transfers Between Funds 0 3,595 1,695 Contract Withdrawals 0 (19,994) (2,049) ---------------- ----------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 0 302,806 202,816 ---------------- ----------------- --------------- Total Increase (Decrease) in Net Assets 0 469,680 229,277 Net Assets, at Beginning of Year 0 694,395 57,904 ---------------- ----------------- --------------- Net Assets, at End of Year $0 $1,164,075 $287,181 ================ ================= =============== Fidelity Investment Fidelity Grade Money Fidelity Bond Market Overseas Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $2,521 $32,116 $9,687 Realized Gain (Loss) on Investment Activity 322 0 1,460 Change in Unrealized Appreciation (Depreciation) of Investments 2,132 0 (3,697) ---------------- ----------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations 4,975 32,116 7,450 ---------------- ----------------- --------------- Capital Transactions: Contract Deposits 29,955 1,214,777 281,913 Cost Of Insurance Charge (6,686) (159,431) (34,464) Policy Loans 0 (52,504) (4,098) Transfers Between Funds 96 (5,335) 951 Contract Withdrawals (16) (1,225) (3,073) ---------------- ----------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 23,349 996,282 241,229 ---------------- ----------------- --------------- Total Increase (Decrease) in Net Assets 28,324 1,028,398 248,679 Net Assets, at Beginning of Year 51,172 197,492 119,661 ---------------- ----------------- --------------- Net Assets, at End of Year $79,496 $1,225,890 $368,340 ================ ================= =============== VanEck VanEck VanEck Worldwide Worldwide Worldwide Emerging Hard Balanced Markets Assets Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $343 $0 $319 Realized Gain (Loss) on Investment Activity 856 0 165 Change in Unrealized Appreciation (Depreciation) of Investments 3,097 0 (1,231) ---------------- ----------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations 4,296 0 (747) ---------------- ----------------- --------------- Capital Transactions: Contract Deposits 60,650 0 24,911 Cost Of Insurance Charge (10,075) 0 (4,740) Policy Loans 0 0 0 Transfers Between Funds 186 0 104 Contract Withdrawals (712) 0 (20) ---------------- ----------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 50,049 0 20,255 ---------------- ----------------- --------------- Total Increase (Decrease) in Net Assets 54,345 0 19,508 Net Assets, at Beginning of Year 33,970 0 10,712 ---------------- ----------------- --------------- Net Assets, at End of Year $88,315 $0 $30,220 ================ ================= =============== WP&G WP&G WP&G Tomorrow Tomorrow Tomorrow Long Medium Short Term Term Term Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $2,058 $331 $243 Realized Gain (Loss) on Investment Activity 303 2 32 Change in Unrealized Appreciation (Depreciation) of Investments (304) (254) (16) ---------------- ----------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations 2,057 79 259 ---------------- ----------------- --------------- Capital Transactions: Contract Deposits 27,159 4,178 2,793 Cost Of Insurance Charge (3,562) (124) (536) Policy Loans 0 0 0 Transfers Between Funds 76 7 2 Contract Withdrawals 0 0 0 ---------------- ----------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 23,673 4,061 2,259 ---------------- ----------------- --------------- Total Increase (Decrease) in Net Assets 25,730 4,140 2,518 Net Assets, at Beginning of Year 160 0 0 ---------------- ----------------- --------------- Net Assets, at End of Year $25,890 $4,140 $2,518 ================ ================= =============== See Accompanying Notes to Financial Statements AIG LIFE INSURANCE COMPANY (AIG LIFE) VARIABLE ACCOUNT II NOTES TO FINANCIAL STATEMENTS 1. History Variable Account II (the "Account") is a separate investment account established under the provisions of Delaware Insurance Law by AIG Life Insurance Company (the "Company"), a wholly-owned subsidiary of American International Group, Inc. The Account operates as a unit investment trust registered under the Investment Company Act of 1940, as amended, and supports the operations of the Company's individual flexible premium variable universal life insurance policies (the "policies"). The following products are offered by the Account: Vision and Gallery Life. The Account invests in shares of AIM Variable Insurance Fund ("AIM Fund"), Alliance Variable Products Series Fund, Inc. ("Alliance Fund"), Dreyfus Variable Investment Fund ("Dreyfus Fund"), Fidelity Investments Variable Insurance Products Fund ("Fidelity Trust"), Fidelity Variable Insurance Products Fund II ("Fidelity Trust II"), Van Eck Investment Trust ("Van Eck Trust") and Weiss, Peck & Greer ("Tomorrow Funds"). The assets in the policies may be invested in the following subaccounts: AIM Fund: Fidelity Trust: International Equity Portfolio Money Market Portfolio Capital Appreciation Portfolio High Income Portfolio Growth Portfolio Alliance Fund: Overseas Portfolio Growth & Income Portfolio Contrafund Portfolio Conservative Investors Portfolio Growth Portfolio Fidelity Trust II: Growth Investors Portfolio Investment Grade Bond Portfolio Quasar Portfolio Asset Manager Portfolio Technology Portfolio Global Bond Portfolio Van Eck Trust: Premier Growth Portfolio Worldwide Hard Assets Portfolio Money Market Portfolio Worldwide Emerging Markets Portfolio Worldwide Balanced Portfolio (Fund closed 06/29/98) Dreyfus Fund: Dreyfus Zero Coupon 2000 Portfolio Weiss, Peck & Greer Tomorrow Fund: Stock Index Portfolio Tomorrow Long Term Portfolio Small Company Stock Portfolio Tomorrow Medium Term Portfolio Stock Index Portfolio Tomorrow Short Term Portfolio The Account commenced operations on May 4, 1995. The assets of the Account are the property of the Company. The portion of the Account's assets applicable to the policies are not chargeable with the liabilities arising out of any other business conducted by the Company. In addition to the Account, policy owners may also allocate assets of the policies to the Guaranteed Account, which is part of the Company's general account. Amounts allocated to the Guaranteed Account are credited with a guaranteed rate of interest. Because of exemptive and exclusionary provisions, interests in the Guaranteed Account have not been registered under the Securities Act of 1933, and the Guaranteed Account has not been registered as an investment company under the Investment Company Act of 1940. AIG LIFE INSURANCE COMPANY (AIG LIFE) VARIABLE ACCOUNT II NOTES TO FINANCIAL STATEMENTS (continued) 2. Summary of Significant Accounting Policies The following is a summary of significant accounting policies followed by the Account in preparation of the financial statements in conformity with generally accepted accounting principles. A. Investment Valuation - The investments in the Funds are stated at market value which is the net asset value of each of the respective series as determined at the close of business on the last business day of the period by the Fund. B. Accounting for Investments - Investment transactions are accounted for on the date the investments are purchased or sold. Dividend income is recorded on the ex-dividend date. C. Federal Income Taxes - The Company is taxed under federal law as a life insurance company. The Account is part of the Company's total operations and is not taxed separately. Under existing federal law, no taxes are payable on investment income and realized capital gains of the Account. D. The preparation of the accompanying financial statements required management to make estimates and assumptions that affect the reported values of assets and liabilities and the reported amounts from operations and policy transactions. Actual results could differ from those estimates. 3. Contract Charges There are charges and deductions which the Company will deduct from each policy. The deductions from premium are a sales charge of 5% plus the state specific premium taxes. Daily charges for mortality and expense risks assumed by the Company are assessed through the daily unit value calculation and are equivalent on an annual basis to .90% of the account value of the policies. This charge may be decreased to not less than .50% in policy years eleven and greater. On the policies' issue date and each monthly anniversary, the following deductions are made from the policies' account value: (a) administrative charges (b) insurance charges (c) supplemental benefit charges If the policy is surrendered during the first fourteen policy years, the Company will deduct a surrender charge based on a percentage of first year premium. A pro rata surrender charge will be deducted for any partial surrender. An administrative charge upon partial surrender will be equal to the lessor of $25.00 or 2% of the amount surrendered. AIG LIFE INSURANCE COMPANY (AIG LIFE) VARIABLE ACCOUNT II NOTES TO FINANCIAL STATEMENTS (continued) 4. Purchases of Investments For the year ended December 31, 1998, investment activity in the Fund was as follows: Cost of Proceeds Purchases From Sales Shares of Aim Capital Appreciation Portfolio $ 201,598 $ 26,283 International Equity Portfolio 499,113 240,193 Alliance Funds: Conservative Investors Portfolio 17,668 10,521 Global Bond Portfolio 9,907 1,670 Global Dollar Government Portfolio 242 31 Growth Portfolio 1,434,835 161,751 Growth & Income Portfolio 7,118,210 5,490,984 Growth Investors Portfolio 83,359 26,366 International Portfolio 7,730,001 7,784,638 Money Market Portfolio 7,530,593 7,510,112 Premier Growth Portfolio 1,721,633 1,617,108 Technology Portfolio 9,312,917 9,128,748 Total Return Portfolio 2,439 21 Quasar Portfolio 9,870,359 9,753,129 U.S. Government High Grade Portfolio 976 8 Utility Income Portfolio 976 8 Dreyfus: Small Company Portfolio 277,608 163,341 Stock Index Portfolio 1,719,925 387,790 Zero Coupon 2000 Portfolio 7,868 5,215 Fidelity Trust Funds: Asset Manager Portfolio 637,629 260,827 Contrafund Portfolio 295,002 38,838 Growth Portfolio 1,684,130 336,475 High Income Portfolio 366,333 353,460 Investment Grade Bond Portfolio 252,481 126,121 Money Market Portfolio 3,777,754 2,255,231 Overseas Portfolio 240,411 252,471 Van Eck: Worldwide Emerging Markets Portfolio 31,817 4,692 Worldwide Hard Assets Portfolio 34,521 13,551 Worldwide Balanced Portfolio 43,581 115,939 Weiss, Peck, & Greer Tomorrow Funds: Tomorrow Long Term Portfolio 43,881 17,022 Tomorrow Medium Term Portfolio 1,311 1,067 Tomorrow Short Term Portfolio 4,968 873 For the year ended December 31, 1997, investment activity in the Fund was as follows: Cost of Proceeds Purchases From Sales Shares of Alliance Funds: Conservative Investors Portfolio $ 18,544 $ 5,676 Growth Portfolio 974,204 280,744 Growth & Income Portfolio 674,003 163,065 Growth Investors Portfolio 111,960 63,096 Technology Portfolio 570,493 325,032 Quasar Portfolio 469,753 253,745 Dreyfus: Small Company Stock Portfolio 134,522 1,321 Stock Index Portfolio 1,010,647 301,445 Zero Coupon 2000 Portfolio 17,381 9,537 Fidelity Trust Funds: Asset Manager Portfolio 386,303 128,841 Growth Portfolio 1,207,119 882,821 High Income Portfolio 338,288 132,191 Investment Grade Bond Portfolio 36,324 10,571 Money Market Portfolio 2,898,075 1,866,353 Overseas Portfolio 339,597 88,568 Van Eck: Worldwide Emerging Markets Portfolio 4 4 Worldwide Hard Assets Portfolio 28,081 7,507 Worldwide Balanced Portfolio 58,655 8,264 Weiss, Peck, & Greer Tomorrow Funds: Tomorrow Long Term Portfolio 28,487 2,754 Tomorrow Medium Term Portfolio 4,465 72 Tomorrow Short Term Portfolio 2,909 406 AIG LIFE INSURANCE COMPANY (AIG LIFE) VARIABLE ACCOUNT II NOTES TO FINANCIAL STATEMENTS (continued) 5. Net Increase (Decrease) in Accumulation Units For the year ended December 31, 1998, transactions in accumulation units of the account were as follows: Aim Aim Alliance Capital International Conservative Appreciation Equity Investors Portfolio Portfolio Portfolio VARIABLE ANNUITY - - - Units Purchased 10,966.16 17,130.11 519.94 Units Withdrawn (1,282.07) (1,912.12) (252.21) Units Transferred Between Funds 7,964.24 5,920.24 151.60 Units Transferred From (To) AI Life 0.00 0.00 0.00 ---------- ---------- --------- Net Increase (Decrease) 17,648.33 21,138.23 419.33 Units, at Beginning of the Year 0.00 0.00 1,986.58 ---------- ---------- --------- Units, at End of the Year 17,648.33 21,138.23 2,405.91 ========== ========== ========= Unit Value at December 31, 1998 $ 11.38 $ 11.57 $ 13.71 ========== ========== ========= Alliance Alliance Global Global Dollar Alliance Bond Government Growth Portfolio Portfolio Portfolio - - - Units Purchased 274.70 0.00 48,680.75 Units Withdrawn (47.46) (4.05) (14,982.74) Units Transferred Between Funds 538.94 33.17 28,539.15 Units Transferred From (To) AI Life 0.00 0.00 0.00 ------- ------ ----------- Net Increase (Decrease) 766.18 29.12 62,237.16 Units, at Beginning of the Year 0.00 0.00 63,940.84 ------- ------ ----------- Units, at End of the Year 766.18 29.12 126,178.00 ======= ====== =========== Unit Value at December 31, 1998 $ 11.15 $ 7.65 $ 22.41 ======= ====== =========== Alliance Growth Alliance & Growth Alliance Income Investors International Portfolio Portfolio Portfolio - - - Units Purchased 33,634.28 4,748.04 0.00 Units Withdrawn (10,914.51) (1,602.25) (789.39) Units Transferred Between Funds 54,953.57 19.95 789.39 Units Transferred From (To) AI Life 0.00 0.00 0.00 ----------- ---------- ------- Net Increase (Decrease) 77,673.34 3,165.74 0.00 Units, at Beginning of the Year 44,589.32 8,820.29 0.00 ----------- ---------- ------- Units, at End of the Year 122,262.66 11,986.03 0.00 =========== ========== ======= Unit Value at December 31, 1998 $ 20.54 $ 16.32 $ 11.06 =========== ========== ======= Footnote 1 are all funds except for IVUL 2. Footnote 2 are the IVUL 2 funds. Alliance Alliance Alliance Money Premier Premier Market Growth Growth Portfolio 1 Portfolio 2 Portfolio - - - Units Purchased 76,950.50 14,340.65 368.47 Units Withdrawn (1,125.28) (1,636.22) (15.78) Units Transferred Between Funds (73,883.89) (2,993.66) 16.87 Units Transferred From (To) AI Life 0.00 0.00 0.00 ---------- ---------- ------- Net Increase (Decrease) 1,941.33 9,710.77 369.56 Units, at Beginning of the Year 0.00 0.00 0.00 ---------- ---------- ------- Units, at End of the Year 1,941.33 9,710.77 369.56 ========== ========== ======= Unit Value at December 31, 1998 $ 10.55 $ 15.06 $ 15.45 ========== ========== ======= Alliance Alliance Total Alliance Technology Return Quasar Portfolio Portfolio 1 Portfolio - - - Units Purchased 35,545.90 212.77 16,965.13 Units Withdrawn (7,116.84) (4.98) (4,825.62) Units Transferred Between Funds (5,978.18) 0.00 (4,170.54) Units Transferred From (To) AI Life 0.00 0.00 0.00 ---------- ------- ---------- Net Increase (Decrease) 22,450.88 207.79 7,968.97 Units, at Beginning of the Year 23,596.78 0.00 20,181.26 ---------- ------- ---------- Units, at End of the Year 46,047.66 207.79 28,150.23 ========== ======= ========== Unit Value at December 31, 1998 $ 17.55 $ 12.18 $ 11.34 ========== ======= ========== Alliance U.S. Government Alliance High Alliance Quasar Grade Utility 2 Portfolio Portfolio Portfolio - - - Units Purchased 531.58 89.14 72.17 Units Withdrawn (11.11) (2.08) (1.69) Units Transferred Between Funds 3.26 0.00 0.00 Units Transferred From (To) AI Life 0.00 0.00 0.00 ------- ------ ------ Net Increase (Decrease) 523.73 87.06 70.48 Units, at Beginning of the Year 0.00 0.00 0.00 ------- ------ ------ Units, at End of the Year 523.73 87.06 70.48 ======= ====== ====== Unit Value at December 31, 1998 $ 9.15 $ 11.12 $ 14.47 ======= ====== ====== Footnote 1 are all funds except for IVUL 2. Footnote 2 are the IVUL 2 funds. Dreyfus Dreyfus Small Dreyfus Zero Company Stock Coupon Stock Index 2000 Portfolio Portfolio Portfolio - - - Units Purchased 15,130.34 64,100.90 653.34 Units Withdrawn (2,752.76) (17,133.95) (197.62) Units Transferred Between Funds 1,013.09 21,583.46 (273.54) Units Transferred From (To) AI Life 0.00 0.00 0.00 ---------- ----------- --------- Net Increase (Decrease) 13,390.67 68,550.41 182.18 Units, at Beginning of the Year 12,290.97 54,287.23 976.29 ---------- ----------- --------- Units, at End of the Year 25,681.64 122,837.64 1,158.47 ========== =========== ========= Unit Value at December 31, 1998 $ 9.66 $ 22.11 $ 11.72 ========== =========== ========= Fidelity Asset Fidelity Fidelity Manager Contrafund Growth Portfolio Portfolio Portfolio - - - Units Purchased 18,697.45 13,543.93 71,686.34 Units Withdrawn (4,063.22) (1,631.36) (19,446.08) Units Transferred Between Funds 6,029.71 11,000.06 16,228.87 Units Transferred From (To) AI Life 0.00 0.00 0.00 ---------- ---------- ----------- Net Increase (Decrease) 20,663.94 22,912.63 68,469.13 Units, at Beginning of the Year 25,997.34 0.00 76,554.16 ---------- ---------- ----------- Units, at End of the Year 46,661.28 22,912.63 145,023.29 ========== ========== =========== Unit Value at December 31, 1998 $ 17.01 $ 12.96 $ 21.02 ========== ========== =========== Fidelity Fidelity Investment Fidelity High Grade Money Income Bond Market Portfolio Portfolio Portfolio - - - Units Purchased 9,445.60 13,513.40 259,198.27 Units Withdrawn (2,853.91) (1,307.38) (28,981.43) Units Transferred Between Funds (7,301.62) (2,236.28) (105,109.51) Units Transferred From (To) AI Life 0.00 0.00 (147.07) ---------- ---------- ----------- Net Increase (Decrease) (709.93) 9,969.74 124,960.26 Units, at Beginning of the Year 21,533.23 6,952.60 109,164.24 ---------- ---------- ----------- Units, at End of the Year 20,823.30 16,922.34 234,124.50 ========== ========== =========== Unit Value at December 31, 1998 $ 12.64 $ 12.33 $ 11.74 ========== ========== =========== Footnote 1 are all funds except for IVUL 2. Footnote 2 are the IVUL 2 funds. Van Eck Van Eck Worldwide Fidelity Worldwide Emerging Overseas Balanced Markets Portfolio Portfolio Portfolio - - - Units Purchased 11,785.44 951.45 1,277.13 Units Withdrawn (4,501.28) (606.33) (278.62) Units Transferred Between Funds (9,535.93) (7,669.26) 3,870.58 Units Transferred From (To) AI Life 0.00 0.00 0.00 ---------- --------- --------- Net Increase (Decrease) (2,251.77) (7,324.14) 4,869.09 Units, at Beginning of the Year 29,558.72 7,324.14 0.00 ---------- --------- --------- Units, at End of the Year 27,306.95 0.00 4,869.09 ========== ========= ========= Unit Value at December 31, 1998 $ 13.92 $ 13.05 $ 6.07 ========== ========= ========= Van Eck WP&G WP&G Worldwide Tomorrow Tomorrow Hard Long Medium Assets Term Term Portfolio Portfolio Portfolio - - - Units Purchased 1,987.17 3,171.98 96.93 Units Withdrawn (614.56) (914.92) (41.35) Units Transferred Between Funds 411.71 (301.20) (53.41) Units Transferred From (To) AI Life 0.00 0.00 0.00 --------- -------- ------- Net Increase (Decrease) 1,784.32 1,955.86 2.17 Units, at Beginning of the Year 2,660.66 2,002.12 338.89 --------- --------- ------- Units, at End of the Year 4,444.98 3,957.98 341.06 ========= ========= ======= Unit Value at December 31, 1998 $ 7.78 $ 14.89 $ 14.09 ========= ========= ======= WP&G Tomorrow Short Term Portfolio - Units Purchased 355.59 Units Withdrawn (66.23) Units Transferred Between Funds 0.00 Units Transferred From (To) AI Life 0.00 ------- Net Increase (Decrease) 289.36 Units, at Beginning of the Year 207.88 ------- Units, at End of the Year 497.24 ======= Unit Value at December 31, 1998 $ 13.53 ======= AIG LIFE INSURANCE COMPANY (AIG LIFE) VARIABLE ACCOUNT II STATEMENT OF ASSETS AND LIABILITIES June 30, 1999 (UNAUDITED) - ------------------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------------------ ASSETS: Investments at Market Value: Shares Cost Market Value ------------------------------------------------------------------- ------------------------------------------------------------------- Aim Capital Appreciation Portfolio 10,805.488 $ 249,819 $ 298,233 International Equity Portfolio 20,496.370 391,703 419,972 Alliance Conservative Investors Portfolio 2,927.800 39,325 38,008 Global Bond Portfolio 917.299 10,918 10,118 Global Dollar Government Portfolio 21.679 207 199 Growth Portfolio 125,732.125 2,913,012 3,613,542 Growth & Income Portfolio 105,558.666 2,199,332 2,366,630 Growth Investors Portfolio 15,147.517 227,200 234,485 International Portfolio 77,466.493 1,266,448 1,267,351 Money Market Portfolio 18,894.760 18,894 18,894 Premier Growth Portfolio 12,701.909 398,621 439,232 Technology Portfolio 57,463.815 968,037 1,268,800 Total Return Portfolio 146.582 2,527 2,596 Quasar Portfolio 34,113.346 431,357 403,561 U.S. Government High Grade Portfolio 80.333 979 894 Utility Income Portfolio 53.460 963 1,096 Dreyfus Small Company Stock Portfolio 20,832.049 304,387 322,063 Stock Index Portfolio 112,926.188 3,354,848 4,077,763 Zero Coupon 2000 Portfolio 1,421.146 17,643 17,522 Fidelity Asset Manager Portfolio 59,137.949 1,015,942 1,046,147 Contrafund Portfolio 26,674.610 626,598 696,208 Growth Portfolio 101,729.251 4,011,783 4,652,079 High Income Portfolio 42,882.754 491,124 484,145 Investment Grade Bond Portfolio 36,337.125 449,167 438,953 Money Market Portfolio 2,135,704.870 2,135,705 2,135,705 Overseas Portfolio 23,221.474 459,413 483,010 Van Eck Worldwide Emerging Markets Portfolio 6,067.441 43,166 63,039 Worldwide Hard Assets Portfolio 3,933.951 39,070 42,131 Weiss,Peck & Greer Tomorrow Long Term Portfolio 7,003.469 60,351 68,282 Tomorrow MediumTerm Portfolio 523.557 4,803 5,074 Tomorrow Short Term Portfolio 807.668 8,611 8,666 ---------------------- --------------------- ====================== --------------------- Total Investments $ 22,141,953 $ 24,924,398 ====================== ====================== Total Assets $ 24,924,398 ===================== ===================== EQUITY: Contract Owners' Equity $ 24,924,398 --------------------- ===================== Total Equity $ 24,924,398 ===================== ===================== AIG LIFE INSURANCE COMPANY (AIG LIFE) VARIABLE ACCOUNT II STATEMENT OF OPERATIONS For The Six Months Ended June 30, 1999 (UNAUDITED) Aim Aim Capital International Appreciation Equity Total Portfolio Portfolio Investment Income (Loss): Dividends $1,156,716 $0 $0 Expenses: Mortality & Expense Risk Fees 95,246 1,003 1,515 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Net Investment Income (Loss) 1,061,470 (1,003) (1,515) ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Realized & Unrealized Gain (Loss) on Investments: Realized Gain (Loss) on Investment Activity 508,874 2,472 (2,086) Change in Unrealized Appreciation (Depreciation) 812,559 22,580 20,530 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Net Gain (Loss) on Investments 1,321,433 25,052 18,444 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations $2,382,903 $24,049 $16,929 ================ ================= ================ ================ ================= ================ Alliance Alliance Alliance Global Conservative Global Dollar Investors Bond Government Portfolio Portfolio Portfolio Investment Income (Loss): Dividends $3,311 $322 $31 Expenses: Mortality & Expense Risk Fees 161 39 1 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Net Investment Income (Loss) 3,150 283 30 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Realized & Unrealized Gain (Loss) on Investments: Realized Gain (Loss) on Investment Activity 250 62 2 Change in Unrealized Appreciation (Depreciation) (3,050) (1,090) (18) ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Net Gain (Loss) on Investments (2,800) (1,028) (16) ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations $350 ($745) $14 ================ ================= ================ ================ ================= ================ Alliance Growth Alliance Alliance & Growth Growth Income Investors Portfolio Portfolio Portfolio Investment Income (Loss): Dividends $270,895 $228,364 $22,202 Expenses: Mortality & Expense Risk Fees 14,062 9,000 962 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Net Investment Income (Loss) 256,833 219,364 21,240 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Realized & Unrealized Gain (Loss) on Investments: Realized Gain (Loss) on Investment Activity 42,071 45,713 6,259 Change in Unrealized Appreciation (Depreciation) 142,860 27,574 (18,333) ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Net Gain (Loss) on Investments 184,931 73,287 (12,074) ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations $441,764 $292,651 $9,166 ================ ================= ================ ================ ================= ================ Alliance Alliance Alliance Money Premier International Market Growth Portfolio Portfolio Portfolio Investment Income (Loss): Dividends $30,720 $9,337 $4,775 Expenses: Mortality & Expense Risk Fees 621 1,935 1,206 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Net Investment Income (Loss) 30,099 7,402 3,569 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Realized & Unrealized Gain (Loss) on Investments: Realized Gain (Loss) on Investment Activity 89,322 0 3,188 Change in Unrealized Appreciation (Depreciation) 904 0 24,050 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Net Gain (Loss) on Investments 90,226 0 27,238 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations $120,325 $7,402 $30,807 ================ ================= ================ ================ ================= ================ Alliance Alliance Total Alliance Technology Return Quasar Portfolio Portfolio Portfolio Investment Income (Loss): Dividends $3,163 $230 $1,251 Expenses: Mortality & Expense Risk Fees 6,236 11 1,941 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Net Investment Income (Loss) (3,073) 219 (690) ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Realized & Unrealized Gain (Loss) on Investments: Realized Gain (Loss) on Investment Activity 155,237 7 33,648 Change in Unrealized Appreciation (Depreciation) 118,625 (44) 26,546 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Net Gain (Loss) on Investments 273,862 (37) 60,194 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations $270,789 $182 $59,504 ================ ================= ================ ================ ================= ================ Alliance U.S. Dreyfus Government Small High Alliance Company Grade Utility Stock Portfolio Portfolio Portfolio Investment Income (Loss): Dividends $60 $44 $0 Expenses: Mortality & Expense Risk Fees 4 5 1,212 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Net Investment Income (Loss) 56 39 (1,212) ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Realized & Unrealized Gain (Loss) on Investments: Realized Gain (Loss) on Investment Activity (1) 5 (4,381) Change in Unrealized Appreciation (Depreciation) (86) 80 14,529 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Net Gain (Loss) on Investments (87) 85 10,148 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations ($31) $124 $8,936 ================ ================= ================ ================ ================= ================ Dreyfus Dreyfus Zero Fidelity Stock Coupon Asset Index 2000 Manager Portfolio Portfolio Portfolio Investment Income (Loss): Dividends $34,929 $367 $61,501 Expenses: Mortality & Expense Risk Fees 15,127 74 4,090 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Net Investment Income (Loss) 19,802 293 57,411 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Realized & Unrealized Gain (Loss) on Investments: Realized Gain (Loss) on Investment Activity 37,382 8 62 Change in Unrealized Appreciation (Depreciation) 324,858 (235) (13,951) ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Net Gain (Loss) on Investments 362,240 (227) (13,889) ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations $382,042 $66 $43,522 ================ ================= ================ ================ ================= ================ Fidelity Fidelity Fidelity High Contrafund Growth Income Portfolio Portfolio Portfolio Investment Income (Loss): Dividends $13,299 $360,271 $25,817 Expenses: Mortality & Expense Risk Fees 2,211 17,101 1,749 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Net Investment Income (Loss) 11,088 343,170 24,068 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Realized & Unrealized Gain (Loss) on Investments: Realized Gain (Loss) on Investment Activity 8,175 105,690 (7,194) Change in Unrealized Appreciation (Depreciation) 32,133 43,368 10,843 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Net Gain (Loss) on Investments 40,308 149,058 3,649 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations $51,396 $492,228 $27,717 ================ ================= ================ ================ ================= ================ Fidelity Investment Fidelity Grade Money Fidelity Bond Market Overseas Portfolio Portfolio Portfolio Investment Income (Loss): Dividends $11,228 $57,899 $16,156 Expenses: Mortality & Expense Risk Fees 1,568 10,734 1,955 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Net Investment Income (Loss) 9,660 47,165 14,201 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Realized & Unrealized Gain (Loss) on Investments: Realized Gain (Loss) on Investment Activity (175) 0 (850) Change in Unrealized Appreciation (Depreciation) (16,477) 0 19,843 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Net Gain (Loss) on Investments (16,652) 0 18,993 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations ($6,992) $47,165 $33,194 ================ ================= ================ ================ ================= ================ VanEck VanEck VanEck Worldwide Worldwide Worldwide Emerging Hard Balanced Markets Assets Portfolio Portfolio Portfolio Investment Income (Loss): Dividends $0 $0 $544 Expenses: Mortality & Expense Risk Fees 0 205 191 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Net Investment Income (Loss) 0 (205) 353 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Realized & Unrealized Gain (Loss) on Investments: Realized Gain (Loss) on Investment Activity 0 2,401 (8,601) Change in Unrealized Appreciation (Depreciation) 0 17,222 15,657 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Net Gain (Loss) on Investments 0 19,623 7,056 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations $0 $19,418 $7,409 ================ ================= ================ ================ ================= ================ WP&G WP&G WP&G Tomorrow Tomorrow Tomorrow Long Medium Short Term Term Term Portfolio Portfolio Portfolio Investment Income (Loss): Dividends $0 $0 $0 Expenses: Mortality & Expense Risk Fees 279 22 26 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Net Investment Income (Loss) (279) (22) (26) ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Realized & Unrealized Gain (Loss) on Investments: Realized Gain (Loss) on Investment Activity 132 2 74 Change in Unrealized Appreciation (Depreciation) 3,502 135 4 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Net Gain (Loss) on Investments 3,634 137 78 ---------------- ----------------- ---------------- ---------------- ----------------- ---------------- Increase (Decrease) in Net Assets Resulting From Operations $3,355 $115 $52 ================ ================= ================ ================ ================= ================ AIG LIFE INSURANCE COMPANY (AIG LIFE) VARIABLE ACCOUNT II STATEMENT OF CHANGES IN NET ASSETS For The Six Months Ended June 30, 1999 and June 30, 1998 (UNAUDITED) 1999 Aim Aim Capital International Appreciation Equity Total Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $1,061,470 ($1,003) ($1,515) Realized Gain (Loss) on Investment Activity 508,874 2,472 (2,086) Change in Unrealized Appreciation (Depreciation) of Investments 812,559 22,580 20,530 --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations 2,382,903 24,049 16,929 --------------- --------------- --------------- --------------- --------------- --------------- Capital Transactions: Contract Deposits 5,722,064 91,862 183,148 Cost Of Insurance Charge (1,039,582) (16,325) (21,491) Policy Loans (146,563) (4,390) (2,936) Transfers 9,636 4,687 831 Contract Withdrawals (185,339) (2,427) (1,125) --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 4,360,216 73,407 158,427 --------------- --------------- --------------- --------------- --------------- --------------- Total Increase (Decrease) in Net Assets 6,743,119 97,456 175,356 Net Assets, at Beginning of Year 18,181,279 200,777 244,616 --------------- --------------- --------------- =============== =============== =============== Net Assets, at End of Year $24,924,398 $298,233 $419,972 =============== =============== =============== =============== =============== =============== Alliance Alliance Alliance Global Conservative Global Dollar Investors Bond Government Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $3,150 $283 $30 Realized Gain (Loss) on Investment Activity 250 62 2 Change in Unrealized Appreciation (Depreciation) of Investments (3,050) (1,090) (18) --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting 350 (745) 14 --------------- --------------- --------------- --------------- --------------- --------------- Capital Transactions: Contract Deposits 6,361 3,017 0 Cost Of Insurance Charge (1,619) (686) (37) Policy Loans 0 0 0 Transfers 10 (15) 0 Contract Withdrawals (89) 0 0 --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 4,663 2,316 (37) --------------- --------------- --------------- --------------- --------------- --------------- Total Increase (Decrease) in Net Assets 5,013 1,571 (23) Net Assets, at Beginning of Year 32,995 8,547 222 --------------- --------------- --------------- =============== =============== =============== Net Assets, at End of Year $38,008 $10,118 $199 =============== =============== =============== =============== =============== =============== Alliance Growth Alliance Alliance & Growth Growth Income Investors Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $256,833 $219,364 $21,240 Realized Gain (Loss) on Investment Activity 42,071 45,713 6,259 Change in Unrealized Appreciation (Depreciation) of Investments 142,860 27,574 (18,333) --------------- --------------- --------------- ---------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations 441,764 292,651 9,166 --------------- --------------- --------------- --------------- --------------- --------------- Capital Transactions: Contract Deposits 552,278 (296,632) 39,410 Cost Of Insurance Charge (131,720) (92,576) (7,893) Policy Loans (29,702) (19,241) (1,507) Transfers (2,095) 1,005 211 Contract Withdrawals (44,226) (29,468) (550) --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 344,535 (436,912) 29,671 --------------- --------------- --------------- --------------- --------------- --------------- Total Increase (Decrease) in Net Assets 786,299 (144,261) 38,837 Net Assets, at Beginning of Year 2,827,243 2,510,891 195,648 --------------- --------------- --------------- =============== =============== =============== Net Assets, at End of Year $3,613,542 $2,366,630 $234,485 =============== =============== =============== =============== =============== =============== Alliance Alliance Alliance Money Premier International Market Growth Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $30,099 $7,402 $3,569 Realized Gain (Loss) on Investment Activity 89,322 0 3,188 Change in Unrealized Appreciation (Depreciation) of Investments 904 0 24,050 --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations 120,325 7,402 30,807 --------------- --------------- --------------- --------------- --------------- --------------- Capital Transactions: Contract Deposits 1,150,203 5,538 278,594 Cost Of Insurance Charge 0 (14,523) (25,155) Policy Loans 0 0 (569) Transfers (3,177) (7) 5,087 Contract Withdrawals 0 0 (1,499) --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 1,147,026 (8,992) 256,458 --------------- --------------- --------------- --------------- --------------- --------------- Total Increase (Decrease) in Net Assets 1,267,351 (1,590) 287,265 Net Assets, at Beginning of Year 0 20,484 151,967 --------------- --------------- --------------- =============== =============== =============== Net Assets, at End of Year $1,267,351 $18,894 $439,232 =============== =============== =============== =============== =============== =============== Alliance Alliance Total Alliance Technology Return Quasar Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) ($3,073) $219 ($690) Realized Gain (Loss) on Investment Activity 155,237 7 33,648 Change in Unrealized Appreciation (Depreciation) of Investments 118,625 (44) 26,546 --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations 270,789 182 59,504 --------------- --------------- --------------- --------------- --------------- --------------- Capital Transactions: Contract Deposits 286,213 0 45,407 Cost Of Insurance Charge (68,064) (116) (20,228) Policy Loans (14,138) 0 (2,780) Transfers (10,382) 0 (120) Contract Withdrawals (3,718) 0 (2,102) --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 189,911 (116) 20,177 --------------- --------------- --------------- --------------- --------------- --------------- Total Increase (Decrease) in Net Assets 460,700 66 79,681 Net Assets, at Beginning of Year 808,100 2,530 323,880 --------------- --------------- --------------- =============== =============== =============== Net Assets, at End of Year $1,268,800 $2,596 $403,561 =============== =============== =============== =============== =============== =============== Alliance U.S. Dreyfus Government Small High Alliance Company Grade Utility Stock Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $56 $39 ($1,212) Realized Gain (Loss) on Investment Activity (1) 5 (4,381) Change in Unrealized Appreciation (Depreciation) of Investments (86) 80 14,529 --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations (31) 124 8,936 --------------- --------------- --------------- --------------- --------------- --------------- Capital Transactions: Contract Deposits 0 0 77,630 Cost Of Insurance Charge (43) (48) (11,603) Policy Loans 0 0 0 Transfers 0 0 (908) Contract Withdrawals 0 0 (20) --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions (43) (48) 65,099 --------------- --------------- --------------- --------------- --------------- --------------- Total Increase (Decrease) in Net Assets (74) 76 74,035 Net Assets, at Beginning of Year 968 1,020 248,028 --------------- --------------- --------------- =============== =============== =============== Net Assets, at End of Year $894 $1,096 $322,063 =============== =============== =============== =============== =============== =============== Dreyfus Dreyfus Zero Fidelity Stock Coupon Asset Index 2000 Manager Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $19,802 $293 $57,411 Realized Gain (Loss) on Investment Activity 37,382 8 62 Change in Unrealized Appreciation (Depreciation) of Investments 324,858 (235) (13,951) --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations 382,042 66 43,522 --------------- --------------- --------------- --------------- --------------- --------------- Capital Transactions: Contract Deposits 1,219,319 4,833 256,536 Cost Of Insurance Charge (184,621) (956) (44,559) Policy Loans (25,151) 0 (6,948) Transfers (1,950) 0 5,187 Contract Withdrawals (27,241) 0 (1,435) --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 980,356 3,877 208,781 --------------- --------------- --------------- --------------- --------------- --------------- Total Increase (Decrease) in Net Assets 1,362,398 3,943 252,303 Net Assets, at Beginning of Year 2,715,365 13,579 793,844 --------------- --------------- --------------- =============== =============== =============== Net Assets, at End of Year $4,077,763 $17,522 $1,046,147 =============== =============== =============== =============== =============== =============== Fidelity Fidelity Fidelity High Contrafund Growth Income Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $11,088 $343,170 $24,068 Realized Gain (Loss) on Investment Activity 8,175 105,690 (7,194) Change in Unrealized Appreciation (Depreciation) of Investments 32,133 43,368 10,843 --------------- --------------- --------------- -------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations 51,396 492,228 27,717 --------------- --------------- --------------- --------------- --------------- --------------- Capital Transactions: Contract Deposits 375,596 1,360,060 214,420 Cost Of Insurance Charge (28,039) (181,621) (16,444) Policy Loans 0 (32,378) (1,388) Transfers 3,721 14,984 1,288 Contract Withdrawals (3,308) (49,698) (4,757) --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 347,970 1,111,347 193,119 --------------- --------------- --------------- --------------- --------------- --------------- Total Increase (Decrease) in Net Assets 399,366 1,603,575 220,836 Net Assets, at Beginning of Year 296,842 3,048,504 263,309 --------------- --------------- --------------- =============== =============== =============== Net Assets, at End of Year $696,208 $4,652,079 $484,145 =============== =============== =============== =============== =============== =============== Fidelity Investment Fidelity Grade Money Fidelity Bond Market Overseas Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $9,660 $47,165 $14,201 Realized Gain (Loss) on Investment Activity (175) 0 (850) Change in Unrealized Appreciation (Depreciation) of Investments (16,477) 0 19,843 --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations (6,992) 47,165 33,194 --------------- --------------- --------------- --------------- --------------- --------------- Capital Transactions: Contract Deposits 256,598 (520,179) 97,031 Cost Of Insurance Charge (15,837) (126,422) (19,725) Policy Loans 0 (1,476) (2,826) Transfers 11 (8,399) 71 Contract Withdrawals (3,545) (3,403) (4,966) --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 237,227 (659,879) 69,585 --------------- --------------- --------------- --------------- --------------- --------------- Total Increase (Decrease) in Net Assets 230,235 (612,714) 102,779 Net Assets, at Beginning of Year 208,718 2,748,419 380,231 --------------- --------------- --------------- =============== =============== =============== Net Assets, at End of Year $438,953 $2,135,705 $483,010 =============== =============== =============== =============== =============== =============== VanEck VanEck VanEck Worldwide Worldwide Worldwide Emerging Hard Balanced Markets Assets Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $0 ($205) $353 Realized Gain (Loss) on Investment Activity 0 2,401 (8,601) Change in Unrealized Appreciation (Depreciation) of Investments 0 17,222 15,657 --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations 0 19,418 7,409 --------------- --------------- --------------- --------------- --------------- --------------- Capital Transactions: Contract Deposits 0 17,834 4,291 Cost Of Insurance Charge 0 (3,079) (2,503) Policy Loans 0 0 0 Transfers 0 (673) 32 Contract Withdrawals 0 0 (1,658) --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 0 14,082 162 --------------- --------------- --------------- --------------- --------------- --------------- Total Increase (Decrease) in Net Assets 0 33,500 7,571 Net Assets, at Beginning of Year 0 29,539 34,560 --------------- --------------- --------------- =============== =============== =============== Net Assets, at End of Year $0 $63,039 $42,131 =============== =============== =============== =============== =============== =============== WP&G WP&G WP&G Tomorrow Tomorrow Tomorrow Long Medium Short Term Term Term Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) ($279) ($22) ($26) Realized Gain (Loss) on Investment Activity 132 2 74 Change in Unrealized Appreciation (Depreciation) of Investments 3,502 135 4 --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations 3,355 115 52 --------------- --------------- --------------- --------------- --------------- --------------- Capital Transactions: Contract Deposits 10,036 335 2,325 Cost Of Insurance Charge (2,982) (181) (486) Policy Loans (1,133) 0 0 Transfers 189 0 48 Contract Withdrawals (104) 0 0 --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 6,006 154 1,887 --------------- --------------- --------------- --------------- --------------- --------------- Total Increase (Decrease) in Net Assets 9,361 269 1,939 Net Assets, at Beginning of Year 58,921 4,805 6,727 --------------- --------------- --------------- =============== =============== =============== Net Assets, at End of Year $68,282 $5,074 $8,666 =============== =============== =============== =============== =============== =============== AIG LIFE INSURANCE COMPANY (AIG LIFE) VARIABLE ACCOUNT II STATEMENT OF CHANGES IN NET ASSETS For The Six Months Ended June 30, 1999 and June 30, 1998 (UNAUDITED) 1998 Aim Aim Capital International Appreciation Equity Total Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $620,103 ($141) ($143) Realized Gain (Loss) on Investment Activity 90,940 239 558 Change in Unrealized Appreciation (Depreciation) of Investments 479,873 3,664 2,791 --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations 1,190,916 3,762 3,206 --------------- --------------- --------------- --------------- --------------- --------------- Capital Transactions: Contract Deposits 4,180,989 60,258 75,808 Cost Of Insurance Charge (677,153) (1,960) (3,222) Policy Loans (92,940) 0 0 Transfers 20,633 30 (48) Contract Withdrawals (72,915) 0 (586) --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 3,358,614 58,328 71,952 --------------- --------------- --------------- --------------- --------------- --------------- Total Increase (Decrease) in Net Assets 4,549,530 62,090 75,158 Net Assets, at Beginning of Year 7,272,203 0 0 --------------- --------------- --------------- =============== =============== =============== Net Assets, at End of Year $11,821,733 $62,090 $75,158 =============== =============== =============== =============== =============== =============== Alliance Alliance Alliance Global Conservative Global Dollar Investors Bond Government Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $1,954 $16 $0 Realized Gain (Loss) on Investment Activity 278 0 0 Change in Unrealized Appreciation (Depreciation) of Investments (134) (12) 0 --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations 2,098 4 0 --------------- --------------- --------------- --------------- --------------- --------------- Capital Transactions: Contract Deposits 9,476 1,000 0 Cost Of Insurance Charge (1,942) (103) 0 Policy Loans 0 0 0 Transfers (1) 2 0 Contract Withdrawals (49) 0 0 --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 7,484 899 0 --------------- --------------- --------------- --------------- --------------- --------------- Total Increase (Decrease) in Net Assets 9,582 903 0 Net Assets, at Beginning of Year 24,072 0 0 --------------- --------------- --------------- =============== =============== =============== Net Assets, at End of Year $33,654 $903 $0 =============== =============== =============== =============== =============== =============== Alliance Growth Alliance Alliance & Growth Growth Income Investors Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $103,935 $106,829 $13,388 Realized Gain (Loss) on Investment Activity 7,627 17,209 1,713 Change in Unrealized Appreciation (Depreciation) of Investments 147,554 (8,204) 4,029 --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations 259,116 115,834 19,130 --------------- --------------- --------------- --------------- --------------- --------------- Capital Transactions: Contract Deposits 774,253 430,609 48,696 Cost Of Insurance Charge (92,573) (70,238) (9,803) Policy Loans (4,363) (16,339) (1,148) Transfers (277) 1,618 238 Contract Withdrawals (23,231) (2,734) (1,423) --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 653,809 342,916 36,560 --------------- --------------- --------------- --------------- --------------- --------------- Total Increase (Decrease) in Net Assets 912,925 458,750 55,690 Net Assets, at Beginning of Year 1,123,048 764,335 117,458 --------------- --------------- --------------- =============== =============== =============== Net Assets, at End of Year $2,035,973 $1,223,085 $173,148 =============== =============== =============== =============== =============== =============== Alliance Alliance Alliance Money Premier International Market Growth Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $0 $2 ($319) Realized Gain (Loss) on Investment Activity 0 0 1,349 Change in Unrealized Appreciation (Depreciation) of Investments 0 0 16,402 --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations 0 2 17,432 --------------- --------------- --------------- --------------- --------------- --------------- Capital Transactions: Contract Deposits 0 2,325 239,765 Cost Of Insurance Charge 0 0 (4,886) Policy Loans 0 0 (122) Transfers 0 7 2,287 Contract Withdrawals 0 0 (486) --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 0 2,332 236,558 --------------- --------------- --------------- --------------- --------------- --------------- Total Increase (Decrease) in Net Assets 0 2,334 253,990 Net Assets, at Beginning of Year 0 0 0 --------------- --------------- --------------- =============== =============== =============== Net Assets, at End of Year $0 $2,334 $253,990 =============== =============== =============== =============== =============== =============== Alliance Alliance Total Alliance Technology Return Quasar Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) ($1,274) $0 $30,035 Realized Gain (Loss) on Investment Activity 18,667 0 7,898 Change in Unrealized Appreciation (Depreciation) of Investments 76,056 0 (1,127) --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations 93,449 0 36,806 --------------- --------------- --------------- --------------- --------------- --------------- Capital Transactions: Contract Deposits 222,857 0 181,742 Cost Of Insurance Charge (26,342) 0 (18,284) Policy Loans (306) 0 (27) Transfers 3,117 0 746 Contract Withdrawals (5,990) 0 (6,366) --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 193,336 0 157,811 --------------- --------------- --------------- --------------- --------------- --------------- Total Increase (Decrease) in Net Assets 286,785 0 194,617 Net Assets, at Beginning of Year 255,061 0 241,676 --------------- --------------- --------------- =============== =============== =============== Net Assets, at End of Year $541,846 $0 $436,293 =============== =============== =============== =============== =============== =============== Alliance U.S. Dreyfus Government Small High Alliance Company Grade Utility Stock Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $0 $0 ($269) Realized Gain (Loss) on Investment Activity 0 0 (279) Change in Unrealized Appreciation (Depreciation) of Investments 0 0 4,132 --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations 0 0 3,584 --------------- --------------- --------------- --------------- --------------- --------------- Capital Transactions: Contract Deposits 0 0 112,792 Cost Of Insurance Charge 0 0 (10,791) Policy Loans 0 0 (1,446) Transfers 0 0 320 Contract Withdrawals 0 0 0 --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 0 0 100,875 --------------- --------------- --------------- --------------- --------------- --------------- Total Increase (Decrease) in Net Assets 0 0 104,459 Net Assets, at Beginning of Year 0 0 127,381 --------------- --------------- --------------- =============== =============== =============== Net Assets, at End of Year $0 $0 $231,840 =============== =============== =============== =============== =============== =============== Dreyfus Dreyfus Zero Fidelity Stock Coupon Asset Index 2000 Manager Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $6,790 $239 $58,821 Realized Gain (Loss) on Investment Activity 24,151 81 (1,580) Change in Unrealized Appreciation (Depreciation) of Investments 172,347 (34) (13,576) --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations 203,288 286 43,665 --------------- --------------- --------------- --------------- --------------- --------------- Capital Transactions: Contract Deposits 802,182 2,321 159,012 Cost Of Insurance Charge (106,448) (1,120) (27,167) Policy Loans (15,535) 0 (471) Transfers 8,369 (11) 1,519 Contract Withdrawals (11,677) 0 (1,183) --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 676,891 1,190 131,710 --------------- --------------- --------------- --------------- --------------- --------------- Total Increase (Decrease) in Net Assets 880,179 1,476 175,375 Net Assets, at Beginning of Year 944,435 10,766 387,906 --------------- --------------- --------------- =============== =============== =============== Net Assets, at End of Year $1,824,614 $12,242 $563,281 =============== =============== =============== =============== =============== =============== Fidelity Fidelity Fidelity High Contrafund Growth Income Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $1,608 $174,038 $32,520 Realized Gain (Loss) on Investment Activity 443 9,309 (55) Change in Unrealized Appreciation (Depreciation) of Investments 6,291 88,810 (19,696) --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations 8,342 272,157 12,769 --------------- --------------- --------------- --------------- --------------- --------------- Capital Transactions: Contract Deposits 126,109 733,715 69,718 Cost Of Insurance Charge (2,866) (117,408) (16,936) Policy Loans 0 (16,149) 0 Transfers (261) 9,306 (33) Contract Withdrawals 0 (12,187) (707) --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 122,982 597,277 52,042 --------------- --------------- --------------- --------------- --------------- --------------- Total Increase (Decrease) in Net Assets 131,324 869,434 64,811 Net Assets, at Beginning of Year 0 1,164,075 287,181 --------------- --------------- --------------- =============== =============== =============== Net Assets, at End of Year $131,324 $2,033,509 $351,992 =============== =============== =============== =============== =============== =============== Fidelity Investment Fidelity Grade Money Fidelity Bond Market Overseas Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $8,965 $26,531 $27,871 Realized Gain (Loss) on Investment Activity (251) 0 15,743 Change in Unrealized Appreciation (Depreciation) of Investments (4,486) 0 15,046 --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations 4,228 26,531 58,660 --------------- --------------- --------------- --------------- --------------- --------------- Capital Transactions: Contract Deposits 54,855 138,831 (28,697) Cost Of Insurance Charge (7,114) (115,215) (26,303) Policy Loans 0 (36,983) (51) Transfers 410 (3,986) (2,219) Contract Withdrawals (109) (618) (4,234) --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 48,042 (17,971) (61,504) --------------- --------------- --------------- --------------- --------------- --------------- Total Increase (Decrease) in Net Assets 52,270 8,560 (2,844) Net Assets, at Beginning of Year 79,496 1,225,890 368,340 --------------- --------------- --------------- =============== =============== =============== Net Assets, at End of Year $131,766 $1,234,450 $365,496 =============== =============== =============== =============== =============== =============== VanEck VanEck VanEck Worldwide Worldwide Worldwide Emerging Hard Balanced Markets Assets Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) $24,499 ($7) $4,424 Realized Gain (Loss) on Investment Activity (10,944) (63) (2,096) Change in Unrealized Appreciation (Depreciation) of Investments (4,930) (549) (7,300) --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations 8,625 (619) (4,972) --------------- --------------- --------------- --------------- --------------- --------------- Capital Transactions: Contract Deposits (88,747) 4,387 13,876 Cost Of Insurance Charge (7,520) (327) (3,022) Policy Loans 0 0 0 Transfers (130) (175) (238) Contract Withdrawals (456) 0 (341) --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions (96,853) 3,885 10,275 --------------- --------------- --------------- --------------- --------------- --------------- Total Increase (Decrease) in Net Assets (88,228) 3,266 5,303 Net Assets, at Beginning of Year 88,315 0 30,220 --------------- --------------- --------------- =============== =============== =============== Net Assets, at End of Year $87 $3,266 $35,523 =============== =============== =============== =============== =============== =============== WP&G WP&G WP&G Tomorrow Tomorrow Tomorrow Long Medium Short Term Term Term Portfolio Portfolio Portfolio Increase (Decrease) in Net Assets Operations: Net Investment Income (Loss) ($176) ($21) ($12) Realized Gain (Loss) on Investment Activity 919 0 24 Change in Unrealized Appreciation (Depreciation) of Investments 2,228 398 173 --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Operations 2,971 377 185 --------------- --------------- --------------- --------------- --------------- --------------- Capital Transactions: Contract Deposits 30,651 871 2,325 Cost Of Insurance Charge (4,898) (303) (362) Policy Loans 0 0 0 Transfers 43 0 0 Contract Withdrawals (341) 0 (197) --------------- --------------- --------------- --------------- --------------- --------------- Increase (Decrease) in Net Assets Resulting From Capital Transactions 25,455 568 1,766 --------------- --------------- --------------- --------------- --------------- --------------- Total Increase (Decrease) in Net Assets 28,426 945 1,951 Net Assets, at Beginning of Year 25,890 4,140 2,518 --------------- --------------- --------------- =============== =============== =============== Net Assets, at End of Year $54,316 $5,085 $4,469 =============== =============== =============== =============== =============== =============== APPENDIX A AVERAGE ANNUAL TOTAL RETURNS As of December 31, 1998 Inception Since Date 1 Year 3 Years 5 Years 10 Years Inception ---- ------ ------- ------- -------- --------- Anchor Series Trust Wellington Management Company, LLP Capital Appreciation Portfolio 3/23/87 22.20 24.25 19.95 20.01 16.87 Growth Portfolio 9/5/84 28.96 28.12 20.41 17.89 17.44 Government and Quality Bond Portfolio 9/5/84 9.18 7.18 7.33 9.19 10.60 Natural Resources Portfolio 1/4/88 -17.33 -4.82 0.46 4.18 4.84 SunAmerica Series Trust Alliance Capital Management L.P. Global Equities Portfolio 2/9/93 22.86 17.31 13.91 n/a 14.78 Alliance Growth Portfolio 2/9/93 52.23 37.21 29.44 n/a 26.80 Growth-Income Portfolio 2/9/93 30.74 29.51 23.18 n/a 20.94 Davis Selected Advisers, L.P. Venture Value Portfolio 10/28/94 13.73 23.98 n/a n/a 25.66 Real Estate Portfolio 6/2/97 -14.11 n/a n/a n/a 0.04 Federated Investment Counseling Corporate Bond Portfolio 7/1/93 6.05 7.11 6.98 n/a 6.78 Federated Value Portfolio 6/3/96 17.96 n/a n/a n/a 22.24 Utility Portfolio 6/3/96 14.04 n/a n/a n/a 19.02 Managed by Goldman Sachs Asset Management/ Goldman Sachs Asset Management International Asset Allocation Portfolio 7/1/93 3.32 14.40 13.53 n/a 13.39 Global Bond Portfolio 7/1/93 10.87 10.09 8.40 n/a 8.52 Massachusetts Financial Services MFS Growth and Income Portfolio 2/9/93 29.28 22.71 17.56 n/a 16.67 MFS Total Return Portfolio 10/28/94 19.53 15.39 n/a n/a 17.42 MFS Mid-Cap Growth Portfolio 4/1/99 n/a n/a n/a n/a n/a A-1 Morgan Stanley Asset Management International Diversified Equities Portfolio 10/28/94 18.53 11.28 n/a n/a 9.63 Worldwide High Income Portfolio 10/28/94 -17.07 6.29 n/a n/a 8.78 Putnam Investment Management, Inc. Emerging Markets Portfolio 6/2/97 -24.27 n/a n/a n/a -25.17 Putnam Growth Portfolio 2/9/93 34.76 29.05 21.42 n/a 18.43 International Growth and Income Portfolio 6/2/97 10.83 n/a n/a n/a 10.91 SunAmerica Asset Management Corp. Aggressive Growth Portfolio 6/3/96 17.43 n/a n/a n/a 13.59 SunAmerica Balanced Portfolio 6/3/96 24.61 n/a n/a n/a 23.17 Cash Management Portfolio 2/9/93 5.05 5.06 4.89 n/a 4.52 "Dogs" of Wall Street Portfolio 4/1/98 n/a n/a n/a n/a -0.60 High-Yield Bond Portfolio 2/9/93 -2.95 8.36 6.55 n/a 7.73 This portfolio performance information is for illustrative purposes only and is not intended to indicate or predict future performance. The performance information reflects the total of the income generated by the portfolio net of the total portfolio operating expenses (i.e., management fees and other portfolio expenses), plus capital gains and losses, realized or unrealized. The performance results do not reflect charges deducted from premiums, contract values or separate account assets, including, mortality and expense risk deductions, monthly deductions, cost of insurance, surrender charges, sales loads, DAC taxes, and any state or local premium taxes. If these charges were included, the total return figures would be lower. A-2 [Back cover] The Securities and Exchange Commission maintains an Internet Web site (http://www.sec.gov.) That contains additional information about AIG Life Insurance Company, the Policy and the Separate Account which may be of interest to you. The Web site also contains additional information about the Policy's variable investment options. Investment Company Act File Number 811-4687. Part II - Other Information UNDERTAKING TO FILE REPORTS Subject to the terms and conditions of Section 15(d) of the Securities Exchange Act of 1934, the undersigned registrant hereby undertakes to file with the Securities and Exchange Commission such supplementary and periodic information, documents, and reports as may be prescribed by any rule or regulation of the Commission theretofore or hereafter duly adopted pursuant to authority conferred in that section. REPRESENTATION AIG Life Insurance Company represents that the fees and charges deducted under the Policy covered by this registration statement, in the aggregate are reasonable in relation to the services rendered, the expenses expected to be incurred, and the risks assumed by the Company. INDEMNIFICATION Under its Bylaws, the Company, to the full extent permitted by Delaware law shall indemnify any person who was or is a party to any proceeding (whether brought by or in right of the Company or otherwise) by reason of the fact that he or she is or was a Director of the Company, or while a Director of the Company, is or was serving at the request of the Company as a Director, Officer, partner, Trustee, Employee, or Agent of another foreign or domestic corporation, partnership, joint venture, trust, other enterprise or employee benefit plan, against judgments, penalties, fines, settlements and reasonable expenses actually incurred by him or her in connection with such proceeding. The company shall extend such indemnification, as is provided to directors above, to any person, not a director of the Company, who is or was an officer of the Company or is or was serving at the request of the Company as a director, officer, partner, trustee, or agent of another foreign or domestic corporation, partnership, joint venture, trust, other enterprise or employee benefit plan. In addition, the Board of Directors of the Company may, by resolution, extend such further indemnification to an officer or such other person as may to it seem fair and reasonable in view of all relevant circumstances. Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the Company pursuant to such provision of the bylaws or statutes or otherwise, the Company has been advised that in the opinion of the Securities and Exchange Commission, such indemnification against such liabilities (other than the payment by the Company of expenses incurred or paid by a director, officer or controlling person of the Company in the successful defense of any such action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the Policies issued by Variable Account II, the Company will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in said Act and will be governed by the final adjudication of such issue. CONTENTS OF REGISTRATION STATEMENT This Registration Statement comprises the following papers and documents: The facing sheet. The Prospectus consisting of ___ pages. The undertaking to file reports. Representation. The signatures Written consents of the following persons: Kenneth D. Walma, Esquire Jorden Burt Boros Cicchetti Berenson & Johnson LLP PriceWaterhouseCoopers LLP The following exhibits: A. Copies of all exhibits required by paragraph A of instructions for Exhibits in Form N-8B-2, unless indicated otherwise. 1. Certificate of Resolution for AIG Life Insurance Company dated June 5, 1986, authorizing the issuance and sale of variable life contracts.* 2. N/A 3. Principal Underwriter's Agreement between AIG Life Insurance Company and American International Fund Distributors, dated August 15, 1989;* 4. N/A 5. Form of Flexible Premium Variable Universal Life Insurance Policy (11LSVUL699) (filed electronically herewith) 6. (a) By-Laws of AIG Life Insurance Company as amended through December 31, 1991;* (b) Certificate of Incorporation of AIG Life Insurance Company, dated December 31, 1991* (c) Restated Certificate of Incorporation, of AIG Life Insurance Company, dated December 31, 1991. The original Certificate of Incorporation was filed in Pennsylvania on June 18, 1962* 7. N/A. 8. N/A. 9. N/A. 10. Form of Life Insurance Application (14APP0396)* 11. (a) Power of Attorney** (b) Power of Attorney for Paul S. Bell (filed electronically herewith) B. Opinion and Consent of Counsel (filed electronically herewith) D. Consent of Independent Certified Public Accountants (filed electronically herewith) E. Consent of Jorden Burt Boros Cicchetti Berenson & Johnson LLP (filed electronically herewith) F. Memorandum Regarding Administrative Procedures* * Incorporated by reference to Registrant's Post-Effective Amendment No. 4, to the Registratin Statement on Form S-6 (File No. 33-90684), dated October 27, 1998. ** Incorporated by reference to Registrant's Post-Effective Amendment No. 2, to the Registratin Statement on Form S-6 (File No. 33-90684), dated May 1, 1997. SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized in the City of Wilmington and State of Delaware on this 15th day of October, 1999. VARIABLE ACOUNT II ------------------------------- (Registrant) By: AIG LIFE INSURANCE COMPANY -------------------------------------------- (Depositor) By: /s/ Kenneth D. Walma -------------------------------------------- Kenneth D. Walma, Vice President and General Counsel Attest: /s/ James A. Bambrick ________________ (Name) Chief Operating Officer ________________ (Title) Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed below by the following persons in the capacities and on the dates indicated: Signature Title Date Gerald Walter Wyndorf* Chief Executive Officer October 15, 1999 - ------------------ and Director Gerald Walter Wyndorf Howard E. Gunton, Jr.* Chief Financial October 15, 1999 __________________ Officer and Comptroller Howard E. Gunton, Jr Paul S. Bell* Director October 15, 1999 - ------------------ Paul Bell Maurice R. Greenberg* Director October 15, 1999 - ------------------ Maurice R. Greenberg Edward Easton Matthews* Director October 15, 1999 - ------------------ Edward Easton Matthews Jerome T. Muldowney* Director October 15, 1999 - ------------------ Jerome T. Muldowney Nicholas A. O'Kulich* Director October 15, 1999 - ------------------ Nicholas A. O'Kulich Howard Ian Smith* Director October 15, 1999 - ------------------ Howard Ian Smith /s/ Kenneth D. Walma *By: ___________________ Kenneth D. Walma Attorney in Fact INDEX TO EXHIBITS EXHIBIT PAGE A.5. Form of Flexible Premium Variable Universal Life Insurance Policy A.11 (b) Power of Attorney of Paul S. Bell B. Opinion and Consent of Counsel D. Consent of Independent Accountants E. Consent of Jorden Boros Cicchetti Berenson & Johnson LLP