SECURITIES AND EXCHANGE COMMISSION
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WASHINGTON, D.C. 20549
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FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended: December 31, 1996 Commission file number: 33-67268
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ARM FINANCIAL GROUP, INC.
(Exact name of registrant as specified in its charter)

DELAWARE 61-1244251
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

515 WEST MARKET STREET
LOUISVILLE, KENTUCKY 40202
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (502) 582-7900

Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
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9.5% Cumulative Perpetual Preferred Stock American Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. /X/ Yes / / No

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /

As of February 28, 1997, 23,796 and 1,000 shares of the Registrant's Class
A and Class B common stock, respectively, were outstanding, all of which are
privately owned and not traded on a public market.

DOCUMENTS INCORPORATED BY REFERENCE
None

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TABLE OF CONTENTS

Item Page
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PART I

1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3
2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
3. Legal Proceedings. . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
4. Submission of Matters to a Vote of Security Holders. . . . . . . . . . . 30

PART II

5. Market for Registrant's Common Equity
and Related Stockholder Matters . . . . . . . . . . . . . . . . . . . . 31
6. Selected Financial Data. . . . . . . . . . . . . . . . . . . . . . . . . 32
7. Management's Discussion and Analysis of
Financial Condition and Results of Operations . . . . . . . . . . . . . 35
8. Financial Statements and Supplementary Data. . . . . . . . . . . . . . . 53
9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure. . . . . . . . . . . . . . . . . 53

PART III
10. Directors and Executive Officers of the Registrant . . . . . . . . . . . 54
11. Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . 59
12. Security Ownership of Certain Beneficial Owners and Management . . . . . 65
13. Certain Relationships and Related Transactions . . . . . . . . . . . . . 67

PART IV
14. Exhibits, Financial Statements and Schedules, and Reports on Form 8-K. . 69

Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74
Index to Financial Statements. . . . . . . . . . . . . . . . . . . . . .F-1
Index to Financial Statement Schedules . . . . . . . . . . . . . . . . .S-1

PART I

ITEM 1. BUSINESS

GENERAL

ARM Financial Group, Inc. (the "Company") specializes in the asset
accumulation business, providing retail and institutional customers with
products and services designed to serve the growing long-term savings and
retirement markets. The Company's earnings are derived from investment spread
(the difference between income earned on investments and interest credited on
customer deposits) and fee income. The Company's retail products include a
variety of fixed, indexed and variable annuities and face-amount certificates
sold through a broad spectrum of distribution channels including
stockbrokers, independent agents, independent broker-dealers and financial
institutions. The Company offers guaranteed investment contracts ("GICs") to
its institutional clients and markets its institutional products and services
directly to bank trust departments, plan sponsors, cash management funds,
other institutional funds and insurance companies as well as through
investment consultants.

The Company was established in July 1993 and completed its first
acquisition in November 1993. The Company's assets under management have grown
from $2.3 billion as of December 31, 1993 to $4.8 billion as of December 31,
1996 (after giving effect to the proposed sale of ARM Capital Advisors, LLC
("ARM Capital Advisors") -- see "History"). The Company attributes this growth
to internally generated sales, new product offerings and opportunistic
acquisitions. Operating earnings (net income applicable to common shareholders,
excluding, net of tax, realized investment gains and losses and non-recurring
charges) have grown from $2.4 million in 1994 to $4.5 million in 1995 and $22.6
million in 1996.

The Company expects to benefit from demographic trends and a growing
demand for retirement savings. As the U.S. population has aged, demand for
retirement savings has accelerated. According to U.S. Census Bureau
information, approximately 30% of today's population was born during the Baby
Boom (1946 to 1964). By the time the Baby Boom generation begins to reach age
65 in 2011, the population between the ages of 45 and 64 -- the peak period
for asset accumulation -- is projected to increase by approximately 45% to 79
million.

The Company also expects to benefit from anticipated higher consumer
savings due to an overburdened social security system, extended life spans,
corporate restructurings and downsizing, and volatile financial markets.
Among the products expected to benefit are tax-advantaged annuities. Annual
industry sales of individual annuity products increased dramatically from
$65.1 billion in 1990 to a preliminary estimate of $106.6 billion in 1996,
with projected growth of at least 9% per year for the next few years,
according to an industry study conducted by LIMRA.

STRATEGY

The Company's strategy is focused on the following:

DEVELOPING AND MARKETING A BROAD ARRAY OF CUSTOMIZED PRODUCTS. The
Company believes that long-term success in the asset accumulation industry
will depend upon the Company's ability to adapt to rapidly changing consumer
preferences in fluctuating interest rate and equity market environments. The
Company continually redesigns existing products with enhanced features and
continues to develop and sell new and innovative products in the marketplace
with a particular focus on minimizing its dependence on any one product and
meeting a variety of needs for consumers and distribution channels. The
Company works closely with its distributors to develop products that are
customized to suit their customers' particular needs. The Company was one of
the first to recognize the market opportunity for equity-indexed annuities
and in 1996 introduced OMNI, the Company's equity-indexed annuity product.
Following initial sales in 1996 the Company expects to introduce a second
generation product with enhanced features in the second quarter of 1997. In
the institutional market, the Company offers a short-term floating rate GIC
product designed to meet the market demand for products with attractive
current yields and access to liquidity. In 1997, the Company anticipates
introducing products for the synthetic GIC marketplace that will provide
institutional clients with either absolute or relative investment performance
guarantees.

CAPTURING A GROWING SHARE OF SALES IN RETAIL DISTRIBUTION CHANNELS.
Over the past few years, the Company has built the infrastructure necessary
to support increased growth in the retail market. The Company believes that
it can distinguish itself by strengthening its relationships with individual
distributors, often referred to as producers. To accomplish this objective,
the Company seeks to (i) provide superior service to producers through an
expanded and dedicated producer services unit; (ii) enhance the Company's
technological platform to permit superior and immediate access for producers
to the Company's administrative systems for transacting business; (iii)
heighten producers' awareness of its products and insurance affiliates
through focused advertisements in industry publications and selective
promotional programs; and (iv) quickly develop innovative products with new
features and services which are responsive to market needs. For example, as
a means to strengthen its relationships with distributors, the Company is in
the process of implementing a program whereby certain distributors will have
the capability to access remotely the Company's systems and transact business
with the Company on-line. The Company also seeks to increase its retail
market share by expanding and diversifying its retail distribution channels.
For example, in 1996 the Company began offering variable annuities through
banks and thrifts. Additionally, the Company recognizes the importance of
building and maintaining a strong capital

base. Primarily as a result of the Company's strengthened financial
condition, A.M. Best Company, Inc. ("A.M. Best") raised the claims-paying
ability rating of the Company's insurance subsidiaries from "A-(Excellent)"
to "A(Excellent)" in 1995. A further upgrade could help the Company expand
its penetration of existing distribution channels.

ENHANCING EFFECTIVE USE OF TECHNOLOGY. The Company continues to invest
in technology designed to enhance the service it provides to producers and
customers, increase the efficiency of its operations and allow administration
of innovative and complex products. The Company's technology also allows it
to respond quickly to customer needs for new products by reducing product
development time. In addition, to supplement traditional inquiry and
transaction processing methods, the Company's client/server network can
provide producers, customers and employees with services and information
easily accessible through Internet, voice response and wide-area network
("WAN") technology. The Company believes that these investments in technology
are necessary to remain competitive in the marketplace.

MINIMIZING FIXED COST STRUCTURE. The Company attempts to minimize fixed
distribution costs by marketing its products through fiduciaries and other third
parties. Unlike many of its competitors, the Company does not maintain its own
field sales force, and distributors are primarily paid based on production. As a
consequence of its low fixed distribution costs, the Company has greater
flexibility to shift the mix of its sales and distribution channels in order to
respond to changes in market demand. In addition, the Company believes that its
administrative cost structure has benefited from economies of scale
achieved as a result of its strategic acquisitions. The relocation of the
Company's main processing center in Worthington, Ohio to the Company's
headquarters in Louisville, Kentucky, which is scheduled to take place in 1997,
is expected to provide further consolidation benefits, in addition to
supplementing the effective delivery of service. The Company will continue to
evaluate whether certain non-strategic systems and administrative functions
should be outsourced to third-party providers.

IMPLEMENTING AN ADVANCED AND INTEGRATED RISK MANAGEMENT PROCESS. The
Company designs its products and manages its capital to achieve a superior
return on common equity. The Company's return on average common equity (based
on operating earnings and equity before unrealized

gains) improved to 19% in 1996. Using its experience in offering investment
guarantees in the insurance market sector, the Company employs a highly
analytical and disciplined asset/liability risk management approach to develop
new products and monitor its investment portfolios and liabilities. The Company
does not view asset/liability management as a discrete function to be performed
by a separate committee. Instead, asset/liability management permeates every
aspect of the Company's operations. Beginning with product design and continuing
through the product sale and eventual payout, professionals in each functional
area (such as marketing, actuarial, investments, legal, finance and
administration) work jointly with a common set of risk/return characteristics
to achieve the Company's liquidity and profit objectives
(rather than the specific objectives of any particular functional area). The
Company implements this process with the analytical risk and capital management
skills and the experience of its management team, supported with sophisticated
computer software and an emphasis on securities whose cash flows can be modeled
extensively against liability cash flows under different interest rate
scenarios. Where the Company cannot match assets and liabilities, these risk
components are typically hedged or outsourced. The Company's investment
portfolios are currently being managed by ARM Capital Advisors; however, the
Company may use additional unaffiliated investment management firms to
supplement the services of ARM Capital Advisors in the future. Importantly, the
Company has and will continue to monitor the investment practices of these firms
to ensure that the Company's prescribed guidelines are followed.

CONTINUING SUCCESSFUL ACQUISITION RECORD. The Company's first
acquisition occurred in 1993 with the acquisition of Integrity Life Insurance
Company ("Integrity") and National Integrity Life Insurance Company
("National Integrity") (collectively, the "Integrity Companies"). In 1995,
the Company acquired the assets and business operations of SBM Company
("SBM"). By acquiring SBM, the Company met its objectives of growing and
diversifying its product offerings and distribution channels and achieving
further economies of scale. The Company increased the investment yields of
the SBM portfolio while improving its associated risk profile through a
restructuring of the investment portfolio, reduced expenses by merging
back-office operations into the Company's existing operations and expanded
the Company's distribution channels. The Company continues to seek
opportunities to purchase interests in blocks of annuity business, other
financial service companies and distributors and to enter into marketing
partnerships and reinsurance ventures with other insurance companies, all
with the goal of achieving greater profitability through growth in market
share and further economies of scale.

MAINTAINING FOCUS ON COMPANY PROFITABILITY. The Company's focus on
profitability is supported by an integrated team approach to developing
products and operating the Company's business. The Company's compensation
system and the equity investments of certain of its employees further
reinforce the Company's focus on the objective of profitability. Employees at
all levels of the Company are eligible to receive bonuses based on
profitability, and as of December 31, 1996, employees (including directors
and executive officers of the Company) controlled, directly or indirectly, 9%
of the Company's outstanding common stock.

The Company conducts its different businesses through the following
subsidiaries:

- INTEGRITY -- provides retail, fixed and variable annuities (including
the Company's equity-indexed annuity) and institutional GICs;

- NATIONAL INTEGRITY -- provides retail, fixed and variable annuities
and institutional GICs, primarily in New York (wholly owned subsidiary
of Integrity);

- SBM CERTIFICATE COMPANY -- offers face-amount certificates which
guarantee a fixed rate of return to investors at a future date.
Face-amount certificates are similar to bank-issued certificates of
deposit but are regulated by the Investment Company Act of 1940, as
amended (the "Investment Company Act") and are not subject to Federal
Deposit Insurance Corporation ("FDIC") protection;

- ARM SECURITIES CORPORATION ("ARM SECURITIES") (FORMERLY KNOWN AS SBM
FINANCIAL SERVICES, INC.) -- this broker-dealer supports the Company's
retail annuity operations and the Company's sales of independent third
party mutual funds; and

- ARM TRANSFER AGENCY, INC. ("ARM TRANSFER AGENCY") -- provides transfer
agent services as needed to support the Company's retail business
operations.

In addition, ARM Capital Advisors, LLC (the successor in interest to ARM
Capital Advisors, Inc., a wholly owned subsidiary of the Company whose name will
be changed to Integrity Capital Advisors, Inc.), which will remain a 20% owned
affiliate after the proposed sale (see "History"), offers fixed income asset
management to third-party institutional clients (currently consisting primarily
of defined benefit pension plans).

HISTORY

INTEGRITY COMPANIES
The Company was established in July 1993 by The Morgan Stanley Leveraged
Equity Fund II, L.P. ("MSLEF II"), an investment fund sponsored by Morgan
Stanley Group Inc., and Analytical Risk Management, Ltd. (now known as Oldarm
L.P.) to acquire Integrity Holdings, Inc. (formerly N.M. U.S. Limited) from The
National Mutual Life Association of Australasia Limited ("National Mutual"). In
connection with the acquisition, which occurred on November 26, 1993, National
Mutual replaced all equity securities, investments in real estate and joint
ventures and fixed maturity securities classified as "6" by the National
Association of Insurance Commissioners ("NAIC"), with cash in an amount equal to
the statutory book value of such assets as of December 31, 1992 adjusted for any
additional cash investments or distributions during the period from January 1,
1993 to November 26, 1993. In addition, National Mutual (i) strengthened
statutory policyholder reserves and surplus by $24.3 million, (ii) indemnified
the Integrity Companies with respect to the payment of principal and interest
due on $146.6 million of commercial and agricultural mortgage loans (since
reduced through repayments to $36.7 million at December 31, 1996) and supported
the indemnification with a $23.0 million escrow arrangement, (iii) provided
indemnification as to the availability of net operating and capital loss
carryforwards and various tax deductions, (iv) provided the Integrity Companies
with indemnification as to future claims for taxes, assessments from guaranty
funds and claims from litigation which arise from pre-closing events, (v)
terminated all surplus relief reinsurance arrangements, (vi) assumed all
obligations under the Integrity Companies' lease for certain office space and
(vii) assumed all obligations for retirement and severance benefits incurred by
the Integrity Companies prior to closing.

ARM CAPITAL ADVISORS
Through its acquisition of the U.S. fixed income unit of Kleinwort Benson
Investment Management Americas, Inc. ("KBIMA") in January 1995, the Company
obtained a recognized fixed income management service, which became part of the
then newly-formed ARM Capital Advisors, to manage the investment portfolios of
the Company's subsidiaries. In addition, the acquisition provided for asset
management services to institutional clients. Although third-party assets
managed by ARM Capital Advisors have grown since the acquisition, the Company
believes that market attitudes towards developing an asset management service
for defined benefit pension plans within a holding company structure consisting
predominantly of insurance companies has constrained ARM Capital Advisors'
growth. Accordingly, the Company is in the process of selling an 80% interest in
ARM Capital Advisors to an entity controlled by Emad A. Zikry, President of ARM
Capital Advisors. The Company expects to recognize an immaterial gain
on the sale. Under the

proposed terms of the sale, which are being negotiated, ARM Capital Advisors
will continue to provide the Company's subsidiaries with investment
management services through December 31, 1997 on the same basis as in the
past. The proposed terms of the sale further provide that after December 31,
1997, the Company can continue to engage and have access to the expertise of
ARM Capital Advisors as its investment advisor at agreed upon rates; but,
beginning in 1998, the Company may also consider retaining other investment
management firms. In connection with the proposed sale, it is anticipated
that Mr. Zikry will terminate his employment with the Company. After
consummation of the sale, Integrity Capital Advisors, Inc. will act as
investment advisor to The Legends Fund, Inc. (the "Legends Fund"), a
series-type registered investment company, the investment portfolios of which
are offerd through one of the Company's variable annuity products.

SBM COMPANY
In June 1995, the Company completed the acquisition of substantially all of
the assets and business operations of SBM, including all of the issued and
outstanding capital stock of SBM's subsidiaries, SBM Life (which was
subsequently merged with and into Integrity to create certain operating
efficiencies), SBM Financial Services, Inc. (which subsequently changed its name
to ARM Securities), SBM Certificate Company, and SBM's management contracts with
six mutual funds (the "State Bond Mutual Funds"). The Company issued 9,770
shares of common stock, primarily to Morgan Stanley Capital Partners III, L.P.,
Morgan Stanley Capital Investors, L.P., and MSCP III 892 Investors, L.P.
(collectively, the "MSCP Funds"), and used the proceeds from the issuance of new
common equity to acquire the assets and business operations of SBM and to make a
$19.9 million capital contribution to SBM Life. On December 13, 1996, the
Company transferred its contracts to perform management and advisory services
for the State Bond Mutual Funds to Federated Investors for $4.5 million. The
State Bond Mutual Funds had aggregate assets of $236.9 million on December 13,
1996 and were not considered a strategic line of business for the Company.

Had the sale of ARM Capital Advisors and the sale of the management
contracts for the State Bond Mutual Funds occurred on January 1, 1995, they
would have had an immaterial effect on the Company's pro forma net income for
the years ended December 31, 1996 and 1995.

PRODUCTS AND SERVICES

The Company offers a diversified array of products and services to meet the
needs of a variety of customers. The Company endeavors to adapt its products to
respond to changes in the retail and institutional marketplace and generally
seeks to have "a product for every market environment." The Company's retail
products include a variety of fixed and variable annuities and face-amount
certificates. In addition, the Company's variable annuity products offer
customers participation in various investment portfolios, some of which are
offered exclusively by the Company's insurance subsidiaries. The Company also
offers GICs to its institutional clients.

subsidiaries receive a fee in exchange for managing deposits, and the customer
accepts the investment risk. Because the investment risk is borne by the
customer, this line of business requires significantly less capital support than
the spread-based business.

SPREAD-BASED BUSINESS
The Company seeks to maintain level investment spreads regardless of the
interest rate environment. To this end, management (i) structures investment
asset durations, convexity and liquidity characteristics in conjunction with
customer deposit characteristics, (ii) regularly trades investment assets to
improve yield while maintaining other portfolio characteristics, (iii) offers an
array of products whose credited rates are based on differing points on the
yield curve and (iv) actively manages the trade-off between credited rates and
persistency.

The Company's spread-based products include retail single premium deferred
annuity ("SPDA") contracts, flexible premium deferred annuity ("FPDA")
contracts, single premium endowment ("SPE") contracts, guaranteed rate options
("GROs") of variable annuity contracts and certain FPDA contracts, single
premium immediate annuity ("SPIA") contracts, face-amount certificates and
institutional GICs as described below. Sales for spread-based business include
premiums and deposits received under these products. Spread-based sales for the
years ended December 31, 1996, 1995 and 1994 were as follows:

Year Ended December 31,
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(IN MILLIONS) 1996 1995 1994
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Retail:
SPDA $ 8.6 $ 44.3 (1) $ 50.5
FPDA 29.9 12.5 (2) --
GRO 83.6 47.1 73.4
Face-amount certificates 8.0 10.7 (3) --
Other 0.5 0.8 7.2
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Total retail 130.6 115.4 131.1
Institutional:
GIC(4) 747.5 142.2 --
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Total spread-based sales $ 878.1 $ 257.6 $ 131.1
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(1) SPDA sales include $6.2 million for the year ended December 31, 1995, which
was attributable to the sale of SBM products following the SBM acquisition.
(2) FPDA sales include $12.5 million for the year ended December 31, 1995,
which was attributable to the sale of SBM products following the SBM
acquisition.
(3) Attributable to the sale of SBM products following the SBM acquisition.

(4) The marketing partnership arrangement with General American was
converted from a fee-based to primarily a spread-based arrangement in
late 1995 through a reinsurance agreement with General American. General
American cedes 50% of new deposits to Integrity under the reinsurance
agreement which the Company recognizes in its spread-based line of
business. The Company receives nominal fee income for the 50% portion
retained by General American (which the Company recognizes as "other fee
income"); accordingly, such deposits are not included in fee-based sales.

Spread-based assets under management at December 31, 1996, 1995 and 1994
were as follows:

December 31,
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1996 1995 1994
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Percent of Percent of Percent of
(DOLLARS IN MILLIONS) Amount Total Amount Total Amount Total
- --------------------------------------------------------------------------------------------------

Retail:
SPDA $ 838.2 23.7% $ 969.8 (1) 33.9% $ 804.7 40.4%
FPDA 409.5 11.6 436.2 (1) 15.2 -- --
SPE 396.7 11.2 403.3 14.1 409.3 20.6
SPIA 650.1 18.4 644.8 22.6 639.0 32.1
GRO 223.1 6.3 164.5 5.8 92.6 4.7
Face-amount certificates 50.2 1.4 52.5 (1) 1.8 -- --
Other 78.4 2.2 45.1 1.6 44.4 2.2
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Total retail 2,646.2 74.8 2,716.2 95.0 1,990.0 100.0
Institutional:
GIC(2) 891.9 25.2 143.2 5.0 -- --
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Total spread-based assets under
management $3,538.1 100.0% $2,859.4 100.0% $1,990.0 100.0%
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(1) Includes amounts acquired in 1995 in connection with the SBM acquisition of
$297.7 million (SPDA), $436.2 million (FPDA) and $52.5 million (face-amount
certificates).

(2) The marketing partnership arrangement with General American was
converted from a fee-based to primarily a spread-based arrangement late
in 1995 through a reinsurance agreement with General American. See
"Guaranteed Investment Contracts."

SINGLE PREMIUM DEFERRED ANNUITY CONTRACTS. Single premium deferred annuity
contracts are sold through stockbrokers, independent agents, independent
broker-dealers and financial institutions. Under these contracts, the
issuing insurance company guarantees the customer's principal and credits the
accumulated deposit with a rate of interest that is guaranteed for a specified
initial period and reset annually or semi-annually thereafter, subject to
guaranteed minimum crediting rates set forth in the contracts (currently 3% or
4%). The Company generally determines the crediting rate by reference to current
yields along the intermediate term section of the yield curve. No front-end
sales charges are imposed for purchases of such contracts, but all such
contracts contain surrender charges for withdrawals in excess of a specified
amount during the surrender charge period. These surrender charges vary
depending upon the guarantee periods in the contracts.

FLEXIBLE PREMIUM DEFERRED ANNUITY CONTRACTS. Flexible premium deferred
annuity contracts are marketed primarily through independent agents. Under these
contracts, the issuing insurance company guarantees the customer's principal and
credits the accumulated deposit with a rate of interest that is guaranteed for a
specified initial period and reset annually thereafter. FPDA contract holders
can make additional contributions, subject to minimums, after the contract is
issued. The Company generally determines the crediting rate by reference to
current yields along the intermediate term section of the yield curve. Certain
FPDA contracts, which were acquired as a result of the SBM acquisition and which
are not currently marketed by the Company, are qualified under section 403(b) of
the Internal Revenue Code of 1986, as amended, and were sold to qualified
employers such as public school districts and churches. The Company developed a
new FPDA

product, OMNI, in 1995, with sales commencing in February 1996. This new product
furnishes customers with the ability to allocate assets among equity index-based
returns and guaranteed rates of return. The index-based options offer the upside
potential tied to a percentage of the appreciation in the S&P 500 Price Index,
but protect the customer against the related downside risk through a guarantee
of principal by the issuing insurance company. By hedging the equity-based risk
component of the product through the purchase of call options or other
investment strategies, the Company is separately able to concentrate on managing
the interest rate spread component.

SINGLE PREMIUM ENDOWMENT CONTRACTS. While single premium endowment
contracts continue to represent a significant portion of the Company's
insurance subsidiaries' business in force, as a result of changes in
applicable tax laws, the Company is no longer selling this product. Under
these contracts, principal is guaranteed, and the face amount of the policy
is paid upon the death of the insured. The contracts are credited with a
specified rate of interest that is guaranteed for a period of time and then
reset annually thereafter, subject to guaranteed minimums and certain other
restrictions. The Company generally determines the crediting rate by
reference to current yields along the intermediate term section of the yield
curve. Due to changes in applicable tax laws, and the consequential loss of
tax benefits associated with SPEs in the event of a withdrawal, and because
the interest rate on SPEs is reset annually based on the intermediate term
section of the yield curve, the Company believes that the level of surrenders
of SPEs associated with increases in interest rates will be lower than would
otherwise be the case.

SINGLE PREMIUM IMMEDIATE ANNUITY CONTRACTS. Single premium immediate
annuity contracts were historically marketed by the Company to insurance
companies and defendants in connection with lawsuits involving structured
liability settlements. As a result of changes in the marketing environment for
this product and the increased competition in pricing, the Company's insurance
subsidiaries are not currently focusing on this segment of the immediate annuity
marketplace. SPIA contracts provide guaranteed payments to contract holders and
are not subject to surrender. Pricing is determined by reference to the
long-term end of the yield curve.

GUARANTEED RATE OPTIONS. Guaranteed rate options provide a fixed-rate
investment alternative for holders of the Company's variable annuity contracts
and are also issued as a separate product by the Company's insurance
subsidiaries. GROs, which were first introduced by the Company's insurance
subsidiaries in 1994, allow customers to lock in a fixed return for three, five,
seven or ten years. There are no up-front or annual fees attached to these
options, but surrender charges apply to withdrawals in excess of a stated
maximum. Funds may be transferred to or from any of the guarantee periods (or
other investment options within the variable annuity contract) subject to a
market value adjustment ("MVA"). The MVA can be either positive or negative, but
the customer is guaranteed principal by the issuing insurance company plus a
return of 3%, before surrender charges. Transfers at the end of a guarantee
period are not subject to the MVA provision. The MVA provision is intended to
offset the gain or loss attributable to the impact of changes in interest rates
on the market value of assets that would be sold to fund surrenders occurring
prior to the end of the guarantee period. The Company currently uses an
immunized investment strategy designed to achieve a target return over the
selected time horizon despite interest rate volatility. Deposits into GROs are
held in a separate account established by the insurance company.

FACE-AMOUNT CERTIFICATES. Face-amount certificates are obligations of SBM
Certificate Company which require it to pay holders the original invested amount
of the certificate, plus a three-year fixed-rate return, at a given maturity
date. Holders are required to accept a reduced rate of interest it they withdraw
their investment prior to the maturity date. The Company selects the interest
rate offered on face-amount certificates based on the short to intermediate
term sections of the yield curve. Face-amount certificates, which are similar to
bank certificates of deposit, generally compete with various types of individual
savings products offered by banks and insurance companies that provide a fixed
rate of return on investors' money. Face-amount certificates are regulated under
the Investment Company Act and, unlike bank certificates of deposit of less than
$100,000, are not guaranteed by the FDIC. The Company continues to investigate
opportunities to expand upon its face-amount certificate retail distribution
channels.

GUARANTEED INVESTMENT CONTRACTS. Guaranteed investment contracts are
issued to institutional customers by the Company primarily through a
marketing partnership with General American Life Insurance Company ("General
American"), which began originally as a fee-based arrangement in March 1993.
The marketing partnership with General American permits the Company to use
its established distribution channel contacts to market GICs in conjunction
with the financial strength of General American's higher claims-paying
ability ratings. The Company markets General American contracts which have
been designed by the Company to meet customer needs. Since September 1995,
General American has ceded 50% of new deposits to Integrity under a
coinsurance agreement. The interest rate on GICs is typically based upon a
short-term floating rate, such as the London Interbank Offered Rate
("LIBOR"), which periodically resets to provide current yields. GIC products
offered by the Company are designed and have historically been held by
customers as long-term core investments, even though under many contracts
customers have the option to liquidate their holdings with written notice of
thirty days or less. The Company has experienced withdrawals by GIC customers
of approximately 5.6% and 3.1% of average GIC customer deposits for the years
ended December 31, 1996 and 1995, respectively.

FEE-BASED BUSINESS
The Company's fee-based business is less capital intensive than the
spread-based business and generally provides the Company with a more diversified
source of income, due to the relative insensitivity of fee-based income to
changes in interest rates. However, significant decreases in price levels in the
securities market could adversely affect the level of fee income earned by the
Company from variable annuities and, thereby, the Company's results of
operations.

Fee-based products include investment portfolio options of variable annuity
contracts and services in connection with the Company's marketing arrangements
for GIC products. Sales for fee-based business represent premiums and deposits
for the investment portfolio options of variable annuity contracts and
off-balance sheet deposits under marketing partnerships. The marketing
partnership arrangement with General American was converted from a fee-based to
primarily a spread-based arrangement in late 1995 through a reinsurance
agreement executed with General American. General American cedes 50% of new
deposits to Integrity under the reinsurance agreement which the Company reports
in its spread-based line of business. The Company receives nominal fee income
for the 50% portion retained by General American, which the Company reports

as "other fee income." Fee-based sales for years ended December 31, 1996, 1995
and 1994 were as follows:

Year Ended December 31,
------------------------------------
(IN MILLIONS) 1996 1995 1994
- -----------------------------------------------------------------------------------------

Retail:
Investment portfolio options of variable annuities $ 200.1 $ 177.7 $ 230.2
Other -- -- 0.9
------------------------------------
Total retail 200.1 177.7 231.1
Institutional:
Marketing partnerships(1) -- (2) 272.9 59.3
------------------------------------
Total fee-based sales(3) $ 200.1 $ 450.6 $ 290.4
------------------------------------
------------------------------------

(1) Off-balance sheet item.
(2) The marketing partnership arrangement with General American was converted
from a fee-based to primarily a spread-based arrangement in late 1995
through a reinsurance agreement with General American.
(3) Does not include new deposits related to off-balance sheet assets managed
by ARM Capital Advisors for institutional clients and the State Bond Mutual
Funds. Total fee-based sales for the years ended December 31, 1996 and 1995
were $1,866.1 million and $930.2 million, respectively, including such
deposits.

Fee-based assets under management at December 31, 1996, 1995 and 1994 were
as follows:

December 31,
---------------------------------------------------------
1996 1995 1994
---------------------------------------------------------
(DOLLARS IN MILLIONS) Amount Percent Amount Percent Amount Percent
- ----------------------------------------------------------------------------------------------------------------

Retail:
Investment portfolio options of variable annuities $ 844.3 69.7% $ 617.3 61.4% $ 388.9 76.3%

Institutional:
Marketing partnerships(1) 366.2 30.3 387.3 38.6 121.0 23.7
---------------------------------------------------------
Total fee-based assets
under management(2) $1,210.5 100.0% $1,004.6 100.0% $ 509.9 100.0%
---------------------------------------------------------
---------------------------------------------------------

(1) Off-balance sheet item.
(2) Does not include off-balance sheet assets managed by ARM Capital Advisors
for institutional clients and the State Bond Mutual Funds. Total fee-based
assets under management at December 31, 1996 and 1995 were $3,937.9 million
and $2,443.7 million, respectively, including such assets.

VARIABLE ANNUITY CONTRACTS. Variable annuity contracts issued by the
Company's insurance subsidiaries are distributed through independent
broker-dealers, stockbrokers and financial institutions. Under variable
annuity contracts, customers may allocate all or a portion of their account
values to a separate account that invests in shares of one or more investment
portfolios (registered investment companies). Values in the separate account
will vary with the investment performance of the underlying investment
portfolio. The Integrity Companies receive income in the form of mortality
and expense fees based primarily on the market value of the invested deposits
and of administrative expense charges in connection with variable annuity
contract deposits in investment portfolios. The Company reinsures most of the
mortality risk associated with its variable annuity contracts. The Integrity
Companies also receive spread income from deposits allocated to the Company's
GRO products. Because the investment risk under the investment portfolio
options of variable annuity products is borne by the customer, these products
are treated as securities under federal securities laws and, therefore, the
salespeople are both appointed as insurance agents for the Company's
insurance subsidiaries and registered as securities representatives. In
addition, ARM Capital Advisors earns fee income by serving as an advisory
manager and by providing supervisory and administrative services to the
portfolios of the Legends Fund. Shares of the Legends Fund are offered only
to the separate accounts of Integrity and National Integrity.

MARKETING PARTNERSHIP ARRANGEMENTS. The Company is currently party to a
marketing partnership arrangement with General American (with respect to
GICs) and, as part of such arrangement, the Company receives fees for certain
administrative, asset/liability, product development and marketing support
activities associated with GIC deposits that are recorded on General
American's balance sheet. In addition, the Company's fee-based marketing and
product development relationship with General American has led to
opportunities for spread-based business through reinsurance of the products
involved, currently GICs. Since September 1995, the Company's insurance
subsidiaries have been participants in reinsurance agreements with General
American, assuming 50% of certain GIC business on a coinsurance basis. The
Company may enter into marketing partnership arrangements with other
unaffiliated insurance companies in the future.

DISTRIBUTION

RETAIL DISTRIBUTION
The Company's retail distribution strategy is focused on diversifying sales
of its products across various distribution channels, reducing its reliance on
any one third-party marketing organization and providing superior services to
its producers and customers. Currently, the Company's fixed, variable and
equity-indexed annuities are sold through the stockbroker, independent agent,
independent broker-dealer and financial institution channels. In addition,
registered representatives affiliated with ARM Securities sell the Company's
face-amount certificates and independent third-party mutual funds.

During 1996, the Company began the process of working with its
distribution channels to enhance its existing products and develop new
products that are customized to meet the needs of customers in each channel.
The Company has initiated a streamlined product development process designed
to enable the Company to respond quickly to changes in the marketplace and
reduce the time required to introduce new or enhanced products. By working
with distribution channels in this manner, the Company was one of the first
to recognize the market opportunity for equity-indexed annuities and
introduced OMNI, the Company's equity-indexed annuity product in mid-1996.
Based on these initial marketing efforts, the Company is currently developing
a second generation of equity-indexed products that will provide enhanced
benefits to customers in the independent agent channel and will be more
appealing to other distribution channels. The Company's 1997 product
development efforts will also include the addition of new investment options
to GRANDMASTER and PINNACLE, the Company's variable annuity products, and the
introduction of a new product customized for the financial institution
channel.

In addition to diversifying sales across distribution channels, the Company
is focused on reducing its reliance on any one third-party marketing
organization. During 1996, this effort involved the development of an in-house
wholesaling unit, a function that in 1995 was performed by an outside marketing
organization. This unit works in the stockbroker and independent agent channels
and is responsible for generating sales from existing producers, recruiting and
developing new producers and promoting the features and benefits of the
Company's products through seminars and one-on-one meetings with producers. As a
result of these efforts, sales in the stockbroker and independent agent channels
increased to 21.2% and 18.3%, respectively, of total retail sales in 1996
compared with 16.8% and 7.5%, respectively, in 1995.

To strengthen relationships with existing producers and assist the
wholesaling unit in recruiting new producers, the Company has significantly
expanded its in-house capability to provide service to producers and to promote
the Company's products and services. Company representatives directly servicing
producers have immediate system response capabilities for virtually any service
request through the Company's PC-based client/server system. Service requests
can also be turned into sales opportunities by keeping producers informed of new
product features and current rate and performance information. In addition,
through this servicing group, the Company works with producers and customers to
retain existing business. As a result of a program implemented in 1994 to
improve persistency, the Company was able to retain $21.0 million and $42.0
million in retail annuity business during 1996 and 1995, respectively, from
customers who had initiated requests to surrender their policies and were
provided with additional choices and incentives to keep their deposits with the
Company.

By diversifying distribution channels, the Company can reduce the impact of
losing any one channel. The Company seeks to expand the depth and breadth of
existing channels to capture additional market share without relying on the
capabilities and influence of a small number of producers.

Retail sales by market and distribution channel for the years ended
December 31, 1996 and 1995 were as follows:

Year Ended December 31,
-------------------------------------
1996 1995
-------------------------------------
Percent Percent
(DOLLARS IN MILLIONS) Amount of Total Amount of Total
- ---------------------------------------------------------------------
Distribution channel:
Stockbrokers $ 70.2 21.2% $ 49.3 16.8%
Independent agents 60.6 18.3 22.1 7.5
Independent broker-dealers 199.0 60.2 212.6 72.5
Financial institutions 0.9 0.3 9.1 3.2
-------------------------------------
Total sales* $ 330.7 100.0% $ 293.1 100.0%
-------------------------------------
-------------------------------------

* Does not include new deposits related to off-balance sheet assets managed
by ARM Capital Advisors for the State Bond Mutual Funds. Total retail sales
for the years ended December 31, 1996 and 1995 were $342.7 million and
$300.9 million, respectively, including such deposits.

INSTITUTIONAL DISTRIBUTION

In the institutional market, a significant level of assets can be
gathered to manage with relatively minimal overhead or marketing expenses. A
small team of in-house marketing professionals is able to market and sell the
Company's products. The Company's products are distributed directly to
defined contribution plans, bank trust departments, investment managers,
consultants, corporate treasurers, cash management funds, endowments and
foundations, and other insurance companies. With products where the Company's
financial strength ratings constrain in its ability to underwrite products
directly, the Company structures arrangements with highly rated and respected
partners, in essence, to raise the level of credit strength backing the
performance guarantees.

Institutional sales by in-house marketing professionals for the years ended
December 31, 1996 and 1995 were $747.5 million and $415.1 million, respectively.
These sales do not include deposits related to off-balance sheet assets managed
by ARM Capital Advisors for institutional clients. Institutional sales including
such deposits for the years ended December 31, 1996 and 1995 were $2,401.5
million and $886.9 million, respectively.

ASSET/LIABILITY SPREAD MANAGEMENT

The Company views asset/liability spread management as an integrated
process, rather than as a series of segregated functions, and integrates this
process into each aspect of its operations. The

Company's overall goal is to ensure that invested asset cash flows will be
sufficient to meet all customer obligations and to maximize investment spreads
on a consistent basis. Beginning with product design and continuing through the
product sale and eventual payout, professionals in each functional area (such as
marketing, actuarial, investments, legal, finance and administration) work
jointly with a common set of risk/return characteristics toward the goal of
achieving the Company's liquidity and profit objectives (rather than the
specific objectives of any particular functional area). The Company also
conducts periodic thorough analyses of its assets and liabilities using
sophisticated software to model the effect of changes in economic conditions on
both its assets and liabilities.

During product development, the Company sets product features and rate
crediting strategies only after it has devised an appropriate investment
strategy that matches the features of the product. The Company employs an
extensive, iterative modeling process to test various asset combinations against
proposed product features over sets of randomly generated interest rate
scenarios. The modeling evaluates whether a particular investment strategy, when
matched with the product features under consideration, will provide adequate
cash flow and generate returns that exceed specified minimum targets
consistently and without significant fluctuations. If necessary, the Company
redesigns investment strategies or product features until these objectives are
met.

The Company utilizes a few key strategies in managing its spread-based
products. One example is an immunization strategy currently used for the
Company's GRO products, in which a portfolio of assets is constructed and
managed to seek a predictable return over a pre-established time horizon. By
the way the Company engineers and packages these products, the Company is
able to custom design and deliver products to suit the needs of different
types of customers in both the retail and institutional marketplaces. This
approach also allows the Company to leverage its resources and expertise.

Once the Company has identified an asset portfolio having the desired
performance characteristics, the Company's investment managers have the
flexibility to trade the portfolio in order to maximize yields while remaining
within well-defined risk parameters (such as duration, convexity, credit quality
and liquidity). In so doing, these professionals follow prescribed measures
designed to (i) minimize anticipated defaults, (ii) minimize anticipated call,
prepayment or extension losses and (iii) enhance yield through sector rotation
and security selection. In addition, the Company aims to generate and maintain
liquidity from scheduled interest and principal payments, projected prepayments
and early calls, cash on hand, floating rate securities and lines of credit (but
not from new product sales), sufficient to presently cover approximately two
times expected cash needs (for benefits, withdrawals, expenses and dividends)
without having to sell any investments at a material loss.

Internal control measures are in place throughout the process to make
any necessary adjustments in the investment portfolio as promptly as
possible. For example, company personnel assess, independently of portfolio
managers, whether trades would alter portfolio characteristics and how
investment yields or realized gains or losses would be accounted for under
statutory accounting practices and generally accepted accounting principles
("GAAP"). The Company also remodels its assets and liabilities periodically
to determine

whether any significant changes in assumptions or interest rates have occurred
or have been overlooked.

In pursuing its investment spread objectives, the Company focuses primarily
on cash flows to expected maturities on its investments, which are quantifiable
and measurable, rather than on estimated total returns to expected maturities or
to some intermediate date. This approach permits the Company to measure
specifically the changes in yield and cash flow on its investments at any given
time. This approach emphasizes securities which are liquid and easily tradeable.
For certain investments, such as common equities, real estate investments and
direct mortgages, the fair market value may be relatively difficult to determine
or predict, thereby further increasing the difficulty of calculating total
return. As a result, the Company invests primarily in fixed-income securities,
which can be more easily modeled and hedged.

The Company's array of spread-based deposits, with crediting rates pegged
to various points on the interest rate yield curve, also supports the Company's
approach to asset/liability management. The liability structures, in combination
with asset structures, generally are aimed at providing balance in the portfolio
as interest rates fluctuate. As a result, the Company believes it is better
positioned to achieve stable margins. In addition, the Company believes that
this diversity gives it flexibility to respond to changing market conditions and
to take advantage of investment opportunities.

SURRENDERS

To encourage persistency and discourage withdrawals, the Company's
spread-based and fee-based insurance products generally incorporate surrender
charges, market value adjustments and/or other features which may discourage or
prevent such surrenders or withdrawals for a specified number of years. As of
December 31, 1996, the Company had approximately $1.7 billion of customer
deposits (39% of total customer deposits) which were no longer subject to
surrender charges or other restrictions on withdrawal. During 1997, surrender
charges will no longer apply to additional existing customer deposits of
approximately $153.8 million. During the third quarter of 1994 and continuing to
date, the Company began implementing programs designed to improve persistency.
Such programs involve direct contact with customers and are designed to inform
customers of the financial strength of the Company and its insurance
subsidiaries and to describe other product offerings available.

REINSURANCE CEDED

The Company's insurance subsidiaries reinsure risks under certain of their
products with other insurance companies through reinsurance agreements. Through
these reinsurance agreements, substantially all mortality risks associated with
SPE and variable annuity deposits, and substantially all risks associated with
the variable life business have been reinsured. The Company's primary reinsurers
in respect of mortality risks associated with SPE deposits are Swiss Reinsurance
Company, RGA Reinsurance Company and The Equitable Life Assurance Society, which
are respectively rated A+, A+ and A by A.M. Best. Connecticut General Life
Insurance Company is the Company's principal reinsurer of the mortality risks
associated with variable annuity deposits and

is rated A+ by A.M. Best. Phoenix Home Life Mutual and American Franklin Life
are the Company's principal reinsurers in respect of risks associated with the
variable life business and are respectively rated A and A++ by A.M. Best. In
addition, Integrity cedes a block of SBM Life SPDAs on a coinsurance basis to
Harbourton Reassurance, Inc., and in accordance with the treaty all assets
supporting the liabilities are held in trust. Reinsurance does not fully
discharge the Company's obligation to pay policy claims on the reinsured
business; the ceding reinsurer remains responsible for policy claims to the
extent the reinsurer fails to pay such claims.

RATINGS AND RATING AGENCIES

Insurance companies are rated by independent rating agencies to provide
both industry participants and insurance consumers meaningful information on
specific insurance companies. Higher ratings generally indicate a higher
relative level of financial stability and a stronger ability to pay claims. The
basis for an opinion on a particular rating includes such factors as capital
resources, financial strength, demonstrated management expertise and stability
of cash flow as well as the quality of investment operations, administration and
marketing. These particular types of ratings are based upon factors relevant to
policyholders and are not directed toward protection of stockholders. Such
ratings are neither a rating of securities nor a recommendation to buy, hold or
sell any security. The Company's insurance subsidiaries currently hold ratings
from four such rating agencies: A.M. Best, Standard & Poor's Corporation
("S&P"), Duff & Phelps and Moody's Investors Service ("Moody's").

The Company's insurance subsidiaries are currently classified "A
(Excellent)" by A.M. Best, reflecting an upgrade from A- in October 1995. A.M.
Best's ratings are based upon an evaluation of the insurer's financial and
operating performance. A.M. Best's ratings range from "A++ (Superior)" to "F
(In liquidation)", and some companies are not rated.

The Company's insurance subsidiaries currently hold an "A (Good)"
claims-paying ability rating from S&P. This rating is based on current
information provided by the Company and other reliable sources on a voluntary
basis. The S&P claims-paying ability rating categories range from "AAA
(Superior)" to "D (Liquidation)."

In addition, the Company's insurance subsidiaries currently hold an "A-1"
short-term rating from S&P. The short-term rating is used for any obligation
whose maturity is typically one year or less or would apply to a put option or
demand feature which would give the policyholder the right to receive their
funds within one year. The S&P short-term rating categories range from "A-1+" to
"D."

Duff & Phelps provides claims-paying ability ratings which concern only the
likelihood of timely payment of policyholder obligations, and not the ability to
pay non-policyholder obligations. The Company's insurance subsidiaries currently
have a claims-paying ability rating from Duff & Phelps of "A+ (High)" and a
short-term claims paying ability of "D-1." Duff & Phelps claims-paying ability
ratings range from "AAA" to "DD" and short-term claims paying ability ratings
range from "D-1+" to "D-5".

Moody's has currently assigned the Company's insurance subsidiaries a "Baa1
(Adequate)" insurance financial strength rating. Moody's financial strength
rating reflects an insurance company's ability to pay policyholder obligations
and claims. Moody's ratings range from "Aaa (Exceptional)" to "C (Lowest)," and
some companies are not rated.

Customers and many financial institutions and broker-dealers tend to focus
on the A.M. Best ratings of an insurer in determining whether to buy or market
the insurer's annuities. If any of the Company's ratings were downgraded from
their current levels or if the ratings of the Company's competitors improved and
the Company's did not, the ability of the Company to distribute its products and
the persistency of its existing business could be adversely affected. Each of
the rating agencies reviews its ratings periodically, and there can be no
assurance that the Company's current ratings will be maintained in the future.

PRODUCER AND CUSTOMER SERVICE, TECHNOLOGY AND ADMINISTRATION

The Company seeks to build a strong customer base by offering high quality
and easily accessible service. To this end, the Company's objective is to
maintain an administrative infrastructure utilizing up-to-date technology,
efficient and effective work flow processes and well-trained personnel. This
infrastructure helps to bring new products to market quickly, enhance product
features and provide timely, accurate information to producers, customers and
management.

Sharing information across the organization supports the integrated
nature of the Company's business operations. Management believes that a
PC-based client/server data processing platform provides users with direct
access to information on a more efficient basis than a mainframe system. A
WAN links all voice and data communications in the Company's principal
locations of Kentucky, Ohio, New York and, following the SBM acquisition,
Minnesota. With proper security clearances, employees may access data bases
on file servers at any location. In addition, the Company has expanded
automated interfaces between systems to help minimize the potential for error
from manual intervention, reduce costs and strengthen internal controls. Some
of these servers are owned and operated directly by the Company. Other
servers and some mainframe systems are operated by external entities with
whom the Company contracts to perform certain investment and administrative
related functions. In 1997, the Company's main processing center in
Worthington, Ohio is being moved to and consolidated with the corporate
headquarters in Louisville in order to improve the effectiveness of service
delivery. The Company is planning to outsource certain systems or
administrative functions in which the Company does not possess critical mass
at this time.

In addition to expanding its WAN during 1996, the Company completed a
restructuring of its organizational and work flow management processes with the
objective of creating additional operating efficiencies. The Company has
implemented an image management and automated work flow management system in
order to significantly reduce the amount of paper and manual work that is
required to process transactions and to perform customer service. Software
development efforts and systems migration projects are intended to eliminate
computer processing redundancies in some lines of business and enhance the
Company's capability to bring increasingly complex and competitive products and
services to market. Producer customer service capabilities have expanded

with the Company's introduction in 1996 of an automated voice response system
for a majority of its retail customers. These customers now have twenty-four
hour access to account and unit values of their annuities. This alternative
supplements producers and customers speaking directly with the Company's
representatives or sending service requests through traditional mail services or
the Internet.

A significantly expanded Producer Services unit is dedicated to supporting
producers and promoting Company products and services to them. Through "one-stop
shopping," producers have direct telecommunications access to these
representatives. These representatives have immediate system response
capabilities for virtually any service request through the Company's PC-based
client/server system. Service requests can also be turned into sales
opportunities by keeping producers informed on new product features or current
rate and performance information.

Technology also allows the Company's producers and customers to be more
closely linked to the Company. The Company has developed and is in the process
of implementing technology which will expand its existing on-line Internet
services and provide new services to its producers and customers. For example,
through either the Internet or direct high speed phone lines, the Company can
equip bank representatives with the ability to offer the issuance of annuities
instantaneously in their branch offices. In addition, the Company's producers
and customers will have similar access to certain service features and inquiry
functions such as daily account values, investment transfers, policy forms and
sales literature.

The Company's Producer Services unit, through direct customer contact, has
also achieved measurable success with the retention of business. As a result of
a program implemented in 1994 to improve persistency, the Company was able to
retain $21.0 million and $42.0 million in annuity business during 1996 and 1995,
respectively, from customers who had initiated requests to surrender their
policies. These customers were provided with additional choices and incentives
to keep their deposits with the Company. This same unit proactively communicates
with annuity customers to advise them of the insurance subsidiaries' financial
strength and recent activities.

The Company maintains current plans to recover its systems and operations
promptly in the event of a disaster. For critical WAN applications, redundant
servers with backed-up data are in place in New York City, Worthington, Ohio and
Louisville, Kentucky, the Company's primary operating sites. Key functions are
intended to be available within a matter of a few hours. The Company intends to
develop revised disaster recovery plans with the anticipated move of operations
to Louisville to provide a similar level of recovery. For recovery of computer
systems accessed through external parties, these vendors provide their own
disaster recovery plans. Offsite storage of magnetic media ensures that data
processing systems and the imaging system can be restored in the event of a
disaster.

COMPETITION

The financial services industry is highly competitive, and each of the
Company's subsidiaries competes with companies that are significantly larger and
have greater access to financial and other resources.

The life insurance industry comprises approximately 1,800 companies in the
United States and is highly competitive, with no one company dominating any of
the principal markets in which the Company's insurance subsidiaries operate.
Many insurance companies and insurance holding companies have substantially
greater capital and surplus, larger and more diversified portfolios of life
insurance policies and annuities, higher ratings and greater access to
distribution channels than the Company's insurance subsidiaries. Competition is
based upon many factors, such as the form and content of annuity policies,
premiums charged, investment return, customer service, access to distribution
channels, financial strength and ratings of the company, experience and
reputation. The Company's insurance subsidiaries also encounter increasing
competition from banks, securities brokerage firms, mutual funds and other
financial intermediaries marketing insurance products, annuities and other forms
of savings and pension products.

On January 18, 1995, the United States Supreme Court held in NationsBank
of North Carolina v. Variable Annuity Life Insurance Company that annuities
are not insurance for purposes of the National Bank Act. In addition, the
Supreme Court also held on March 26, 1996 in Barnett Bank of Marion County v.
Nelson that state laws prohibiting national banks from selling insurance in
small town locations are pre-empted by federal law. The Office of the
Comptroller of the Currency also adopted a ruling in November 1996 that
permits national banks, under certain circumstances, to expand into other
financial services, thereby increasing potential competition for the Company.
At present, the extent to which banks can sell insurance and annuities
without regulation by state insurance departments is being litigated in
various courts in the United States. Although the effect of these recent
developments on the Company and its competitors is uncertain, the Company may
encounter increased competition from banks in the future. The Company
believes that the fact that it is not hampered with a large captive sales
force like many insurance companies is an advantage in enabling the Company
to create strategic alliances with banks and other financial institutions.

The principal competitive factors in the sale of annuity products are
product features, perceived stability of the insurer, customer service, name
recognition, crediting rates, and commissions. The Company's insurance
subsidiaries compete in their markets with numerous major national life
insurance companies. Management believes that its ability to compete with other
insurance companies is dependent upon its ability to develop competitive
products with unique features and services that focus on the needs of targeted
market segments and to build market share.

REGULATION

The Company's business activities are subject to extensive regulation. Set
forth below is a summary discussion of the principal regulatory requirements
applicable to the Company.

INSURANCE REGULATION
The Company's insurance subsidiaries are subject to regulation and
supervision by the states in which they are organized and in the other
jurisdictions where they are authorized to transact business. State insurance
laws establish supervisory agencies with broad administrative and supervisory
powers including granting and revoking licenses to transact business, regulation
of marketing and other trade practices, operating guaranty associations,
licensing agents, approving policy forms, regulating certain premium rates,
regulating insurance holding company systems,

establishing reserve requirements, prescribing the form and content of required
financial statements and reports, performing financial and other examinations,
determining the reasonableness and adequacy of statutory capital and surplus,
regulating the type and amount of investments permitted, limiting the amount of
dividends that can be paid without first obtaining regulatory approval, and
other related matters. The primary purpose of such supervision and regulation
under the insurance statutes of Ohio and New York, as well as other
jurisdictions, is the protection of policyholders rather than investors or
shareholders of an insurer. State insurance departments also conduct periodic
examinations of the affairs of insurance companies and require the filing of
annual and other reports relating to the financial condition of insurance
companies.

In recent years, the insurance regulatory framework has been placed under
increased scrutiny by various states, the federal government and the NAIC.
Various states have considered or enacted legislation that changes, and in many
cases increases, the states' authority to regulate insurance companies. Over the
past few years, the NAIC has approved and recommended to the states for adoption
and implementation several regulatory initiatives designed to reduce the risk of
insurance company insolvencies. These initiatives include new investment reserve
requirements, risk-based capital standards and restrictions on an insurance
company's ability to pay dividends to its stockholders. Specifically, the NAIC
"Codification of Statutory Accounting Principles" project may revamp the current
statutory accounting practices for the Company's insurance subsidiaries. Certain
proposals under consideration may have a negative impact on the statutory
surplus of the Company's insurance subsidiaries and thus their ability to pay
dividends to the Company. Issue papers have been released for industry review
and a first draft of the accounting practices manual is expected to be issued by
the NAIC in 1997. This project will not undermine the states' authority to make
a final determination on acceptable and appropriate accounting practices as the
NAIC proposals are subject to implementation only upon legislative enactment by
the applicable state legislature. The Company is monitoring developments in the
regulatory area and assessing the potential effects any changes would have on
the Company.

Although the federal government currently does not directly regulate the
business of insurance generally, federal initiatives can significantly affect
the insurance business. Legislation has been introduced from time to time in
Congress that could result in the federal government assuming a role in the
regulation of insurance companies. Congress and certain federal agencies are
investigating the current condition of the insurance industry in the United
States in order to decide whether some form of federal regulation of insurance
companies would be appropriate. It is not possible to predict the outcome of any
such congressional activity, which could result in the federal government
assuming some role in the regulation of the insurance industry, or the potential
effects thereof on the Company.

INSURANCE HOLDING COMPANY REGULATION. The Company and its affiliates are
subject to regulation under the insurance holding company statutes of Ohio, the
domiciliary state of Integrity, and of New York, the domiciliary state of
National Integrity, and under the insurance statutes of other states in which
the Integrity Companies are licensed to transact the business of insurance. Most
states have enacted legislation which regulates insurance holding company
systems, including acquisitions, extraordinary dividends, the terms of affiliate
transactions and other related matters. The Integrity Companies are required to
file certain reports in Ohio, New York and certain other

states, including information concerning their capital structure, ownership,
financial condition and general business operations. The Ohio and New York
insurance laws also require prior notice or approval of changes in control of an
insurer or its holding companies and of material intercorporate transfers of
assets and material agreements between an insurer and affiliates within the
holding company structure. Under the Ohio and New York insurance laws, any
person, corporation or other entity which seeks to acquire, directly or
indirectly, 10% or more of the voting securities of an Ohio or New York
insurance company or any of its parent companies is presumed to acquire
"control" of such insurance company and must obtain the prior approval of the
Ohio Insurance Director and New York Insurance Superintendent, respectively.
Prior to acquiring such control, the proposed acquirer must either file an
application containing certain information including, but not limited to, the
identity and background of the acquirer and its affiliates and the source and
amount of funds to be used to effect the acquisition, or obtain an exemption
from the approval requirement.

In the event of a default on the Company's debt or the insolvency,
liquidation or other reorganization of the Company, the creditors and
stockholders of the Company will have no right to proceed against the assets
of Integrity or National Integrity or to cause their liquidation under
federal or state bankruptcy laws. Insurance companies are not subject to such
bankruptcy laws but are, instead, governed by state insurance laws relating
to liquidation or rehabilitation due to insolvency or impaired financial
condition. Therefore, if Integrity or National Integrity were to be
liquidated or be the subject of rehabilitation proceedings, such liquidation
or rehabilitation proceedings would be conducted by the Ohio Insurance
Director and the New York Insurance Superintendent, respectively, as the
receiver with respect to all of Integrity's or National Integrity's assets
and business. Under the Ohio and New York insurance laws, all creditors of
Integrity or National Integrity, including policyholders, would be entitled
to payment in full from such assets before the Company or Integrity Holdings,
Inc. as indirect or direct stockholders, would be entitled to receive any
distribution therefrom.

DIVIDEND RESTRICTIONS. The Company's ability to declare and pay dividends
will be affected by Ohio and New York laws regulating the ability of National
Integrity to pay dividends to Integrity and the ability of Integrity to pay
dividends to the Company.

Under Ohio law, an Ohio domestic life insurance company may not make,
without the prior approval of the Ohio Insurance Director, dividend payments in
excess of the greater of (i) 10% of such insurance company's statutory capital
and surplus as of the preceding December 31 and (ii) such insurance company's
statutory net income for the preceding year. Under New York insurance law,
National Integrity may pay dividends to Integrity only out of its earnings and
surplus and may not distribute any dividends without at least 30 days' prior
written notice to the New York Insurance Superintendent, who may disapprove a
proposed dividend upon a determination that National Integrity's financial
condition does not warrant such distribution. Because National Integrity is a
subsidiary of Integrity, dividend payments made by National Integrity to
Integrity must be made in compliance with New York standards, and the ability of
Integrity to pass those dividends on to the Company is subject to compliance
with Ohio standards.

The maximum dividend payments that Integrity could have made to the Company
during 1996 were $17.6 million; dividends in the amount of $16.0 million were
paid during 1996. For 1997, the

maximum dividend payments that may be made by Integrity to the Company are $26.0
million of which $7.0 million was paid in the first quarter of 1997.

MANDATORY INVESTMENT RESERVE. Under NAIC rules, life insurance companies
must maintain an asset valuation reserve ("AVR"), supplemented by an interest
maintenance reserve ("IMR"). These reserves are recorded for purposes of
statutory accounting practices; they are not recorded under the provisions of
GAAP and therefore have no impact on the Company's reported results of
operations or financial position. These reserves affect the determination of
statutory surplus, and changes in such reserves may impact the ability of the
Integrity Companies to pay dividends or other distributions to the Company. The
extent of the impact of the AVR will depend upon the future composition of the
investment portfolio of the Integrity Companies. The extent of the impact of the
IMR will depend upon the extent of the gains and losses of the Integrity
Companies' investment portfolio and the related amortization thereof. Based on
the current investment portfolio of the Company's insurance subsidiaries, the
Company does not anticipate that expected provisions for the AVR and IMR will
materially adversely affect the ability of the Integrity Companies to pay
dividends or other distributions to the Company.

RISK-BASED CAPITAL REQUIREMENTS. The NAIC Risk-Based Capital ("RBC")
requirements evaluate the adequacy of a life insurance company's adjusted
statutory capital and surplus in relation to investment, insurance and other
business risks. The RBC formula is used by the states as an early warning tool
to identify potential weakly capitalized companies for the purpose of initiating
regulatory action and is not designed to be a basis for ranking the financial
strength of insurance companies. In addition, the formula defines a minimum
capital standard which supplements the previous system of low fixed minimum
capital and surplus requirements. The RBC requirements provide for four
different levels of regulatory attention depending on the ratio of a company's
adjusted capital and surplus to its RBC.

The consolidated statutory-basis capital and surplus of the Company's life
insurance subsidiaries totaled $163.8 million and $146.0 million at December 31,
1996 and 1995, respectively, and were substantially in excess of the minimum
level of RBC that would require regulatory action. In addition, the consolidated
statutory-basis AVRs of the Company's insurance subsidiaries totaled $15.6
million and $14.4 million at December 31, 1996 and 1995, respectively (excluding
voluntary reserves of $12.5 million and $5.0 million at December 31, 1996 and
1995, respectively). These reserves, together with voluntary reserves, are
generally added to statutory capital and surplus for purposes of assessing
capital adequacy against various measures used by rating agencies and
regulators.

GUARANTY FUND ASSESSMENTS. Under the insurance guaranty fund laws existing
in each state, insurers licensed to do business in the state can be assessed for
certain obligations of insolvent insurance companies to policyholders and
claimants. In connection with the acquisition by the Company of the Integrity
Companies from National Mutual, National Mutual agreed to indemnify the Company
for guaranty fund assessments levied in respect of companies declared insolvent
or subject to conservatorship prior to November 26, 1993. The amounts actually
assessed to and paid by the Company's insurance subsidiaries for the years ended
December 31, 1996, 1995 and 1994 were approximately $1.5 million, $1.1 million
and $0.7 million, respectively. Of such amounts,

approximately $0.5 million, $0.4 million and $0.7 million, respectively, were
reimbursed by National Mutual under its indemnity obligation to the Company.
Because such assessments are typically not made for several years after an
insurer fails and depend upon the final outcome of liquidation or rehabilitation
proceedings, the Company cannot accurately determine the precise amount or
timing of its exposure to known insurance company insolvencies at this time.
During 1996, 1995 and 1994, the Company recorded provisions for future state
guaranty fund association assessments of $1.6 million, $0.3 million and $0.4
million, respectively. At December 31, 1996, the Company's reserve for such
assessments was $6.6 million. No assurance can be given that the Company's
reserve for assessments or such indemnity will be adequate in the event of any
loss suffered by the Company in respect of any assessment made under state
insurance guaranty fund laws. The reserve does not include any provision for
future assessments related to unknown failures or to known failures for which no
estimate of the Company's exposure currently can be made. The Company estimates
its reserve for assessments using information provided by the National
Organization of Life and Health Guaranty Associations. The insolvency
of large life insurance companies in future years could result in additional
material assessments to the Company by state guaranty funds that could have a
material adverse impact on the Company's future earnings and liquidity.

TRIENNIAL EXAMINATIONS. The Ohio and New York insurance departments usually
conduct an examination of Integrity and National Integrity, respectively, every
three years, and may do so at such other times as are deemed advisable by the
Ohio Insurance Director and New York Insurance Superintendent. The report with
respect to the most recent triennial examination of Integrity issued in 1994
covered the periods 1990 through 1992 and contained no material adverse
findings. The report with respect to the most recent triennial examination of
National Integrity issued in 1994 covered the periods 1990 through 1992 and also
contained no material adverse findings. National Integrity is currently
undergoing a triennial examination by the New York insurance department.
Integrity is also currently undergoing a triennial examination by the Ohio
insurance department.

INSURANCE REGULATORY INFORMATION SYSTEM. The NAIC has developed a set of
financial relationships or "tests" called the Insurance Regulatory Information
System ("IRIS") that were designed for early identification of companies that
may require special attention by insurance regulatory authorities. These tests
were developed primarily to assist state insurance departments in executing
their statutory mandate to oversee the financial condition of insurance
companies. Insurance companies submit data on an annual basis to the NAIC, which
in turn analyzes the data using ratios covering twelve categories of financial
data with defined "usual ranges" for each category.

Falling outside the usual range of IRIS ratios is not considered a failing
result; rather, unusual values are viewed as a part of the regulatory early
warning monitoring system. Furthermore, in some years, it may not be unusual for
financially sound companies to have several ratios with results outside the
usual ranges. An insurance company may fall outside of the usual range for one
or more ratios because of specific transactions that are in themselves
immaterial or eliminated at the consolidated level. Generally, an insurance
company will become subject to increased regulatory scrutiny if it falls outside
the usual ranges of four or more of the ratios. In normal years, 15% of the

companies included in the IRIS system are expected by the NAIC to be outside the
usual range on four or more ratios.

In 1995, the Company's insurance subsidiaries were each outside of the
usual range for three IRIS ratios. For Integrity, the net change in capital and
surplus ratio was -12%, as compared to a usual range of between +50% and -10%.
This ratio was below the usual range because the specific line items in the
financial statements used to prepare the ratios included a $15.3 million direct
charge to paid-in capital that SBM Life recognized as a result of
marking-to-market its bond portfolio in connection with its acquisition by the
Company, but did not include the $19.9 million capital contribution that the
Company made to offset that charge. Integrity's change in premium ratio was
- -25%, as compared to a usual range of between +50% and -10%. This ratio was
below the usual range because of a decrease in premiums caused by (i) greater
competition from banks and other financial institutions for savings products
primarily as a result of the flattening of the yield curve during 1995 and
(ii) lower SBM Life sales in 1995 due to (a) termination of a modified
coinsurance reinsurance agreement under which SBM Life had assumed premiums of
$18.2 million during 1994 and (b) a downgrade of SBM Life's rating by A.M. Best
at the end of 1994 from "A- (Excellent)" to "B+ (Very Good)" (although following
the acquisition, this rating was upgraded in October 1995 to "A (Excellent)").
Finally, Integrity's change in reserving ratio was -99%, as compared with a
usual range of between +20% and -20%. This ratio measures the difference in
reserves as a percentage of premiums from one year to the next. The change in
this ratio was below the usual range because premiums (the denominator of the
fraction), excluding deposits for deferred annuity and GIC products, fell from
$23.0 million in 1994 to approximately $1.5 million in 1995 largely as a result
of the termination in 1995 of SBM Life's modified coinsurance reinsurance
agreement.

For National Integrity, the change in premium ratio was +68%, as compared
to a usual range of between +50% and -10%, and the change in product mix ratio
was 9.9%, whereas the usual change does not exceed 5%. The reason for both
ratios being above the usual range was the increase in sales of GICs in 1995 and
the decrease in sales of deferred annuity products, which events were primarily
attributable to the relative advantage enjoyed by shorter-maturity products in
that year as a result of the flattening of the yield curve. Finally, National
Integrity's change in reserving ratio was -99%, as compared with a usual range
of between +20% and -20%. This ratio was below the usual range because National
Integrity reduced reserves for ordinary life business by $1.0 million in 1995 as
a consequence of an increase in death and surrender benefits of $0.9 million
paid on this closed block of business.

OTHER REGULATION
The Company's non-insurance activities are also subject to extensive
regulation. ARM Capital Advisors is registered with the Securities and Exchange
Commission ("SEC") as an investment adviser under the Investment Advisers Act of
1940 (the "Advisers Act") and is subject to regulation and examination under the
Employee Retirement Income Security Act ("ERISA") by the U.S. Department of
Labor and under the Advisers Act by the SEC. In addition, variable annuities and
the related separate accounts of the Company's insurance subsidiaries are
subject to regulation by the SEC under the Securities Act and the
Investment Company Act.

The Company's broker-dealer subsidiary, ARM Securities, is registered with
the SEC under the Securities Exchange Act of 1934 and is subject to regulation
by the SEC. ARM Securities is also subject to regulation, supervision and
examination by the states in which it transacts business, as well as by the
NASD. The NASD has broad administrative and supervisory powers relative to all
aspects of ARM Securities' business and may examine its business and accounts at
any time.

SBM Certificate Company is subject to regulation and supervision by federal
and state regulators. The Investment Company Act and rules issued by the SEC
thereunder specify certain terms applicable to face-amount certificates, the
method for calculating reserve liabilities on outstanding certificates, the
minimum amounts and types of investments to be deposited with a qualified
custodian to support such reserve liabilities, and a variety of other
restrictions on the operation and governance of a face-amount certificate
company. Pursuant to statutory authority, the Minnesota Department of Commerce
(the "MDC") exercises supervisory powers over SBM Certificate Company's
face-amount certificate business similar to those exercised by the SEC under the
Investment Company Act. In addition, the MDC conducts annual examinations of SBM
Certificate Company. The offer and sale of its face-amount certificates also are
subject to federal and state securities laws.

ARM Transfer Agency was established to provide transfer agent services to
the Company as needed. ARM Transfer Agency, a wholly owned subsidiary of the
Company, is registered with the SEC and is subject to examination by the SEC.

The securities laws and regulations referred to above generally grant
supervisory agencies and bodies broad administrative powers, including the power
to fine, limit or restrict a firm from conducting its business in the event that
it fails to comply with such laws and regulations. In addition to maintaining
registrations, the regulatory requirements include reporting, maintaining books
and records in prescribed forms, maintaining certain mandatory custodial
arrangements, approving employees, representatives and, in some cases, owners,
and other compliance procedures. Possible sanctions that may be imposed in the
event of noncompliance include, without limitation, the suspension of individual
employees, limitations on the firm's engaging in business for specified periods
of time, revocation of the firm's registration as an investment advisor or
broker-dealer, censures and fines. The regulators make periodic examinations and
review annual, monthly and other reports on the operations of the Company or its
subsidiaries. Changes in these laws or regulations could have a material adverse
impact on the profitability and mode of operations of the Company.

The Company's and ARM Capital Advisors' standard investment management
agreements expressly provide that they may not be assigned by a party without
the prior written consent of the other party. Under the Advisers Act and the
Investment Company Act, an investment management agreement of any firm is
deemed to have been assigned when there is a "change in control" of the firm,
either directly or indirectly, as through a transfer of a "controlling block"
of the firm's voting securities or, under certain circumstances, upon the
transfer of a "controlling block" of the voting securities of its parent
corporation. The Investment Company Act presumes that any person holding more
than 25% of the voting stock of any person "controls" such person. If such a
change in control were to occur, all investment management agreements between
the firm and its clients would terminate, unless the

clients consent to the continuation of the agreements. Under the Investment
Company Act, substantially similar change of control principles apply with
respect to investment management agreements with mutual funds and mandate
stockholder approval for deemed assignments of investment management agreements.
Following completion of a proposed public offering of common stock, significant
sales of existing or issuances of new common stock by the Company, among other
things, may raise issues relating to a deemed assignment of the Company's
investment management agreements under such statutes.

EXAMINATIONS. The SEC conducts routine examinations of the Company's
registered investment adviser operations to ensure compliance with the
requirements prescribed by the Advisers Act. Similarly, the NASD regulates the
activities of the Company's broker-dealer operations and conducts routine
examinations thereof.

EMPLOYEES
At December 31, 1996, the Company and its subsidiaries had approximately
300 employees, none of whom was represented by a labor union. The Company
believes that its relations with its employees are good.

ITEM 2. PROPERTIES

The Company leases approximately 31,010 square feet of office space in
Louisville, Kentucky under a lease agreement (the "Lease") which expires on
September 1, 2006, and which is subject to two five-year renewal options.
This office space accommodates the executive, marketing, product development,
actuarial, accounting, corporate finance and legal functions of the Company.
The Company is also negotiating to lease an additional 31,000 square feet in
the Louisville office to accommodate the relocation of the Company's main
processing center, including information systems, customer service and policy
issuance activities, which is currently housed in the Columbus, Ohio
vicinity. The Company executed a $1.1 million standby letter of credit with
one of its lending institutions to secure the Company's obligations under the
Lease.

In addition to its headquarters, the Company and its subsidiaries lease
approximately 62,000 square feet of office space in the Columbus, Ohio vicinity
and approximately 7,500 square feet of office space in New York, New York. The
Columbus office space houses the Company's main processing center which is being
relocated and consolidated with the corporate headquarters in Louisville as
mentioned above. The operations of the Company's asset management subsidiary,
ARM Capital Advisors, and New York insurance subsidiary, National Integrity, are
conducted from the New York facility. Additional office space owned in New Ulm,
Minnesota supports the distribution operations of SBM Certificate Company.

ITEM 3. LEGAL PROCEEDINGS

As a consequence of the acquisition of SBM Life and SBM Life's merger
with and into Integrity, Integrity became a party to a marketing agreement
with Multico Marketing Corporation ("Multico"). In reliance upon the
marketing agreement, Integrity eliminated commissions to Multico on new

product sales on a prospective basis effective July 1, 1995. Multico filed a
lawsuit in the United States District Court for the Western District of Kentucky
against Integrity on February 23, 1996, alleging breach of contract and breach
of the covenant of good faith and fair dealing, and seeking a trial by jury and
compensatory and punitive damages of approximately $61 million. Integrity filed
a counterclaim against Multico seeking a declaration that Integrity's actions in
revising commissions did not constitute a breach of contract, and the recovery
of commissions, fees, trailers, overwrites and bonuses paid to Multico in the
amount of approximately $9.3 million. Discovery is proceeding between the
parties. On May 23, 1996, Integrity filed a motion for summary judgment in the
litigation; this motion was denied by the court on March 10, 1997. It is
anticipated that the parties will proceed with further discovery. Company
management believes that the ultimate resolution of this litigation will not
result in any material adverse impact to the financial position of the Company.

Except as described above, the Company is currently involved in no material
legal or administrative proceedings that could result in a material adverse
impact on the financial position of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the fourth
quarter of 1996.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

The Company's voting stock, comprised of Class A and Class B common
stock (collectively, the "Common Stock"), is not publicly traded.
Approximately 91% of the outstanding shares of the Common Stock of the
Company are held by certain private equity funds sponsored by Morgan Stanley
Group Inc. The remaining shares of the Common Stock are held by New ARM, LLC,
Oldarm L.P., certain members of management, the Company's independent
directors, and certain current and former employees of the Company.

The preferred stock of the Company has been listed for trading on the
American Stock Exchange (the "AMEX") since December 7, 1993 under the symbol
"ARM Pr". Based upon information supplied by the AMEX, the high and low sales
prices on the AMEX during 1996 and 1995 were as follows:

1996 1995
----------------------------------- ---------------------------------
Cash Cash
Dividend Dividend
High Low Per Share High Low Per Share
----------------------------------- ---------------------------------

1st Quarter $ 27 1/4 $ 25 1/2 $ 0.59375 $ 23 $ 20 5/8 $ 0.59375
2nd Quarter 26 1/8 25 0.59375 25 1/4 22 0.59375
3rd Quarter 26 25 1/4 0.59375 26 1/4 24 7/8 0.59375
4th Quarter 27 25 1/2 0.59375 26 5/8 25 5/8 0.59375

As of February 28, 1997, there were approximately 3,012 holders of record
of the outstanding shares of preferred stock.

The Company is dependent on dividends from Integrity and management and
service fee income from the Company's subsidiaries to meet ongoing cash needs,
including amounts required to pay dividends on the preferred stock. The ability
of the Company's insurance subsidiaries to pay dividends and enter into
agreements with affiliates is limited by state insurance laws.

On February 13, 1997, the Company declared a preferred stock dividend of
59.375 cents per share payable on March 17, 1997, to record holders as of
February 28, 1997.

ITEM 6. SELECTED FINANCIAL DATA

The following table sets forth selected historical financial information
of the Company for the years ended December 31, 1996, 1995 and 1994, for the
period from November 27, 1993 through December 31, 1993, for the period from
January 1, 1993 through November 26, 1993 (for the Historical Integrity
Companies) and for the year ended December 31, 1992 (for the Historical
Integrity Companies). The financial information for the years ended December
31, 1996, 1995 and 1994 and for the periods from January 1, 1993 through
November 26, 1993 and November 27, 1993 through December 31, 1993 has been
derived from consolidated financial statements of the Company, prepared in
conformity with GAAP, that have been audited by Ernst & Young LLP. The
financial information for the Historical Integrity Companies for the year
ended December 31, 1992 has been derived from financial statements of the
Historical Integrity Companies.

Effective May 31, 1995, the Company acquired substantially all of the
assets and business operations of SBM. This acquisition was accounted for as a
purchase, and the results of operations of the acquired businesses are included
in the Company's historical financial information from the date of acquisition.
Because 1996 includes a full year of acquired SBM business operations compared
to seven months in 1995, the results of operations for 1996, 1995 and 1994 are
not completely comparable. "Historical Integrity Companies" refers to
operations, for accounting and reporting purposes, prior to the Company's
November 26, 1993 acquisition of the Integrity Companies. The Historical
Integrity Companies' results of operations for 1993 and 1992 are presented for
purposes of comparison; however, because of purchase accounting adjustments, the
new capital structure and new management team resulting from that acquisition,
the Company's results have differed from the results of the Historical Integrity
Companies.

The selected historical financial information set forth below should be
read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations," the Company's consolidated financial
statements and the notes thereto and other financial and operating information
included herein.

The Company Historical
Integrity Companies(1)
------------------------------------------------- -----------------------------
Period from Period from
November 27, January 1,
1993 through 1993 through Year Ended
(IN THOUSANDS, Year Ended December 31, December 31, November 26, December 31,
EXCEPT SHARE AMOUNTS AND ------------------------------------
PER SHARE AMOUNTS) 1996 1995 1994 1993 1993 1992
- -----------------------------------------------------------------------------------------------------------------------

INCOME STATEMENT DATA:

Investment income $ 250,031 $ 196,024 $ 149,142 $ 16,260 $ 148,120 $ 158,037

Interest credited on
customer deposits (182,161) (146,867) (116,463) (13,563) (116,341) (122,190)
------------------------------------------ --------- ---------- ----------

Net investment spread 67,870 49,157 32,679 2,697 31,779 35,847

Fee income:

Variable annuity fees 10,786 7,238 4,291 91 1,000 123

Asset management fees 5,780 3,161 -- -- -- --

Other fee income 1,267 949 4,100 369 1,258 2,063
------------------------------------------ --------- ---------- ----------

Total fee income 17,833 11,348 8,391 460 2,258 2,186

Other income and expenses:

Surrender charges 5,024 3,339 2,356 145 1,615 1,837

Operating expenses (31,055) (22,957) (21,484) (1,423) (30,663) (25,461)

Commissions, net of
deferrals (2,372) (1,557) (2,551) (309) (4,877) (1,766)

Interest expense on debt (3,146) (3,461) (3,136) (245) (133) (546)

Amortization:

Deferred policy
acquisition costs (6,835) (2,932) (1,296) (12) (1,470) (1,045)

Value of insurance
in force (7,320) (7,104) (3,830) (552) (6,444) (41,594)

Acquisition-related
deferred charges (1,503) (9,920) (2,163) (249) -- --

Goodwill (488) (358) -- -- -- (8,978)

Non-recurring charges (5,004) -- -- -- -- --

Other, net (5,366) (687) 4,972 (46) -- (6,434)
------------------------------------------ --------- ---------- ----------

Total other income
and expenses (58,065) (45,637) (27,132) (2,691) (41,972) (83,987)

Realized investment gains
(losses) 907 4,048 (36,727) (79) (32,776) (9,759)
------------------------------------------ --------- ---------- ----------

Income (loss) before federal
income taxes 28,545 18,916 (22,789) 387 (40,711) (55,713)

Federal income tax benefit
(expense) (5,167) (7,026) 6,018 (508) -- --
------------------------------------------ --------- ---------- ----------

Net income (loss) 23,378 11,890 (16,771) (121) $(40,711) $(55,713)
---------- ----------
---------- ----------
Dividends on preferred stock (4,750) (4,750) (4,750) (462)
------------------------------------------ ---------

Net income (loss) applicable
to common shareholders $18,628 $7,140 $(21,521) $(583)
------------------------------------------ ---------
------------------------------------------ ---------

Net income (loss)
per common share $ 751.58 $ 344.94 $(1,434.73) $(38.87)
------------------------------------------ ---------
------------------------------------------ ---------

Average common shares
outstanding 24,785 20,699 15,000 15,000
------------------------------------------ ---------
- ---- ------------------------------------------ ---------

OTHER OPERATING DATA:

Operating earnings (loss)(2) $22,577 $4,509 $2,352 $ (532)
------------------------------------------ ---------
------------------------------------------ ---------
Operating earnings (loss)
per common share $ 910.91 $ 217.84 $ 156.80 $ (35.47)
------------------------------------------ ---------
------------------------------------------ ---------

The Company Historical
Integrity Companies
------------------------------------------------- -----------------------------
December 31, December 31
(IN THOUSANDS) 1996 1995 1994 1993 1992
- ----------------------------------------------------------------------------------------------------------------------

BALANCE SHEET AND OTHER DATA:

Total cash and investments (3) $ 3,347,477 $ 2,798,027 $ 1,782,501 $ 2,103,856 $ 1,838,435

Assets held in separate accounts 1,135,048 809,927 506,270 231,687 38,952

Total assets(3) 4,701,664 3,793,580 2,447,888 2,427,886 1,991,205

Long-term debt 40,000 40,000 40,000 40,000 --

Total liabilities 4,519,722 3,605,589 2,462,021 2,315,535 1,857,978

Shareholders' equity:

Carrying amount(3) 181,942 187,991 (14,133) 112,351 133,227

Excluding the effects
of SFAS No. 115(4) 178,273 159,461 90,816 n/a n/a

Fair value(5) 224,276 187,721 115,192 111,709 n/a

(1) The Company had no significant business activity until November 26, 1993,
when it acquired the Integrity Companies from National Mutual. Results of
operations prior to the acquisition for the period from January 1, 1993
through November 26, 1993 and the year ended December 31, 1992 are
presented for comparative purposes.

(2) "Operating earnings" is defined as net income applicable to common
shareholders, excluding, net of tax, realized investment gains and losses
and non-recurring charges.

(3) Total cash and investments, total assets and carrying amount shareholders'
equity for the periods ending subsequent to December 31, 1993 reflect a
change in accounting principle for the January 1, 1994 adoption of SFAS
No. 115, "Accounting for Certain Investments in Debt and Equity
Securities."

(4) Excludes from carrying amount shareholders' equity the net unrealized gains
and losses on securities classified as available-for-sale, net of related
amortization and taxes.

(5) The methodologies used to estimate fair value are described in the notes to
the consolidated financial statements contained herein.

n/a Not applicable.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION

GENERAL

The Company specializes in the asset accumulation business, providing
retail and institutional customers with products and services designed to
serve the growing long-term savings and retirement markets.

The Company's revenues are derived from its spread-based business and its
fee-based business. The products and services comprising the spread-based and
fee-based businesses are sold in two principal markets, the retail and
institutional markets, through a broad spectrum of distribution channels. In the
spread-based line of business the Company earns a spread between what is earned
on invested assets and what is credited to customer accounts. In the fee-based
line of business the Company receives a fee in exchange for managing customers'
deposits, and the customer accepts the investment risk. The Company believes
that market forces and population demographics are producing and will continue
to generate strong consumer demand for long-term savings and retirement
products, including variable and equity-indexed annuity type products.
Acquisitions by the Company have provided it with the opportunity to leverage
its resources and enter into new markets in order to try to meet this demand.
The Company has focused on the development of its fee-based variable annuity
business in addition to exploring other alternatives to increase the size of the
fee-based business line, which is less capital intensive than the spread-based
business and provides the Company with diversified sources of income. Although
the Company believes it is desirable to achieve a reasonable business mix
between its spread-based and fee-based businesses, the business mix may vary
from time to time, due to opportunistic acquisitions.

Although third-party assets managed by ARM Capital Advisors have grown
since the KBIMA acquisition, the Company believes that market attitudes towards
developing an asset management service for defined benefit pensions plans within
a holding company structure consisting predominantly of insurance companies has
constrained ARM Capital Advisors' growth. Accordingly, the Company is in the
process of selling the operations and assets of ARM Capital Advisors. ARM
Capital Advisors' management of defined benefit pension plan accounts generated
asset management fees of $4.2 million and $2.2 million during 1996 and 1995,
respectively. On December 13, 1996, the Company transferred its contracts to
perform management and advisory services for the State Bond Mutual Funds to
Federated Investors for $4.5 million. Asset management fee income of $1.6
million and $1.0 million was recorded by the Company during 1996 and 1995,
respectively, with respect to management of such funds. Had the sale of ARM
Capital Advisors and the sale of the management contracts for the State Bond
Mutual Funds occurred on January 1, 1995, they would have had an immaterial
effect on the Company's pro forma net income for the years ended December 31,
1996 and 1995.

The following discussion compares the results of operations for the Company
for the three years ended December 31, 1996. As the Company acquired
substantially all of the assets and business operations of SBM effective May 31,
1995, results for 1996 include a full year of acquired SBM business operations
compared to seven months in 1995. Therefore, results of operations for 1996,
1995 and 1994 are not necessarily comparable.

RESULTS OF OPERATIONS

1996 COMPARED TO 1995

During 1996, net income for the Company was $23.4 million compared to $11.9
million for 1995. Operating earnings (net income applicable to common
shareholders, excluding, net of tax, realized investment gains and losses and
non-recurring charges) were $22.6 million and $4.5 million for 1996 and 1995,
respectively. The increase in operating earnings is primarily attributable to
(i) an increase in net investment spread due to ongoing asset/liability
management and deposit growth from the full year's effects of the May 31, 1995
acquisition of the SBM assets and business operations and additional sales of
spread-based products and (ii) an increase in fee income as a result of a
growing base of variable annuity deposits and institutional assets under
management. Such increases in revenues were partially offset by an increase in
operating expenses as a result of business growth.

Spread-based operating earnings were 1.05% and 0.90% of average
spread-based assets under management of $3.22 billion and $2.47 billion during
1996 and 1995, respectively. This increase in spread-based margins is primarily
attributable to ongoing asset/liability management, which generated higher net
investment spreads. Fee-based operating earnings were 0.15% and 0.19% of average
fee-based assets under management of $3.28 billion and $1.84 billion during 1996
and 1995, respectively. Fee-based margins for the 1996 period were slightly
lower compared to the corresponding prior period primarily from the growth of
institutional fee-based assets under management which generated lower margins
than the Company's variable annuity deposits. Certain expenses including federal
income taxes and unallocated corporate overhead are not reflected in
spread-based and fee-based operating earnings.

Net investment spread for the years ended December 31, 1996 and 1995 was as
follows:

Year Ended December 31,
------------------------
(DOLLARS IN THOUSANDS) 1996 1995
- ----------------------------------------------------------------
Investment income $ 250,031 $ 196,024
Interest credited on customer deposits (182,161) (146,867)
------------------------
Net investment spread $ 67,870 $ 49,157
------------------------
------------------------

Investment yield 7.75% 7.84%
Average credited rate 5.67% 5.90%
------------------------
Investment spread 2.08% 1.94%
------------------------
------------------------

Average cash and investments $3,227,825 $2,501,125
Average customer deposits 3,213,313 2,488,866

The decrease in investment yields on cash and investments primarily
relates to a significant increase in GIC deposits which grew from zero to
$143.2 million during 1995 and to $891.9 million at December 31, 1996. The
proceeds from GIC sales are invested in securities of shorter duration (which
generally have lower investment yields) than the Company's other investment
portfolios. The investment yield on cash and investments supporting GIC
deposits was 6.53% for 1996. In comparison, the investment yield on cash and
investments, excluding assets supporting GIC deposits, was 8.01% for 1996, up
from 7.85% for 1995, which reflects the benefits of the ongoing management of
the Company's investment portfolios. The average credited rate pattern is
dependent upon the general trend of interest rates, frequency of credited
rate resets and business mix. The decrease in the average rate of interest
credited on customer deposits during 1996 was due primarily to annual or
semi-annual crediting rate resets occurring at a time when the overall
interest rate environment was generally lower (the last half of 1995 and the
first half of 1996 compared to the last half of 1994 and the first half of
1995).

Fee income increased to $17.8 million in 1996 from $11.3 million in 1995.
This increase is in part attributable to variable annuity fees which are based
on the market value of assets supporting the investment portfolio options of
variable annuity customer deposits in separate accounts. Variable annuity fees
increased to $10.8 million in 1996 from $7.2 million in 1995 principally due to
asset growth from the receipt of variable annuity deposits and from a
market-driven increase in the value of existing variable annuity deposits
invested in mutual funds. Fee-based variable annuity deposits increased to
$844.3 million in 1996 from $617.3 million in 1995. In addition, asset
management fees earned by ARM Capital Advisors on off-balance sheet assets,
related to defined benefit pension plans and the State Bond Mutual Funds,
increased to $5.8 million in 1996 from $3.2 million in 1995. This increase in
asset management fees reflects a significant increase in the average amount of
corresponding off-balance sheet assets managed due to new defined benefit
pension plan accounts. The average amount of off-balance sheet assets managed by
ARM Capital Advisors was $2.16 billion in 1996 compared to $1.10 billion in
1995. With the proposed sale of 80% of ARM Capital Advisors and the sale of the
State Bond Mutual Funds, asset management fee income is expected to decrease in
the future.

Assets under management by type of product and service as of December 31,
1996 and 1995 were as follows:

1996 1995
---------------------------------------------
Percent Percent
(DOLLARS IN MILLIONS) Amount of Total Amount of Total
- -----------------------------------------------------------------------------------------

Spread-based:
Retail (fixed annuity, guaranteed rate
option and face-amount certificate
deposits) $2,646.2 55% $2,716.2 69%
Institutional (GIC deposits) 891.9 18 143.2 4
---------------------------------------------
Total spread-based 3,538.1 73 2,859.4 73
Fee-based:
Retail (investment portfolio options of
variable annuity deposits) 844.3 17 617.3 16
Institutional (off-balance sheet deposits
under marketing partnership
arrangements) 366.2 8 387.3 10
---------------------------------------------
Total fee-based* 1,210.5 25 1,004.6 26
Corporate and other (primarily cash and
investments in excess of customer
deposits) 77.0 2 61.1 1
---------------------------------------------
Total assets under management* $4,825.6 100% $3,925.1 100%
---------------------------------------------
---------------------------------------------

* Does not include off-balance sheet assets managed by ARM Capital Advisors
for institutional clients and the State Bond Mutual Funds. Total fee-based
assets under management at December 31, 1996 and 1995 were $3,937.9 million
and $2,443.7 million, respectively, and total assets under management at
December 31, 1996 and 1995 were $7,553.0 million and $5,364.2 million,
respectively, including such assets.

The increase in spread-based deposits was attributable to sales of GICs to
institutional customers. The increase in the fee-based line of business was
primarily attributable to variable annuity sales. The Company continues to focus
on its fee-based variable annuity business to diversify its spread-based and
fee-based products and their associated channels of distribution.

Sales for spread-based products include premiums and deposits received
under products issued by the Company's insurance and face-amount certificate
subsidiaries. Sales for fee-based products include premiums and deposits for the
investment portfolio options of variable annuity products issued by the
Company's insurance subsidiaries.

Sales by market and type of business for 1996 and 1995 were as follows:

Year Ended December 31,
(IN MILLIONS) 1996 1995
- -------------------------------------------------
Retail:
Spread-based $ 130.6 $115.4
Fee-based 200.1 177.7
-----------------------
Total retail* 330.7 293.1
Institutional:
Spread-based 747.5 142.2
Fee-based - 272.9
-----------------------
Total institutional* 747.5 415.1
-----------------------
Total sales $1,078.2 $708.2
-----------------------
-----------------------

* Does not include new deposits related to off-balance sheet assets managed
by ARM Capital Advisors for institutional clients and the State Bond Mutual
Funds. Total retail sales for the years ended December 31, 1996 and 1995
were $342.7 million and $300.9 million, respectively, and total
institutional sales for the years ended December 31, 1996 and 1995 were
$2,401.5 million and $886.9 million, respectively, including such deposits.

The increase in retail sales was primarily attributable to an increase
in sales of fee-based investment portfolio options of variable annuity
contracts due, in part, to the continuing strong stock market returns during
1996 and an increased emphasis on marketing efforts of both spread-based and
fee-based products during the fourth quarter, principally through
stockbrokers and independent agents. The Company's institutional spread-based
products (i.e., GICs) are issued primarily through a marketing partnership
with another insurance company. Expanded distribution of GIC products through
bank trust departments, mutual fund companies, investment managers, insurance
companies and investment consultants contributed to the increase in sales of
such products. The decrease in institutional fee-based sales was attributable
to the Company's marketing partnership arrangement with General American
which was converted from a fee-based to primarily a spread-based arrangement
in late 1995. The Company's sales strategy is to broaden its mix of products,
services and distribution channels to enable it to achieve its target sales
within different interest rate environments.

Net surrenders of annuity products issued by the Company's insurance
subsidiaries were $326.2 million and $319.8 million in 1996 and 1995,
respectively. Of these amounts, $106.9 million and $62.8 million, respectively,
can be attributed to fixed annuity business acquired from SBM. Surrender charge
income increased to $5.0 million in 1996 from $3.3 million in 1995, due to
higher average surrender charges associated with SBM products compared to other
products of the Company's insurance subsidiaries and to the overall increase in
the volume of surrenders. Policies issued by the Company's insurance
subsidiaries generally include lapse protection provisions that provide a
deterrent to surrenders when interest rates rise. These provisions can include
surrender charges and market value adjustments on annuity withdrawals. During
the period that surrender charges are assessable, generally the first five to
seven years after a policy is issued, surrenders are

relatively low. The surrender and withdrawal activity during 1995 and 1996 was
generally expected by the Company due to the level of customer deposits written
several years ago that were subject to declining or expiring surrender charges
and the Company's strategy of maintaining investment spreads. The Company has
programs designed to reduce surrender activity and improve persistency. During
1996 and 1995, through one such program, $21.0 million and $42.0 million,
respectively, of new annuity contracts were issued to customers that had
initiated a withdrawal request. The Company excludes this activity from its net
surrenders and sales disclosures because such amounts have no impact on net cash
flow. Other programs involve direct contact with customers and are designed to
inform customers of the financial strength of the Company and its insurance
subsidiaries and to describe other product offerings available.

Operating expenses increased to $31.1 million in 1996 from $23.0 million in
1995. The increase was primarily attributable to (i) the inclusion of twelve
months of incremental operating expenses related to the acquired SBM operations
in the 1996 results versus seven months for the comparable 1995 period, (ii) the
expansion of product distribution channels, and (iii) a charge of $1.6 million
to increase the reserve for anticipated future guaranty fund assessments.

Commissions, net of deferrals, were $2.4 million and $1.6 million in 1996
and 1995, respectively. The increase was primarily attributable to the inclusion
in 1996 results of twelve months' renewal and trailer commissions under certain
deferred annuity contracts acquired through the SBM acquisition versus seven
months for the comparable 1995 period.

Amortization of deferred policy acquisition costs related to operations was
$6.8 million and $2.9 million during 1996 and 1995, respectively. This increase
was the result of growth in the deferred policy acquisition cost asset due to
additional sales of fixed and variable annuity products. Variable costs of
selling and issuing the Company's insurance subsidiaries' products (primarily
first-year commissions) are deferred and then amortized over the expected life
of the contract.

Amortization of value of insurance in force related to operations increased
to $7.3 million in 1996 from $7.1 million in 1995. The increase is attributable
to amortization of the value of insurance in force established as an asset by
the Company on May 31, 1995 in connection with the acquisition of SBM's
insurance subsidiary.

Amortization of acquisition-related deferred charges was $1.5 million and
$9.9 million in 1996 and 1995, respectively. The decrease was primarily
attributable to the accelerated amortization during the third quarter of 1995 of
certain costs and charges deferred during 1993 and 1994. During the third
quarter of 1995, Company management determined that changes in facts and
circumstances had resulted in a change in their original estimate of the periods
benefited by these costs and charges. As a result of this change in estimate,
the remaining unamortized balances of these deferred costs and charges were
fully amortized as of September 30, 1995, resulting in lower amortization in
future periods.

The Company recorded a $5.0 million non-recurring charge in 1996 including
$3.2 million related to the move of operations facilities from Columbus, Ohio to
Louisville, Kentucky; costs of

$1.0 million for mergers and acquisitions activities that did not result in a
transaction; and costs of $0.8 million related to the Company's filing of a
public offering of common stock.

Other expenses, net were $5.4 million in 1996 compared to $0.7 million in
1995. The increase is primarily attributable to an increase in premiums and fees
paid or accrued in 1996, net of a reduction in net benefits paid, under
reinsurance agreements. Through the reinsurance agreements, one of which
commenced December 31, 1995, substantially all mortality risks associated with
single premium endowment deposits have been reinsured.

Realized investment gains, which are reported net of related amortization
of deferred policy acquisition costs and value of insurance in force, were $0.9
million in 1996 compared to $4.0 million in 1995. Realized investment gains in
1996 include an estimated loss of $15.2 million related to the write-down to
fair value of an investment in a corporate fixed maturity security and a gain of
$4.5 million, before selling expenses, related to the sale of the State Bond
Mutual Funds. Other 1996 and all 1995 realized investment gains and losses were
interest-rate related and attributable to the ongoing management of the
Company's fixed maturity securities classified as available-for-sale which can
result in period-to-period swings in realized investment gains since securities
are sold during both rising and falling interest rate environments. The ongoing
management of securities is a significant component of the Company's
asset/liability management strategy. The ongoing portfolio management process
involves evaluating the various asset sectors (i.e., security types and industry
classes) and individual securities comprising the Company's investment
portfolios and, based on market yield rates, repositioning holdings from sectors
perceived to be relatively overvalued to sectors perceived to be undervalued
with the aim of improving cash flows. The Company endeavors to accomplish this
repositioning without materially changing the overall credit, asset duration,
convexity, and liquidity characteristics of its portfolios.

Federal income tax expense was $5.2 million and $7.0 million in 1996 and
1995, respectively, reflecting effective tax rates of 18.1% and 37.1%. The lower
effective tax rate in 1996 resulted primarily from the recognition of benefits
associated with certain deferred tax assets established in connection with the
Company's acquisition of the Integrity Companies on November 26, 1993 for which
a full valuation allowance was originally provided. These deferred tax benefits
are being recognized based on the taxable income generated by the Integrity
Companies in the post-acquisition period and projections of future taxable
income.

1995 COMPARED TO 1994

During 1995, net income for the Company was $11.9 million compared to a net
loss of $16.8 million for 1994. Operating earnings were $4.5 million and
$2.4 million for 1995 and 1994, respectively. The improvement in operating
earnings in 1995 was primarily attributable to an increase in net investment
spread, the acquired operations of SBM which generated operating earnings of
approximately $3.5 million during the period from June 1, 1995 to December
31, 1995 and an increase in fee income from a growing base of variable annuity
deposits and institutional assets under management. Such increases in operating
earnings were partially offset by the accelerated amortization of certain
acquisition-related deferred charges.

Spread-based operating earnings were 0.90% and 0.81% of average
spread-based assets under management of $2.47 billion and $2.00 billion during
1995 and 1994, respectively. This increase in spread-based margins was primarily
attributable to ongoing asset/liability management, which generated higher net
investment spreads. Fee-based operating earnings were 0.19% and 0.51% of average
fee-based assets under management of $1.84 billion and $421.7 million during
1995 and 1994, respectively. The decrease in fee-based margins was primarily
attributable to the growth in off-balance sheet fee-based assets managed by ARM
Capital Advisors for institutional clients, which generate lower margins than
the Company's other fee-based products, specifically variable annuities. For
example, margins on the Company's variable annuities were 0.64% and 0.66% during
1995 and 1994, respectively.

Net investment spread for the years ended December 31, 1995 and 1994 were
as follows:

Year Ended December 31,
-------------------------
(DOLLARS IN THOUSANDS) 1995 1994
- ------------------------------------------------------------------
Investment income $ 196,024 $ 149,142
Interest credited on customer deposits (146,867) (116,463)
-------------------------
Net investment spread $ 49,157 $ 32,679
-------------------------
-------------------------
Investment yield 7.84% 7.30%
Average credited rate 5.90% 5.88%
-------------------------
Investment spread 1.94% 1.42%
-------------------------
-------------------------
Average cash and investments $2,501,125 $2,042,785
Average customer deposits 2,488,866 1,980,807

The increase in investment yield was primarily attributable to benefits
from ongoing management of the Company's investment portfolios, the rising
interest rate environment during 1994 and lower amortization of invested asset
write-ups resulting from purchase accounting adjustments.

Fee income increased to $11.3 million in 1995 from $8.4 million in 1994.
This increase is in part attributable to variable annuity fees which are based
on the market value of assets supporting the investment portfolio options of
variable annuity deposits in separate accounts. Variable annuity fees increased
to $7.2 million in 1995 from $4.3 million in 1994 principally due to asset
growth from the receipt of variable annuity deposits and from increased market
values. In addition, ARM Capital Advisors, which began operations in January
1995, added asset management fees earned on off-balance sheet assets managed for
institutional clients. Offsetting these increases was a reduction in other fee
income from $4.1 million in 1994 to $0.9 million in 1995 primarily related to
variable life insurance business which was sold in 1994.

Assets under management by type of product and service as of December 31,
1995 and 1994 were as follows:

1995 1994
--------------------------------------
Percent Percent
(DOLLARS IN MILLIONS) Amount of Total Amount of Total
- -------------------------------------------------------------------------------------

Spread-based:
Retail (fixed annuity, guaranteed rate
option and face-amount certificate
deposits) $2,716.2 69% $1,990.0 78%
Institutional (GIC deposits) 143.2 4 - -
--------------------------------------
Total spread-based 2,859.4 73 1,990.0 78
Fee-based:
Retail (investment portfolio options of
variable annuity deposits) 617.3 16 388.9 15
Institutional (off-balance sheet deposits
under marketing partnership
arrangements) 387.3 10 121.0 5
--------------------------------------
Total fee-based 1,004.6 * 26 509.9 20
--------------------------------------
Corporate and other (primarily cash and
investments in excess of customer
deposits) 61.1 1 60.3 2
--------------------------------------
Total assets under management $3,925.1 * 100% $2,560.2 100%
--------------------------------------
--------------------------------------

* Does not include off-balance sheet assets managed by ARM Capital Advisors
for institutional clients and the State Bond Mutual Funds. Total fee-based
assets under management and total assets under management at December 31,
1995 were $2,443.7 million and $5,364.2 million, respectively, including
such assets. Both ARM Capital Advisors and the State Bond Mutual Funds
were acquired in 1995.

The increase in the spread-based deposits was primarily attributable to the
SBM acquisition and sales of GICs. The increase in the fee-based line of
business is primarily due to fees related to funds managed by ARM Capital
Advisors under investment management and investment advisory contracts that were
acquired on January 5, 1995, assets managed under contract for the State Bond
Mutual Funds that were acquired effective May 31, 1995, and new sales.

Sales by market and type of business during 1995 and 1994 were as follows:

Year Ended December 31,
------------------------
(IN MILLIONS) 1995 1994
- -------------------------------------------------
Retail:
Spread-based $115.4 $131.1
Fee-based 177.7 231.1
------------------------
Total retail 293.1 * 362.2
Institutional:
Spread-based 142.2 _
Fee-based 272.9 59.3
------------------------
Total institutional 415.1 * 59.3
------------------------
Total sales $708.2 $421.5
------------------------
------------------------

* Does not include new deposits related to off-balance sheet fee-based assets
managed by ARM Capital Advisors for institutional clients and the State
Bond Mutual Funds. Total retail and institutional sales for the year ended
December 31, 1995 were $300.9 million and $886.9 million, respectively,
including such deposits. Both ARM Capital Advisors and the State Bond
Mutual Funds were acquired in 1995.

The decrease in retail sales was primarily attributable to greater
industry-wide competition from banks and other financial services institutions
for savings products. However, the Company believes yield curve flattening
benefited sales of institutional spread-based products (i.e., GICs), resulting
in total overall sales growth of spread-based products. The increase in sales of
institutional fee-based products and services is primarily attributable to
the increase in GIC deposits from the Company's arrangement with General
American.

Net surrenders of annuity products issued by the Company's insurance
subsidiaries were $319.8 million (including $62.8 million attributable to
business acquired from SBM) in 1995, compared to $221.8 million in 1994. This
resulted in an increase in surrender charge income to $3.3 million in 1995 from
$2.4 million in 1994. The surrender and withdrawal activity during 1994 and 1995
was generally expected by the Company due to the level of customer deposits
written several years ago that were subject to declining or expiring surrender
charges during 1994 and 1995, and the Company's strategy of maintaining
investment spreads. During the third quarter of 1994 and continuing to date, the
Company began implementing programs designed to reduce surrender activity and
improve persistency. During 1995, through one such program, $42.0 million of new
annuity contracts were issued to customers that had initiated a withdrawal
request.

Operating expenses increased to $23.0 million in 1995 from $21.5 million
in 1994. The increase was primarily attributable to additional expenses
attributable to ARM Capital Advisors, which began operations in 1995, and the
acquired SBM businesses.

Commissions, net of deferrals were $1.6 million for the year ended
December 31, 1995 consisting primarily of renewal and trailer commissions of
approximately $1.3 million on fixed

annuities acquired in connection with the SBM acquisition. Commissions, net of
deferrals for the corresponding period in 1994 were $2.6 million which included
$2.5 million of commissions on variable life insurance contracts. The majority
of the variable life block of business was sold in December 1994.

Amortization of deferred policy acquisition costs related to operations was
$2.9 million and $1.3 million during 1995 and 1994, respectively. The increase
in amortization was related to growth in the deferred policy acquisition cost
asset.

Amortization of value of insurance in force related to operations increased
to $7.1 million in 1995 from $3.8 million in 1994 reflecting amortization of the
value of insurance in force established as an asset by the Company on May 31,
1995 in connection with the acquisition of SBM's insurance subsidiary.

Amortization of acquisition-related deferred charges was $9.9 million in
1995 compared to $2.2 million in 1994. The increase was primarily attributable
to the accelerated amortization of $4.3 million of certain costs and charges
deferred during 1993 and 1994. During the third quarter of 1995, Company
management determined that changes in facts and circumstances had resulted in a
change in their original estimate of the periods benefited by these costs and
charges. As a result of this change in estimate, the remaining unamortized
balances of these deferred costs and charges were fully amortized as of
September 30, 1995.

Other expenses, net were $0.7 million in 1995 compared to other income, net
of $5.0 million in 1994. The 1994 results include the benefits of favorable
mortality experience and a gain from the sale of the Company's variable life
business.

Realized investment gains were $4.0 million in 1995, compared to realized
investment losses of $36.7 million in 1994. Such realized investment gains and
losses were primarily interest-rate related and attributable to the ongoing
management of the Company's fixed maturity securities classified as
available-for-sale. The 1994 realized investment losses were a result of the
market interest rate environment at November 26, 1993 when the acquisition of
the Integrity Companies occurred. This acquisition was accounted for under the
purchase method which required that the Integrity Companies' investment
portfolio be marked-to-market on November 26, 1993, at which time the yield on
ten-year U.S. Treasury Notes was 5.74%. The yield on such notes increased
steadily during 1994 and at year-end was 7.83%. As a result of the acquisition
and mark-to-market occurring in a low interest rate environment and ongoing
portfolio management during the rising interest-rate environment of 1994,
realized investment losses of $36.7 million were generated.

Federal income tax expense during 1995 was $7.0 million compared to a
federal income tax benefit during 1994 of $6.0 million. This change was
attributable to income before federal income taxes of $18.9 million in 1995
compared to a loss before federal income taxes of $22.8 million in 1994.

ACQUISITION ACTIVITY

INTEGRITY COMPANIES
Effective November 26, 1993, the Company acquired N.M. U.S. Limited (the
holding company for National Mutual's U.S. operations) and its wholly owned
subsidiaries, Integrity and National Integrity, from National Mutual, for an
aggregate purchase price of $121.0 million. Immediately following the
acquisition, N.M. U.S. Limited changed its name to Integrity Holdings Inc. The
Company financed the acquisition by issuing new common equity and its perpetual
preferred stock for proceeds of approximately $70.0 million and $50.0 million,
respectively, and through $40.0 million of bank financing obtained under a
Credit Agreement.

ARM CAPITAL ADVISORS
Through its acquisition of the U.S. fixed income unit of KBIMA in January
1995, the Company obtained a recognized fixed income management service which
became part of the then newly-formed ARM Capital Advisors. In addition to
providing asset management services to institutional clients, ARM Capital
Advisors manages the investment portfolios of the Company's subsidiaries. Assets
managed by ARM Capital Advisors under contracts with institutional clients
acquired from KBIMA and new contracts with other institutional clients increased
from $0.8 billion as of January 5, 1995 to $2.7 billion as of December 31, 1996.
Although third-party assets managed by ARM Capital Advisors have grown since the
acquisition, the Company believes that market attitudes towards developing an
asset management service for defined benefit pension plans within a holding
company structure consisting predominantly of insurance companies has
constrained ARM Capital Advisors' growth. Accordingly, the Company is in the
process of selling the operations and assets of ARM Capital Advisors (see
"Business-History").

SBM COMPANY
Effective May 31, 1995, the Company completed the acquisition of
substantially all of the assets and business operations of SBM, including all of
the issued and outstanding capital stock of SBM's subsidiaries, SBM Life and ARM
Securities (formerly known as SBM Financial Services, Inc.), as well as the
State Bond Mutual Funds. The aggregate purchase price for the SBM acquisition
was $38.8 million. The Company financed the acquisition by issuing a total of
9,770 shares of new common equity to private equity funds sponsored by Morgan
Stanley Group Inc. and to New ARM, LLC (a limited liability company owning 170
shares of the Company's Class A common stock) and certain directors of the
Company for an aggregate sale price of $63.5 million. The Company used proceeds
from the issuance of the new common equity in excess of the adjusted purchase
price for the acquisition to (i) make a $19.9 million capital contribution to
SBM Life; (ii) acquire SBM Certificate Company from SBM Life for $3.3 million;
and (iii) along with approximately $1.0 million of additional cash from the
Company, provide for fees and expenses related to the acquisition of
approximately $2.5 million. The capital contribution to SBM Life of $19.9
million was used to strengthen SBM Life's financial position and allowed for a
significant investment portfolio restructuring immediately following the
acquisition with no net adverse effect on statutory adjusted capital and
surplus. On December 31, 1995, SBM Life was merged with and into Integrity to
create certain operating efficiencies. The SBM acquisition provided the Company
with expanded distribution channels, as well as a deposit base in the 403(b)
tax-deferred annuity marketplace. On December 13, 1996, the Company transferred
its responsibility for performing management and

investment advisory services for the State Bond Mutual Funds to Federated
Investors for $4.5 million. The State Bond Mutual Funds had aggregate assets of
$236.9 million on December 13, 1996.

The Company continues to actively pursue material acquisitions of companies
and blocks of business, marketing partnerships and reinsurance opportunities
with other insurance companies, with the goal of realizing additional economies
of scale and enhanced profitability.

ASSET PORTFOLIO REVIEW

The Company primarily invests in securities with fixed maturities with the
objective of providing reasonable returns while limiting credit and liquidity
risks. At amortized cost, fixed maturities at December 31, 1996 totaled $3.0
billion, compared with $2.5 billion at December 31, 1995, both representing
approximately 91% of total cash and investments. This increase in investments in
fixed maturities primarily resulted from the investment of the proceeds from
sales of GIC products.

The Company's cash and investments as of December 31, 1996 are detailed as
follows:

Amortized Cost
------------------------------------
Percent Estimated Fair
(DOLLARS IN MILLIONS) Amount of Total Value
- ---------------------------------------------------------------------------------------------

Fixed maturities:
Corporate securities $ 992.0 29.7% $ 991.6
U.S. Treasury securities and obligations of U.S.
government agencies 247.0 7.4 246.9
Other government securities 50.6 1.5 50.3
Asset-backed securities 299.4 9.0 298.1
Mortgage-backed securities ("MBSs"):
Agency pass-throughs 238.0 7.1 239.3
Collateralized mortgage obligations ("CMOs"):
Agency 406.3 12.2 410.0
Non-agency 800.2 24.0 801.2
Interest only 15.3 0.4 17.1
-------------------------------
Total fixed maturities 3,048.8 91.3 3,054.5

Equity securities (i.e., non-redeemable preferred stock) 21.3 0.6 22.5
Mortgage loans on real estate 36.9 1.1 36.9
Policy loans 123.5 3.7 123.5
Cash and cash equivalents 110.1 3.3 110.1
-------------------------------
Total cash and investments $3,340.6 100.0% $3,347.5
-------------------------------
-------------------------------

Agency pass-through certificates are MBSs which represent an undivided
interest in a specific pool of residential mortgages. The payment of principal
and interest is guaranteed by the U.S. government or U.S. government agencies.
CMOs are pools of mortgages that are segregated into sections, or tranches,
which provide prioritized retirement of bonds rather than a pro rata share of
principal return as in the pass-through structure. The underlying mortgages of
agency CMOs are guaranteed by the U.S. government or U.S. government agencies.
Of the non-agency CMOs, 53.9% use mortgage loans or mortgage loan pools, letters
of credit, agency mortgage pass-through securities and other types of credit
enhancement as collateral. The remaining 46.1% of the non-agency CMOs use
commercial mortgage loans as collateral.

The Company manages prepayment exposure on CMO holdings by diversifying
not only within the more stable CMO tranches, but across alternative collateral
classes such as commercial mortgages and Federal Housing Administration project
loans, which are generally less volatile than agency-backed, residential
mortgages. Additionally, prepayment sensitivity is evaluated and monitored,
giving full consideration to the collateral characteristics such as weighted
average coupon rate, weighted average maturity and the prepayment history of the
specific collateral. MBSs are subject to risks associated with prepayments of
the underlying collateral pools. Prepayments cause these securities to have
actual maturities different from those projected at the time of purchase.
Securities that have an amortized cost that is greater than par (i.e., purchased
at a premium) that are backed by mortgages that prepay faster than expected will
incur a reduction in yield or a loss, versus an increase in yield or a gain if
the mortgages prepay slower than expected. Those securities that have an
amortized cost that is less than par (i.e., purchased at a discount) that are
backed by mortgages that prepay faster than expected will generate an increase
in yield or a gain, versus a decrease in yield or a loss if the mortgages prepay
slower than expected. The reduction or increase in yields may be partially
offset as funds from prepayments are reinvested at current interest rates. The
degree to which a security is susceptible to either gains or losses is
influenced by the difference between its amortized cost and par, the relative
sensitivity of the underlying mortgages backing the assets to prepayments in a
changing interest rate environment and the repayment priority of the securities
in the overall securitization structure. The Company has gross unamortized
premiums and unaccreted discounts of MBSs of $28.7 million and $45.7 million,
respectively, at December 31, 1996. Although the interest rate environment has
experienced significant volatility during 1996 and 1995, prepayments and
extensions of cash flows from MBSs have not materially affected investment
income of the Company.

Asset-backed securities ("ABS") are securitized bonds which can be backed
by, but not limited to, collateral such as home equity loans, second mortgages,
automobile loans and credit card receivables. Home equity loan collateral
represents 54.6% of the Company's investments in the ABS market. The typical
structure of an ABS provides for favorable yields, high credit rating and stable
prepayments.

Total cash and investments were 96% and 93% investment grade or equivalent
as of December 31, 1996 and 1995, respectively. Investment grade securities are
those classified as 1 or 2 by the NAIC or, where such classifications are not
available, having a rating on the scale used by Standard & Poor's Corporation
("S&P") of BBB- or above. Yields available on non-investment grade securities
are generally higher than are available on investment grade securities. However,

credit risk is greater with respect to such non-investment grade securities. The
Company attempts to reduce the risks associated with non-investment grade
securities by limiting the exposure to any one issuer and by closely monitoring
the creditworthiness of such issuers. Additionally, the Company's investment
portfolio has minimal exposure to real estate, non-indemnified mortgage loans
and common equity securities, which represent less than 0.1% of cash and
investments as of December 31, 1996.

The Company analyzes its investment portfolio, including below investment
grade securities, at least quarterly in order to determine if its ability to
realize its carrying value on any investment has been impaired. For fixed
maturity and equity securities, if impairment in value is determined to be other
than temporary (i.e., if it is probable that the Company will be unable to
collect all amounts due according to the contractual terms of the security), the
cost basis of the impaired security is written down to fair value, which becomes
the security's new cost basis. The amount of the write-down is included in
earnings as a realized loss. Future events may occur, or additional or updated
information may be received, which may necessitate future write-downs of
securities in the Company's portfolio. Significant write-downs in the carrying
value of investments could materially adversely affect the Company's net income
in future periods.

At December 31, 1996 the ratings assigned by the NAIC and comparable S&P
ratings on the Company's fixed maturity portfolio, and the percentage of total
fixed maturity investments classified in each category were as follows:

Amortized Cost
------------------------
Percent Estimated
NAIC Designation (Comparable S&P Rating) Amount of Total Fair Value
- ------------------------------------------------------------------------------
(DOLLARS IN MILLIONS)

1 (AAA, AA, A) $2,210.8 72% $2,217.2
2 (BBB) 689.5 23 692.2
3 (BB) 110.2 4 105.9
4 (B) 38.3 1 39.2
5 (CCC, CC, C) -- -- --
6 (CI, D) -- -- --
---------------------------------
Total fixed maturities $3,048.8 100% $3,054.5
---------------------------------
---------------------------------

Pursuant to Statement of Financial Accounting Standards ("SFAS") No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," the Company
classifies its entire fixed maturities portfolio as available-for-sale. Fixed
maturities classified as available-for-sale are carried at fair value and
changes in fair value, net of related value of insurance in force and deferred
policy acquisition cost amortization and deferred income taxes, are charged or
credited directly to shareholders' equity.

The higher interest rate environment at December 31, 1996 compared to
December 31, 1995 resulted in unrealized gains on available-for-sale securities
which totaled $3.7 million (net of $1.3 million of related amortization of
deferred policy acquisition costs and value of insurance in force and $2.0
million of deferred income taxes) at December 31, 1996, compared to unrealized
gains of $28.5 million (net of $14.2 million of related amortization of deferred
policy acquisition costs and value of insurance in force and $15.4 million of
deferred income taxes) at December 31, 1995. This change in net unrealized gains
on available-for-sale securities for the year ended December 31, 1996 decreased
reported shareholders' equity by $24.9 million as compared to an increase of
$133.5 million for the year ended December 31, 1995. This volatility in reported
shareholders' equity occurs as a result of SFAS No. 115, which requires that
available-for-sale securities be carried at fair value while other assets and
all liabilities are carried at historical values. At December 31, 1996 and 1995,
shareholders' equity excluding the effects of SFAS No. 115 was $178.3 million
and $159.5 million, respectively.

The Company manages assets and liabilities in a closely integrated manner,
with the aim of reducing the volatility of investment spreads during a changing
interest rate environment. As a result, adjusting shareholders' equity for
changes in the fair value of the Company's fixed maturities and equity
securities without reflecting offsetting changes in the value of the Company's
liabilities or other assets creates volatility in reported shareholders' equity
but does not reflect the underlying economics of the Company's business. The
Company's accompanying consolidated financial statements include fair value
balance sheets which demonstrate that the general rise in interest rates during
1996 did not have a material effect on the financial position of the Company
when all assets and liabilities are adjusted to estimated fair values.

Mortgage loans on real estate represented 1% and 2% of total cash and
investments at December 31, 1996 and 1995, respectively. Pursuant to the terms
of the acquisition of certain of the Company's insurance operations, National
Mutual has indemnified the Company with respect to principal (up to 100% of the
investments' year-end 1992 statutory book value) and interest with respect to
approximately 99% of these loans at December 31, 1996. In support of its
indemnification obligations, National Mutual placed $23.0 million into escrow in
favor of the Company's insurance subsidiaries, which will remain available until
the subject commercial and agricultural loans have been paid in full.

Assets held in separate accounts at December 31, 1996 totaled $1.1 billion,
compared to $0.8 billion at December 31, 1995. The increase is primarily
attributable to the receipt of variable annuity deposits and from a
market-driven increase in the value of existing variable annuity deposits
invested in mutual funds.

LIQUIDITY AND FINANCIAL RESOURCES

HOLDING COMPANY OPERATIONS

The Company's principal need for liquidity has historically consisted of
debt service obligations under its bank financing agreement, dividend payments
on its preferred stock, operating expenses not absorbed by management fees
charged to its subsidiaries and corporate development

expenditures. The Company is dependent on dividends from Integrity and
management and service fee income from the Company's subsidiaries to meet
ongoing cash needs, including amounts required to pay dividends on its preferred
stock.

The ability of the Company's insurance subsidiaries to pay dividends and
enter into agreements with affiliates is limited by state insurance laws.
During 1996, the Company received dividends of $16.0 million from Integrity.
The maximum dividend payments that may be made by Integrity to the Company
during 1997 without the prior approval of the Ohio Insurance Director are
$26.0 million, of which $7.0 million was paid in the first quarter of 1997.
The Company had cash and investments at the holding company level of $6.8
million at December 31, 1996. In addition, $20.0 million was available on
unused bank lines of credit at December 31, 1996.

On October 23, 1996, the Company filed a registration statement with the
Securities and Exchange Commission with respect to the public offering of a yet
to be determined number of shares of Class A common stock, par value $.01 per
share. The Company's decision to proceed with the offering is subject to market
and other conditions. See Note 10 to "Notes to Consolidated Financial
Statements."

INSURANCE SUBSIDIARIES OPERATIONS

The primary sources of liquidity of the Company's insurance subsidiaries
are investment income and proceeds from maturities and redemptions of
investments. The principal uses of such funds are benefits, withdrawals and
loans associated with customer deposits, commissions, operating expenses and the
purchase of new investments.

The Company develops cash flow projections under a variety of interest rate
scenarios generated by the Company. The Company attempts to structure asset
portfolios so that the interest and principal payments, along with other fee
income, are more than sufficient to cover the cash outflows for benefits,
withdrawals and expenses under the expected scenarios developed by the Company.
In addition, the Company maintains other liquid assets and aims to meet
unexpected cash requirements without exposure to material realized losses
during a higher interest rate environment. These other liquid assets include
cash and cash equivalents and high-grade floating-rate securities held by both
the Company and its insurance subsidiaries. The Company also has $20 million
available on unused bank lines of credit as mentioned above.

During the years ended December 31, 1996, 1995 and 1994, the Company met
its liquidity needs entirely by cash flows from operating activities and
principal payments and redemptions of investments. At December 31, 1996, cash
and cash equivalents totaled $110.1 million compared to $76.9 million at
December 31, 1995. The Company's aim is to manage its cash and cash equivalents
position in order to satisfy short-term liquidity needs. In connection with this
management of cash and cash equivalents, the Company may invest idle cash in
short-duration fixed maturities to capture additional yield when short-term
liquidity requirements permit.

The Company generated cash flows of $192.9 million, $138.4 million and
$105.7 million from operating activities during the years ended December 31,
1996, 1995 and 1994, respectively. These

cash flows resulted principally from investment income, less commissions and
operating expenses. Proceeds from sales, maturities and redemptions of
investments generated $2,214.4 million, $1,463.3 million and $761.1 million in
cash flows during 1996, 1995 and 1994, respectively, which were offset by
purchases of investments of $2,772.0 million, $1,506.5 million and $854.4
million, respectively. An increase in investment purchases and sales activity
during 1996 compared to 1995 reflects the Company's ongoing management of its
fixed maturity portfolio which has increased in size due to sales of
spread-based products and the SBM acquisition.

INCOME TAXES

At December 31, 1996, the Company reported an asset for deferred federal
income taxes of $35.6 million on the carrying amount balance sheet. Such amount
reflects deferred tax assets of $56.2 million, net of valuation allowance of
$38.8 million, in excess of deferred tax liabilities of $20.6 million. The net
deferred tax assets represent deductible temporary differences and net operating
loss carryforwards. Based on historical operating results and projections of
future taxable ordinary income, management believes that the net tax benefit
recorded will be fully utilized.

DERIVATIVES

The Company has only limited involvement with derivative financial
instruments and does not use them for trading purposes. They are used to manage
well defined interest rate risks and, with respect to the Company's
equity-indexed annuity deposits, equity market risks.

EFFECTS OF INFLATION AND INTEREST RATE CHANGES

The Company believes that inflation will not have a material adverse effect
on results of operations. The Company manages its investment portfolios in part
to reduce its exposure to interest rate fluctuations. In general, the fair value
of the Company's fixed maturities portfolio increases or decreases inversely
with fluctuations in interest rates, and the Company's investment income
increases or decreases directly with interest rate changes. For example, if
interest rates decline, the Company's fixed maturity investments generally will
increase in fair value, while investment income will decrease as fixed income
investments are sold or mature and proceeds are reinvested at declining rates.
The converse will be true if interest rates rise.

FORWARD-LOOKING STATEMENTS

The Company has made a number of forward-looking statements in this
document that are subject to risks and uncertainties. Forward-looking
statements include the information concerning possible or assumed future
results of operations and those preceded by, followed by or that include the
words "believes," "expects," "anticipates" or similar expressions. Such
forward-looking statements are based on the Company's beliefs as to its
competitive position in its industry and the factors affecting its business.
In particular, the statements of the Company's belief as to the stimulation
of future demand for long-term savings and retirement products, including
variable and equity-indexed annuity type products, under the heading
"General" are forward-looking statements.

Factors that could cause actual results to differ materially from the
forward-looking statements related to the demand for variable and equity-indexed
annuity type products include, but are not limited to, a change in population
demographics, development of alternative investment products, a change in
economic conditions, and changes in current federal income tax laws. In
addition, there can be no assurance that (i) the Company has correctly
identified and assessed all of the factors affecting its business; (ii) the
publicly available and other information on which the Company has based its
analyses is complete or correct; (iii) the Company's analyses are correct; or
(iv) the Company's strategy, which is based in part on these analyses, will be
successful.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The Company's consolidated financial statements begin on page F-3.
Reference is made to the Index to Financial Statements on page F-1 herein.

Additional financial statement schedules are included on pages S-3 through
S-10. Reference is made to the Index to Financial Statement Schedules on page
S-1 herein.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

There have been no changes in or disagreements with accountants.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS

The directors and executive officers of the Company, their ages, and
positions with the Company as of March 27, 1997, are set forth below.

Name Age Title

John Franco............. 54 Co-Chairman of the Board and Co-Chief Executive
Officer

Martin H. Ruby......... 46 Co-Chairman of the Board and Co-Chief Executive
Officer

John R. Lindholm....... 48 President--Retail Business Division

Dennis L. Carr......... 47 Executive Vice President and Chief Actuary

David E. Ferguson...... 49 Executive Vice President and Chief Technology
Officer

Daniel R. Gattis....... 53 Executive Vice President--Institutional Business
Group

John R. McGeeney....... 40 Executive Vice President--Retail Business Division

Robert H. Scott........ 50 Executive Vice President, General Counsel and
Secretary

Edward L. Zeman........ 42 Executive Vice President and Chief Financial
Officer

Patricia L. Winter..... 38 Senior Vice President--Mergers/Acquisitions and
Investment Assurance

Peter S. Resnik........ 36 Treasurer

Barry G. Ward.......... 35 Controller

James S. Cole.......... 60 Director

Warren M. Foss......... 50 Director

Dudley J. Godfrey, Jr.. 70 Director

Edward D. Powers....... 64 Director

Colin F. Raymond....... 26 Director

Frank V. Sica.......... 45 Director

Irwin T. Vanderhoof.... 69 Director

JOHN FRANCO has served as Co-Chairman of the Board and Co-Chief Executive
Officer of the Company since July 1993. From January 1993 until November 1993,
Mr. Franco served as Co-Chief Executive Officer of Oldarm L.P. and was Co-Chief
Executive Officer of its predecessor from March 1992 until December 1992. From
November 1989 to November 1991, Mr. Franco was the Chief Executive Officer and a
Director of ICH Corporation. From 1979 to 1989, Mr. Franco was employed by
Capital Holding Corporation (now known as Providian Corporation) in various
positions, including Vice Chairman of the Board and President, Accumulation and
Investment Group (September 1987 to October 1989), President, Agency Group
(April 1984 to September 1987), and Executive Vice President and Chief Financial
Officer (September 1979 to April 1984).

MARTIN H. RUBY has served as Co-Chairman of the Board and Co-Chief
Executive Officer of the Company since July 1993. From its inception in March
1992 until November 1993, Mr. Ruby served as Co-Chief Executive Officer of
Oldarm L.P. From May 1990 to January 1992, Mr. Ruby was President and Managing
Director of the ICH Capital Management Group, ICH Corporation, and the President
of Constitution Life Insurance Company, the accumulation product subsidiary of
ICH

Corporation. From 1986 to 1989, Mr. Ruby was the Chief Executive Officer and
Managing Director of Capital Initiatives Corporation, a subsidiary of Providian
Corporation. From 1980 to 1986, Mr. Ruby held various other positions with
Providian Corporation.

JOHN R. LINDHOLM has served as President--Retail Business Division of the
Company since January 1997. He had been Executive Vice President and Chief
Marketing Officer of the Company since July 1993. Until November 1993, he served
as the Chief Marketing Officer of Oldarm L.P., a position he held since its
inception in March 1992. From June 1990 to February 1992, Mr. Lindholm was the
Chief Marketing Officer and a Managing Director of the ICH Capital Management
Group, ICH Corporation. From 1980 to 1990, he was employed by Providian
Corporation, first as Vice President--Compensation and Benefits and then as
Chief Marketing Officer and Managing Director of its Accumulation and Investment
Group. Mr. Lindholm is also Chairman of the Board of The Legends Fund, Inc.

DENNIS L. CARR has served as Executive Vice President and Chief Actuary
of the Company since June 1996. He had been Executive Vice President and
Chief Product Development Officer of the Company since September 1993, and
was appointed Actuary in June 1995. Prior to joining the Company in September
1993, he was Director of Product Development for the Accumulation and
Investment Group of Providian Corporation. From July 1983 to July 1988, Mr.
Carr was a consulting actuary for Tillinghast-Towers Perrin, being named a
principal of that firm in 1987.

DAVID E. FERGUSON has served as Executive Vice President and Chief
Technology Officer of the Company since January 1997. He had been Executive Vice
President and Chief Administrative Officer of the Company since July 1993. He
also served as Chief Technology Officer of Oldarm L.P. from January 1993 until
November 1993, and was Chief Technology Officer of Franco Associates, Ltd. from
its inception in March 1992 to its merger with Oldarm L.P. in December 1992.
From 1990 to March 1992, Mr. Ferguson was employed as the President and Chief
Executive Officer of the James Graham Brown Foundation, Inc., a private
philanthropic association in Louisville, Kentucky. From 1984 to 1990, Mr.
Ferguson was a partner at Ernst & Young LLP (or its predecessor Arthur Young)
and National Director of its Insurance Industry Consulting groups.

DANIEL R. GATTIS has served as Executive Vice President--Institutional
Business Group of the Company since January 1997. He had been a Senior Marketing
Officer of the Company since January 1996. From May 1991 to October 1995, Mr.
Gattis was President of The Chalke Consulting Group. Prior to that time, he was
a Senior Vice President with SEI Corporation from May 1988 to May 1991. From
December 1983 to May 1988, Mr. Gattis was a partner of KPMG Peat Marwick, and
served as National Consulting Partner for the firm's Insurance Industry
Practice.

JOHN R. MCGEENEY has served as Executive Vice President--Retail Business
Division of the Company since January 1997. He had been Co-General Counsel of
the Company since January 1994, was Assistant General Counsel of the Company
from October 1993 to December 1993, and served as Secretary from December
1993 to December 1995. From February 1988 to October 1993, Mr. McGeeney
served as Assistant General Counsel for the Accumulation and Investment Group
of

Providian Corporation. He had also been an associate with the law firm of
Middleton & Reutlinger from 1986 to 1988. Mr. McGeeney is Chairman of the Board
of SBM Certificate Company.

ROBERT H. SCOTT has served as Executive Vice President and General Counsel
of the Company since January 1997, and was appointed Secretary of the Company in
December 1995. He had been Co-General Counsel of the Company since January 1994,
and was Assistant General Counsel of the Company from July 1993 to December
1993. From June 1993 until November 1993, he served as Assistant General Counsel
of Oldarm L.P. Mr. Scott also served as Deputy General Counsel for ICH
Corporation from June 1990 to March 1993. Prior to that time, he was employed by
Providian Corporation from November 1976 to May 1990 in various tax positions,
the last of which was Second Vice President--Tax.

EDWARD L. ZEMAN has been Executive Vice President and Chief Financial
Officer of the Company since September 1995. Prior to joining the Company, Mr.
Zeman served in various positions with SBM Company from June 1990 to June 1995,
the last of which was Vice President, Chief Operating Officer, Chief Financial
Officer and Treasurer. He also served in various positions with Deloitte &
Touche LLP, a certified public accounting firm, from 1977 through 1990, the last
of which was Senior Manager. Mr. Zeman currently serves on the Board of
Directors of Dotronix, Inc.

PATRICIA L. WINTER was named Senior Vice President--Mergers/Acquisitions
and Investment Assurance in March 1997. She had served in other various
positions within the Company since April 1992, the last of which was
Asset/Liability Officer. Prior to that time, Ms. Winter had been a
Director--Accumulation Product Development of the ICH Capital Management Group,
ICH Corporation from August 1990 to March 1992.

PETER S. RESNIK has been the Treasurer of the Company since December 1993.
From December 1992 to November 1993, he served in various financial and
operational positions for Oldarm L.P. From June 1986 through July 1992, he
served as Assistant Vice President of Commonwealth Life Insurance Company, a
subsidiary of Providian Corporation, in various management positions, the last
of which was Director of Planning and Budgets in the Agency Group Division.

BARRY G. WARD has served as Controller of the Company since April 1996.
From October 1993 to April 1996, Mr. Ward served as financial officer directly
responsible for the Company's financial reporting function. From January 1989 to
October 1993, he served in various positions within Ernst & Young LLP's
Insurance Industry Accounting and Auditing Practice, the last of which was
Manager.

JAMES S. COLE has been a Director of the Company since February 1994. He
has also served as Director of Finance of the Merchant Banking Division of
Morgan Stanley & Co. Incorporated ("MS & Co.") since 1988. From 1980 to 1988, he
served as Controller for North American Philips. Prior to that time, Mr. Cole
was Chief Financial Officer for GE Plastics from 1976 to 1980. He served in
various positions from 1959 to 1976 within the financial function of General
Electric Company.

WARREN M. FOSS has been a Director of the Company since June 1996. He has
been a Senior Managing Director of Bear, Stearns & Co. Incorporated since
September 1996. Mr. Foss had been self-employed as a financial consultant,
handling various assignments for corporate clients from April 1996 to August
1996. From January 1993 until March 1996, he served as a Managing Director and
Principal of Donaldson, Lufkin & Jenrette Securities Corp. Prior to that time,
Mr. Foss was a founding partner of Scully Brothers & Foss, an investment banking
firm founded in February 1988.

DUDLEY J. GODFREY, JR. has been a Director of the Company since February
1994. He has been a senior shareholder in the law firm of Godfrey & Kahn, S.C.,
Milwaukee, Wisconsin, since 1957. Mr. Godfrey serves on the Board of Directors
of Manpower, Inc., Clarcor, Inc., Fort Howard Corporation and other closely and
privately held corporations.

EDWARD D. POWERS has been a Director of the Company since September 1994.
Mr. Powers currently serves as Chairman and Chief Executive Officer of Powers
Holding Co. He served as Chairman and Chief Executive Officer of Burnham Service
Co. from 1989 through 1993. Prior to 1989, he served as Chairman and Chief
Executive Officer of The Mueller Co. Mr. Powers also serves on the Board of
Directors of Red Roof Inn Inc.

COLIN F. RAYMOND has been a Director of the Company since January 1997. He
has been an Associate of Morgan Stanley since April 1996, and is an Associate of
Morgan Stanley Capital Partners III, Inc. (the general partner of the general
partner of the MSCP Funds). From January 1995 to April 1996, Mr. Raymond was an
Associate with Wolfensohn & Co. Prior to that time, he had been an Associate in
J.P. Morgan & Co.'s corporate finance division. Mr. Raymond also serves on the
Board of Directors of Consolidated Hydro, Inc.

FRANK V. SICA has been a Director of the Company since July 1993. He has
been a Managing Director of Morgan Stanley & Co. Incorporated since 1988 and is
a Vice Chairman and a Director of Morgan Stanley Leveraged Equity Fund II, Inc.
(the general partner of MSLEF II), and of Morgan Stanley Capital Partners III,
Inc. (the general partner of the general partner of the MSCP Funds). Mr. Sica
also serves on the Board of Directors of Consolidated Hydro, Inc., CSG Systems
International, Inc., Fort Howard Corporation, Kohls Corporation, PageMart
Wireless, Inc. and Sullivan Communications, Inc.

IRWIN T. VANDERHOOF has been a Director of the Company since November 1993.
Mr. Vanderhoof has been a clinical professor of Finance at the Stern School of
Business at New York University since 1989. He is the principal of Actuarial
Investment Consulting. Prior to 1988, Mr. Vanderhoof was the Chief Actuary and
Investment Officer for the individual lines of business of The Equitable Life
Assurance Company of the United States.

ELECTION OF DIRECTORS AND OFFICERS

All directors hold office until the next annual meeting of the stockholders
or until their respective successors have been duly elected and qualified.
Officers serve at the discretion of the Board of Directors with the exception of
Messrs. Franco, Ruby, Lindholm, and Ferguson who serve under certain employment
contracts, the terms of which are discussed herein under the heading "Employment
Contracts."

FAMILY RELATIONSHIPS

There are no family relationships among any directors or executive officers
of the Company.

SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
directors and executive officers, and persons who own more than 10% of a
registered class of the Company's equity securities, to file with the SEC and
the American Stock Exchange initial reports of beneficial ownership and reports
of changes in beneficial ownership of any equity securities of the Company. Such
persons are also required by SEC regulation to furnish the Company with copies
of all Section 16(a) forms they file. To the Company's knowledge, which is based
solely on a review of the copies of such reports furnished to the Company and
written representations that no other reports were required during 1996, all
Section 16(a) filing requirements applicable to such individuals were complied
with.

ITEM 11. EXECUTIVE COMPENSATION

The following table sets forth compensation information for the Co-Chief
Executive Officers of the Company and the four other most highly compensated
executive officers (the "Named Executive Officers") during the fiscal years
ended December 31, 1996, 1995 and 1994:

SUMMARY COMPENSATION TABLE

LONG-TERM
COMPENSATION
AWARDS
--------------
SECURITIES
ANNUAL COMPENSATION UNDERLYING
--------------------------------------------------- OPTIONS ALL OTHER
GRANTED(2) COMPENSATION(3)
NAME AND PRINCIPAL POSITION YEAR SALARY(1) BONUS
- -----------------------------------------------------------------------------------------------------------------------------

John Franco 1996 $400,000 $314,000 70 $20,000
Co-Chief Executive Officer and 1995 $375,000 $224,300 309 $7,500
Co-Chairman of the Board 1994 $375,000 $246,000 -- $7,500

Martin H. Ruby 1996 $400,000 $314,000 70 $20,000
Co-Chief Executive Officer and 1995 $375,000 $224,300 309 $7,500
Co-Chairman of the Board 1994 $375,000 $246,000 -- $7,500

John R. Lindholm 1996 $300,000 $185,000 20 $15,000
President--Retail Business 1995 $250,000 $146,400 159 $7,500
Division 1994 $250,000 $164,000 53 $7,500

Emad A. Zikry(4) 1996 $300,000 $700,000(6) 20 $7,500
Executive Vice President and 1995 $250,000 $520,000(6) 159 $7,500
Chief Investment Officer 1994 $41,666(5) $1,500,000(6) 159 --

David E. Ferguson 1996 $279,500 $170,000 -- $13,975
Executive Vice President and Chief 1995 $215,000 $133,900 113 $7,500
Technology Officer 1994 $215,000 $141,000 -- $7,500

Dennis L. Carr 1996 $200,000 $120,000 -- $10,000
Executive Vice President and Chief 1995 $160,000 $67,600 52 $7,500
Actuary 1994 $160,000 $75,000 -- $6,000

- -------------------------------------------------

(1) Includes amounts contributed by each of the Named Executive Officers to
various deferred compensation plans of the Company.

(2) All stock options are for shares of Class A Common Stock of the Company.
The total number of options granted to the Named Executive Officers in 1995
includes a certain number of replacement options that were issued in
exchange for Series 2 Options (as defined herein under the heading "Stock
Option Plan") originally granted in 1993 and 1994 as part of the amendment
and restatement of the ARM Financial Group, Inc. Stock Option Plan
effective as of June 14, 1995 (as amended through the date hereof, the
"Plan"), as more fully described herein under the heading "Stock Option
Plan."

(3) The amounts presented in this column represent matching contributions made
by the Company under the ARM Financial Group, Inc. Savings Plan (the
"Savings Plan"), and the ARM Financial Group, Inc. Nonqualified Savings
Plan (the "Nonqualified Plan"). Under the Savings Plan, which is generally
available to all salaried employees, the Company currently matches a
participant's tax-deferred contributions by an amount equal to 100% of such
contribution for each year, subject to a maximum of 5% of the participant's
compensation for the year. Under the Nonqualified Plan, the Company
currently matches the tax-deferred contributions made by a select group of
management or highly compensated employees in an amount equal

to 100% of such contribution for each year, subject to a maximum of 5% of
the participant's compensation for the year, less any matching
contributions allocated to the participant's account in the Savings Plan.
Participants may allocate their contributions to the Savings Plan and
Nonqualified Plan among seven investment funds. In 1996, the Company
contributed $7,500 to each of the Named Executive Officers under the
Savings Plan. Under the Nonqualified Plan, the following contributions were
made in 1996: Mr. Franco received $12,500, Mr. Ruby received $12,500, Mr.
Lindholm received $7,500, Mr. Ferguson received $6,475, and Mr. Carr
received $2,500.

(4) Mr. Zikry resigned as Executive Vice President and Chief
Investment Officer of the Company effective March 27, 1997, but remains
in his capacity as President of ARM Capital Advisors and as an employee
of the Company. See "Employment Contracts."

(5) The 1994 salary figure for Mr. Zikry reflects two months of compensation
included in 1994 (November and December).

(6) Pursuant to Mr. Zikry's employment agreement, he was entitled to a minimum
bonus for each of the 1995 and 1996 calendar years and an initial bonus
upon accepting employment with the Company in 1994, as more fully described
herein under the heading "Employment Contracts."

OPTION GRANTS

The following table sets forth information regarding those Named Executive
Officers who received stock option grants during fiscal year 1996:

OPTIONS GRANTED DURING 1996

INDIVIDUAL GRANTS
-------------------------------------------------------------
POTENTIAL REALIZABLE
VALUE AT ASSUMED
NUMBER OF % OF TOTAL ANNUAL RATE OF STOCK
SECURITIES OPTIONS PRICE APPRECIATION FOR
UNDERLYING GRANTED TO OPTION TERM(2)
OPTIONS EMPLOYEES BASE PRICE EXPIRATION ----------------------
NAME GRANTED IN 1996 PER SHARE(1) DATE 5% 10%
- ------------------------------------------------------------------------------------------------------------------------

John Franco 70 21% $6,923 01/01/2006 -- --
Martin H. Ruby 70 21% $6,923 01/01/2006 -- --
John R. Lindholm 20 6% $6,923 01/01/2006 -- --
Emad A. Zikry 20 6% $6,923 01/01/2006 -- --
David E. Ferguson -- -- -- -- -- --
Dennis L. Carr -- -- -- -- -- --

- --------------------------

(1) The base price of each option increases at a rate of 12% per annum,
compounded annually, from the respective date of grant and continues until
exercise of the option, or if shorter, up to the date of a public offering,
a sale of the Company, or a Change in Control (as defined below).

(2) The options will have no potential realizable value using the assumed rate
of appreciation required by the rules promulgated by the SEC upon exercise
unless the Company's Class A Common Stock appreciates at an annual rate in
excess of 12%.

OPTION EXERCISES

The following table sets forth as to each of the Named Executive Officers
information with respect to options exercised during 1996 and the status of
their options on December 31, 1996:

AGGREGATED OPTION EXERCISES DURING 1996 AND OPTION VALUES
AT DECEMBER 31, 1996

NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY
OPTIONS AT YEAR END OPTIONS AT YEAR END (*)
----------------------------------------------------------
NUMBER OF SHARES
AQUIRED UPON NON- NON-
NAME EXERCISE OF OPTIONS EXERCISABLE EXERCISABLE EXERCISABLE EXERCISABLE
- --------------------------------------------------------------------------------------------------------

John Franco -- 215.20 370.80 $123,979.16 $87,491.84
Martin H. Ruby -- 215.20 370.80 $123,979.16 $87,491.84
John R. Lindholm -- 110.60 174.40 $63,758.43 $44,982.86
Emad A. Zikry -- 81.80 203.20 $42,752.87 $65,988.42
David E. Ferguson -- 76.80 107.20 $44,276.52 $31,234.08
Dennis L. Carr -- 36.80 51.20 $21,250.77 $14,984.51

- ----------------------------------------------

(*) In accordance with the SEC's rules, values are calculated by subtracting
the exercise price from the fair market value of the underlying Class A
Common Stock. For purposes of this table, fair market value is deemed to be
$7,754, the base price at which New Options (as defined below) were
granted by the Stock Option Committee as of January 1, 1997, to certain
employees of the Company in accordance with the terms of the Plan.

STOCK OPTION PLAN

The Plan provides for the grant of options to purchase Class A Common Stock
to officers and other key employees of the Company. The maximum aggregate number
of shares of Class A Common Stock that may be issued under the Plan is 3,445
(subject to adjustment in accordance with the terms of the Plan), consisting of
1,765 Old Options and 1,680 New Options (as such terms are defined below).
Approximately 45 individuals currently participate in the Plan. As of March 1,
1997, 5 Old Options had been exercised, and an aggregate of 1,178 Old Options
and 1,535.40 New Options were outstanding and unexercised.

As originally adopted, the Plan provided for the grant of options to
purchase Class A Common Stock of the Company with an exercise price that
increased at a rate equal to 12% per annum ("Series 1 Options") or 30% per annum
("Series 2 Options"), in each case compounded annually. As of June 14, 1995 (the
"Amendment Date"), outstanding Series 2 Options were replaced by a number of
options with an exercise price that increases at a rate of 12% per annum,
compounded annually. All options granted prior to the Amendment Date and all
options granted to replace Series 2 Options are referred to as "Old Options" and
all options that were or will be granted on or after

the Amendment Date (other than the options issued to replace Series 2 Options)
are referred to as "New Options."

Pursuant to the terms of the Plan, the exercisability of the Old Options
and the New Options will be accelerated upon the occurrence of certain specified
events, including, without limitation, a Change in Control or a sale by the
Company of all or substantially all of its business to a third party. For
purposes of the Plan, a "Change in Control" means the acquisition of equity
securities of the Company, directly or indirectly, through a merger or
otherwise, in a single transaction or a series of transactions, by a person,
entity or group that is not, directly or indirectly, in control of, controlled
by, or under common control with the Company, Morgan Stanley & Co. Incorporated
("MS & Co."), MSLEF II or the MSCP Funds, entitling such person, entity or group
to elect a majority of the members of the Board of Directors. In addition, upon
the occurrence of certain specified events, all unallocated Old Options will be
granted pro rata to existing holders of Old Options, and all unallocated New
Options will be granted pro rata to existing holders of New Options.

Following a holder's termination of employment by the Company for cause (as
defined in the Plan) on or prior to the fifth anniversary of the date on which
options were granted to the employee, such holder's vested and unvested options
are automatically forfeited and cancelled and must be surrendered without
payment and the shares previously issued upon exercise of the options will be
subject to repurchase by the Company at its discretion. In the event of such a
repurchase, Option Shares (as defined in the Plan and specifically including any
Option Shares transferred to permitted transferees under the Stockholders
Agreement) will be repurchased at a price based on their original purchase price
(or, if less, the then Applicable Value (as defined in the Plan) of the
shares).

If, on or prior to the fifth anniversary of the date on which options were
granted, the holder resigns other than for good reason (as defined in the Plan),
such holder's unvested options will be forfeited and cancelled and must be
surrendered without payment, such holder's vested options will generally remain
exercisable for 30 days and the shares previously issued upon exercise of the
options will be subject to repurchase by the Company. In the event of such a
repurchase, Option Shares will be repurchased at a price equal to the then
Applicable Value. If a holder's employment is terminated by reason of death or
permanent disability, such holder's options will become 50% vested if such
options were less than 50% vested at the time of termination. If a holder's
employment is terminated due to his resignation for good reason, all unvested
options will vest. The Plan further provides that if a holder is terminated
without cause, resigns for good reason or terminates employment by reason of
death or permanent disability (or terminates employment for any other reason
following the fifth anniversary of the date on which options were granted to the
holder), (i) all vested options (including options that vest as a consequence of
such termination of employment) will generally remain exercisable for 90 days
(or one year in the event of death or permanent disability) following the date
of termination and (ii) no options or Option Shares shall be subject to
repurchase by the Company.

The Plan is administered by the Stock Option Committee of the Board of
Directors. Under certain circumstances, the Plan permits the holders to satisfy
the payment of the exercise price by

delivery of shares of Class A Common Stock previously owned by the holder for at
least a six-month period and to satisfy their withholding and exercise price
obligations by delivery of such shares or by having the Company retain a number
of Option Shares that would otherwise be issued upon the exercise of such
holder's options.

All options are nontransferable except by will or the laws of descent and
distribution, and all shares of Class A Common Stock issued upon exercise of any
option will be subject to the Stockholders' Agreement.

COMPENSATION OF DIRECTORS

The Company's four independent directors, Messrs. Foss, Godfrey, Powers and
Vanderhoof, are compensated annually in the amount of $10,000 plus $1,000 per
Board meeting attended and their expenses of each attendance. Messrs. Foss,
Godfrey, Powers and Vanderhoof are also directors of National Integrity, and
each receive $20,000 annually plus $1,000 per Board meeting attended and the
expenses of attendance (unless such Board meeting is held concurrently by with a
Board meeting of the Company, in which case these directors receive a total of
$1,000 and the expenses of attendance at the concurrent meetings). In addition,
Messrs. Foss, Godfrey, Powers and Vanderhoof serve on the Audit Committee for
both the Company and National Integrity and receive $1,000 per committee meeting
attended if held separately by from the respective Board meetings.

EMPLOYMENT CONTRACTS

The Company has entered into employment agreements with Messrs. Franco,
Ruby, Lindholm, Zikry and Ferguson. The employment agreements with respect to
Messrs. Franco, Ruby, Lindholm and Ferguson terminate on July 1, 1999, and
the employment agreement with respect to Mr. Zikry terminates on October 31,
1997. Each of such agreements may be extended automatically for additional
one-year periods by means of the Board of Directors giving written notice to
such executive of its intention to extend the term at least sixty days (in
the case of Mr. Franco and Mr. Ruby, twelve months) prior to the expiration
of the then effective term. Each employment agreement specifies salary levels
and describes the bonus plan, employee benefits and perquisites available.
The present base salaries for Messrs. Franco, Ruby, Lindholm, Zikry and
Ferguson are $416,000, $416,000, $312,000, $300,000 and $290,000,
respectively. It is anticipated that Mr. Zikry's employment will be
terminated without any severance obligation on the part of the Company in
connection with the proposed sale of ARM Capital Advisors as more fully
discussed herein under the heading "Business -- History."

The employment agreements with respect to Messrs. Franco and Ruby (i) fix
such executives' responsibilities and titles as Co-Chief Executive Officers and
directors of the Company and (ii) provide that such executives' base salary may
be increased by the Board of Directors at any time, but may not be decreased.
The employment agreement with respect to Mr. Zikry (i) establishes his
responsibilities and title as President of ARM Capital Advisors and
(ii) provides that his base salary may be increased at any time, but may not be
decreased, upon recommendation of the Company's Co-Chief Executive

Officers and review by the Board of Directors. The employment agreements with
respect to Messrs. Lindholm and Ferguson prohibit any decrease in base
salary, but, in contrast to the agreements for Messrs. Franco, Ruby and
Zikry, do not fix such executives' responsibilities or titles (other than
providing that each will serve the Company in a professional capacity). Each
of the employment agreements provides that the executives shall be entitled
to participate in the Company's bonus plan. In addition, Mr. Zikry's
employment agreement provided for a $1,500,000 one-time initial bonus upon
accepting employment with the Company in 1994, and a guaranteed minimum bonus
of $500,000 for each of the 1995 and 1996 calendar years.

The benefits provided by the employment agreements include, to the extent
each executive is eligible, any plans, programs or arrangements of the Company
providing for retirement benefits, incentive compensation, profit sharing,
bonuses, disability benefits, health, dental and life insurance, or vacation and
paid holidays. The executives will also receive indemnification from the Company
to the fullest extent permitted by Delaware law and the Certificate of
Incorporation and By-Laws of the Company as currently in effect and the Company
will procure and maintain insurance policies, to the extent reasonably
available, for the benefit of its directors and officers, including the
executives.

Generally, the employment agreements provide that, upon a termination of an
executive's employment by the Company without "cause" or a resignation for "good
reason" (as such terms are defined in the employment agreements; among other
things, a termination by the executive following a Change in Control (as
previously defined under the heading "Stock Option Plan") is a resignation with
"good reason"), the executive will receive (i) severance pay in an amount equal
to the base salary for the greater of the remainder of the employment term or
two years and (ii) additional severance amounts for each full or partial
calendar year during the severance period in cash equal to the same percentage
of base salary as of the date of termination as the percentage of base salary
used in calculating the bonus paid to the executive for the year preceding the
year of termination. Severance pay will be subject to each executive's
compliance with certain restrictive covenants. In the event an executive's
employment is terminated by the Company for cause or the executive resigns
without good reason, he will be entitled only to base salary through the
relevant date of termination or resignation of employment. In the event an
executive dies or is permanently disabled, he (or his beneficiary or estate in
the event of his death) will be entitled to receive base salary and benefits
(including a pro rata cash bonus for the year of death or disability) for the
period ending on the date of death or, in the case of disability, through the
later of the date of termination or the date (not later than one year following
the date of termination) on which the executive commences to receive disability
benefits.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

The full Board of Directors of the Company, including Mr. Franco and Mr.
Ruby, have approved the employment agreements described herein and will continue
to perform the functions of a compensation committee.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

STOCK OWNERSHIP OF CERTAIN BENEFICIAL OWNERS

The following table provides information as to each person or entity known
to the Company as of March 27, 1997, to be the beneficial owner of more than 5%
of any class of the Company's voting securities.

PERCENT OF
SHARES TOTAL VOTING
CLASS OF COMMON BENEFICIALLY PERCENT STOCK
NAME AND ADDRESS OF BENEFICIAL OWNERS STOCK(1) OWNED OF CLASS(2) OUTSTANDING
- ------------------------------------------------------------------------------------------------------------

The Morgan Stanley Leveraged Equity Fund II, L.P.(3) Class A 12,896.00 49.86% 48.00%
1221 Avenue of the Americas
New York, New York 10020

Morgan Stanley Capital Partners III, L.P.(3) Class A 8,395.18 32.46% 31.25%
1221 Avenue of the Americas
New York, New York 10020

Morgan Stanley Capital Investors, L.P.(3) Class A 246.77 .95% .92%
1221 Avenue of the Americas
New York, New York 10020

MSCP III 892 Investors, L.P.(3). Class A 896.51 3.47% 3.34%
1221 Avenue of the Americas
New York, New York 10020

Oldarm L.P.(4) Class B 1,000.00 100.00% 3.72%
515 West Market Street, 8th Floor
Louisville, Kentucky 40202

- -----------------------------------
(1) The rights and privileges of each share of Class A Common Stock and Class B
Common Stock are identical except that each share of Class A Common Stock
has a liquidation preference, subject to that of the Company's 91/2%
Cumulative Perpetual Preferred Stock (the "Perpetual Preferred Stock"), of
$5,000 per share and each share of Class B Common Stock has a liquidation
preference, subject to those of the Perpetual Preferred Stock and the Class
A Common Stock, of $5,000 per share.

(2) Based on the number of shares outstanding at, or acquirable within 60 days
of, March 27, 1997.

(3) The general partner of which, in the case of MSLEF II, and the general
partner of the general partner of which, in case of the MSCP Funds, are
wholly owned subsidiaries of Morgan Stanley.

(4) Oldarm GP Partnership, the general partner of Oldarm L.P., has the power to
vote, or direct the voting of, the shares of Class B Common Stock owned by
Oldarm L.P. Messrs. Franco and Ruby may, by virtue of their positions as
Co-Chief Executive Officers of Oldarm GP Partnership, be deemed to be
beneficial owners of the Class B Common Stock owned by Oldarm L.P.;
however, Messrs. Franco and Ruby disclaim any such beneficial ownership. As
of the date hereof, the Named Executive Officers, excluding Messrs. Carr
and Zikry, and certain of the directors of the Company were limited
partners of, or beneficial owners of, limited partnership interests in
Oldarm L.P.

STOCK OWNERSHIP OF MANAGEMENT

The following table provides information concerning the number of shares of
the Company's equity securities beneficially owned as of March 27, 1997, by each
director and Named Executive Officer of the Company and by all current directors
and executive officers as a group.

NUMBER OF SHARES BENEFICIALLY OWNED
------------------------------------------------------------------------
CLASS A CLASS B PERPETUAL
COMMON STOCK(1) COMMON STOCK(2) PREFERRED STOCK(3)
------------------------------------------------------------------------
BENEFICIAL OWNERS NUMBER % OF CLASS(4) NUMBER % OF CLASS(4) NUMBER % OF CLASS(4)
- -----------------------------------------------------------------------------------------------------

John Franco 899.20(5) 3.48% 1,000 100% 61,650 3.08%

Martin H. Ruby 599.20(5) 2.32% 1,000 100% 1,600 *

Dennis L. Carr 76.80(5) * -- -- 500 *

David E. Ferguson 115.80(5) * 1,000 100% 3,800 *

John R. Lindholm 139.60(5) * 1,000 100% 800 *

Emad A. Zikry 85.80(5) * -- -- -- --

James S. Cole -- -- -- -- -- --

Warren M. Foss 21.00 * -- -- -- --

Dudley J. Godfrey, Jr. 50.77 * -- -- -- --

Edward D. Powers 50.77 * -- -- -- --

Colin F. Raymond -- -- -- -- -- --

Frank V. Sica -- -- -- -- -- --

Irwin T. Vanderhoof 10.00 * -- -- -- --

All current directors and
executive officers as a
group (20 persons) 2076.54(5) 8.03% 1,000 100% 69,150 3.46%

- ---------------------------------------------
(*) Indicates beneficial ownership of less than one percent of such class of
equity securities.

(1) All shares of Class A Common Stock are held directly with the following
exceptions: Mr. Ferguson beneficially owns 2 shares which are held in the
IRA account of his wife Jeanne Ferguson; Messrs. Ruby, Lindholm, Ferguson
and all directors and executive officers as a group, hold 200 shares, 4
shares, 31 shares, and 273 shares, respectively, in trust for the purpose
of securing personal loans, and over which they have full voting, but
limited investment power. In their capacity as managers of New ARM, LLC,
which is the direct owner of 170 shares of the Class A Common Stock,
Messrs. Franco and Ruby acting in concert would have voting and limited
investment power over, but no pecuniary interest in, the 170 shares of
Class A Common Stock (included above), of which they each disclaim
beneficial ownership.

(2) 1,000 shares of Class B Common Stock are directly owned by Oldarm L.P.
Despite the fact that the named beneficial owners of Class B Common Stock
as a group hold a majority of the stock of Oldarm GP Partnership, the
general partner of Oldarm L.P., and therefore may be deemed to beneficially
own such shares, each such individual disclaims any beneficial ownership of
the Class B Common Stock owned by Oldarm L.P., except to the extent of
their pecuniary interest therein.

(3) Mr. Franco holds shared investment power over 25,400 shares of the
Perpetual Preferred Stock which are indirectly held by the John and Mary
Franco Family Foundation, Inc. Mr. Franco also disclaims beneficial
ownership of such shares of Perpetual Preferred Stock held by the John and
Mary Franco Family Foundation in accordance with the Foundation's 501(c)(3)
tax-exempt status. In addition, 3,950 shares of Perpetual Preferred Stock
are owned indirectly by Mr. Franco's minor daughter under the Uniform
Transfer to Minors Act. 1,600 shares of Perpetual Preferred Stock held by
Mr. Ruby are indirectly owned by his

two minor daughters under the Uniform Transfer to Minors Act. Mr. Ferguson
owns 3,500 shares of Perpetual Preferred Stock jointly with his wife.
Dennis Carr owns 500 shares of Perpetual Preferred Stock jointly with his
wife.

(4) Based on the number of shares outstanding of the respective class of equity
securities at, or acquirable within 60 days of, March 27, 1997.

(5) Includes 229.20, 229.20, 36.80, 76.80, 114.60, 85.80, and 855.00 shares for
Messrs. Franco, Ruby, Carr, Ferguson, Lindholm, Zikry, and all current
directors and executive officers as a group, respectively, that may be
acquired upon the exercise of options that are exercisable within 60 days
after March 27, 1997. Such options were granted pursuant to the Plan.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

STOCKHOLDERS' AGREEMENT

The Company, MSLEF II, Oldarm L.P., Messrs, Franco and Ruby, the MSCP
Funds, New ARM, LLC and certain directors and current and former employees are
parties to the Amended and Restated Stockholders' Agreement dated as of June 14,
1995 (the "Stockholders' Agreement"), which sets forth the rights and
obligations of each holder of the Company's Common Stock. Pursuant to the terms
of the Stockholders' Agreement, no stockholder may make or solicit the sale of,
or create, incur, solicit or assume the encumbrance of, any share of Common
Stock except in compliance with the terms of the Stockholders' Agreement.

Among the restrictions on transfer of shares of Common Stock contained in
the Stockholders' Agreement is a right of first refusal granted to the Company,
its assignees and the holders of the Common Stock, subject to the priorities set
forth therein, to purchase from any stockholder any Common Stock subject to a
bona fide fully financed, all cash offer to purchase such stock by a third party
which such stockholder intends to accept. In addition, in the event that MSLEF
II or any of the MSCP Funds elect to sell or otherwise dispose of some or all of
its Common Stock, the Stockholders' Agreement grants to each other stockholder
the right, at its option, to include a Pro Rata Portion (as defined in the
Stockholders' Agreement) of the Common Stock then owned by such stockholder in
such transaction on the same terms and conditions as MSLEF II and the MSCP
Funds. Also, in the event that MSLEF II and the MSCP Funds propose to sell all
of their shares of Common Stock to a third party, MSLEF II and MSCP Funds shall
have the right, at their option, to compel each other stockholder to sell all of
its shares to such third party on the same terms and conditions as MSLEF II and
the MSCP Funds.

Subject to certain limitations, if the Company proposes to file a
registration statement to register under the Securities Act of 1933, as amended
(the "Securities Act"), any of its authorized but unissued shares of Common
Stock, the Stockholders' Agreement grants to each holder of Common Stock the
right to request that shares of Common Stock owned by such holder be covered by
such registration statement. In addition, the Stockholders' Agreement grants to
each holder of Common Stock certain preemptive rights to purchase from the
Company shares of Common Stock, rights, options or warrants to purchase shares
of Common Stock and securities convertible into or exchangeable for shares of
Common Stock which the Company proposes to issue.

OTHER TRANSACTIONS

From time to time MS & Co. performs financial advisory services for the
Company in connection with specific transactions. The Company paid MS & Co. or
accrued approximately $70,500 in 1996, $655,000 in 1995, and $3.1 million in
1994, for these and other miscellaneous services.

During 1996, in the ordinary course of business, certain of the Company's
insurance subsidiaries purchased debt securities in public offerings with an
aggregate purchase price of approximately $397 million through Bear, Stearns &
Co. Incorporated ("Bear Stearns"). During 1995, in the ordinary course of
business, certain of the Company's insurance subsidiaries purchased debt and
equity securities in public offerings with an aggregate purchase price of
approximately $16.5 million through MS & Co. The Company entered into an
interest rate collar agreement in 1994 with MS & Co. under which MS & Co. was
paid a one-time fee of $480,000.

Based on transactions of similar size and nature, the Company believes that
the foregoing fees received by Bear Stearns and MS & Co. were no less favorable
to the Company than would be available from unaffiliated third parties.

CERTAIN RELATIONSHIPS AND RELATED PARTIES

Four of the Named Executive Officers and certain of the directors of the
Company are limited partners of, or are the beneficial owners of limited
partnership interests in, Oldarm L.P. Two of the Named Executive Officers manage
New ARM, LLC which owns 170 shares of the Class B Common Stock. Three of the
Company's nine directors are employees of MS & Co. and officers (including, in
one case, a director) of affiliates of MS & Co. which control MSLEF II and the
MSCP Funds. One of the Company's directors is an officer of Bear Stearns.

The Company is in the process of selling an 80% interest in ARM Capital
Advisors to an entity controlled by Mr. Zikry, President of ARM Capital
Advisors. The Company expects to recognize an immaterial gain on the sale. Under
the proposed terms of the sale, which are being negotiated, ARM Capital Advisors
will continue to provide the Company's subsidiaries with investment management
services through December 31, 1997 on the same basis as in the past. The
proposed terms of the sale further provide that, after December 31, 1997, the
Company can continue to engage ARM Capital Advisors as its investment advisor at
agreed upon rates, but, beginning in 1998, the Company may also consider
retaining other investment management firms. In connection with the proposed
sale, it is anticipated that Mr. Zikry will terminate his employment with the
Company without any severance obligation on the part of the Company.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES, AND
REPORTS ON FORM 8-K

FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES

Reference is made to the indexes set forth on pages F-1 and S-1 of this
report.

REPORTS ON FORM 8-K

No reports on Form 8-K were filed by the Company during the fourth quarter
of 1996.

EXHIBITS

EXHIBIT
NUMBER DESCRIPTION
- --------------------------------------------------------------------------------
2.1 Asset Purchase Agreement, dated as of January 5, 1995, among
Kleinwort Benson Investment Management Holdings Ltd., Kleinwort
Benson Investment Management Americas Inc., ARM Financial Group,
Inc., and ARM Capital Advisors, Inc. (incorporated by reference to
Exhibit 2.6 to Form 10-K filed by the Registrant on March 30, 1995).

2.2 Amended and Restated Stock and Asset Purchase Agreement dated as of
April 7, 1995, by and between SBM Company and ARM Financial Group,
Inc. (incorporated by reference to Exhibit 2 to Form 10-Q filed by
the Registrant on May 15, 1995), amending the Stock and Asset
Purchase Agreement, dated as of February 16, 1995 (incorporated by
reference to Exhibit 2.7 to Form 10-K filed by the Registrant on
March 30, 1995).

2.3 Subscription Agreement dated as of June 12, 1995, among ARM Financial
Group, Inc. and Morgan Stanley Capital Partners III, L.P., Morgan
Stanley Capital Investors, L.P. and MSCP III 892 Investors, L.P.
(incorporated by reference to Exhibit 2.3 to Form 10-K filed by the
Registrant on March 29, 1996).

2.4 Subscription Agreement dated as of June 12, 1995, among ARM Financial
Group, Inc. and New ARM, LLC, Dudley J. Godfrey, Jr. and Edward
Powers(incorporated by reference to Exhibit 2.4 to Form 10-K filed
by the Registrant on March 29, 1996).

2.5 Subscription Agreement dated as of July 1, 1996, between ARM
Financial Group, Inc. and Warren M. Foss (incorporated by
reference to Exhibit 2.5 to Form S-1 filed by the Registrant on
October 23, 1996).

3(i).1 Certificate of Incorporation of ARM Financial Group, Inc.
(incorporated by reference to Exhibit 3(i).1 to the Registration
Statement on Form S-1 of the Registrant, File No. 33-67268 (the
"Registration Statement").

EXHIBIT
NUMBER DESCRIPTION
- -----------------------------------------------------------------------------
3(i).2 Certificate of Amendment to the Certificate of Incorporation of ARM
Financial Group, Inc., filed with the Delaware Secretary of State on
October 5, 1993 (incorporated by reference to Exhibit 3(i).3 to the
Registration Statement).

3(i).3 Certificate of Amendment to the Certificate of Incorporation of ARM
Financial Group, Inc., filed with the Delaware Secretary of State on
November 10, 1993 (incorporated by reference to Exhibit 3(i).3 to Form
10-K filed by the Registrant on March 29, 1996).

3(i).4 Certificate of Designations of Cumulative Perpetual Preferred Stock of
ARM Financial Group, Inc., filed with the Delaware Secretary of State
on November 23, 1993 (incorporated by reference to Exhibit 3(i).2 to
the Registration Statement).

3(i).5 Certificate of Amendment to the Certificate of Incorporation of ARM
Financial Group, Inc., filed with the Delaware Secretary of State on
June 12, 1995 (incorporated by reference to Exhibit 3(i).5 to Form
10-K filed by the Registrant on March 29, 1996).

3(i).6 Certificate of Amendment to the Certificate of Incorporation of ARM
Financial Group, Inc., filed with the Delaware Secretary of State on
May 8, 1996 (incorporated by reference to Exhibit 3(i).6 to Form S-1
filed by the Registrant on October 23, 1996).

3(ii).1 By-laws of ARM Financial Group, Inc. (incorporated by reference to
Exhibit 3(ii).1 to the Registration Statement).

3(ii).2 Amendment to By-laws of ARM Financial Group, Inc., adopted by the
Board of Directors on November 9, 1994 (incorporated by reference to
Exhibit 3(ii).2 of Form 10-K filed by the Registrant on March 30,
1995).

4.1 Amended and Restated Stockholders Agreement dated as of June 14, 1995,
among ARM Financial Group, Inc., The Morgan Stanley Leveraged Equity
Fund II, L.P., John Franco, Martin H. Ruby, Oldarm L.P., Morgan
Stanley Capital Partners III, L.P., Morgan Stanley Capital Investors,
L.P., MSCP III 892 Investors, L.P. and New ARM, LLC (incorporated by
reference to Exhibit 4.1 to Form 10-K filed by the Registrant on March
29, 1996).

4.2 The instruments defining the rights of holders of the long-term debt
securities of the Company and its subsidiaries are omitted pursuant to
section (b)(4)(iii)(A) of Item 601 of Regulation S-K. The Company
hereby agrees to furnish copies of these instruments to the Securities
and Exchange Commission upon request.

EXHIBIT
NUMBER DESCRIPTION
- -----------------------------------------------------------------------------

10.1 ARM Financial Group, Inc. Amended and Restated Stock Option Agreement
dated effective as of June 14, 1995 (incorporated by reference to
Exhibit 10.1 to Form 10-K filed by the Registrant on March 29, 1996).

10.2 Amendment, Waiver and Consent dated as of March 27, 1995 to (a) the
Credit Agreement dated as of November 15, 1993 (as amended, the
"Credit Agreement"), among ARM Financial Group, Inc., Integrity
Holdings, Inc., the financial institutions listed on Schedule 2.01 to
the Credit Agreement (the "Lenders"), The Chase Manhattan Bank, N.A.
("Chase"), and Chemical Bank ("Chemical"), as managing agents for the
Lenders, (b) the Security Agreement dated as of November 26, 1993 (as
amended, the "Security Agreement"), between ARM Financial Group, Inc.
and Chase, and (c) the Pledge Agreement dated as of November 26, 1993
(as amended, the "Pledge Agreement"), among ARM Financial Group, Inc.,
Integrity Holdings, Inc. and Chase (incorporated by reference to
Exhibit 10.1 to Form 10-Q filed by the registrant on August 14, 1995).

10.3 Second Amendment to the Credit Agreement, Security Agreement and
Pledge Agreement dated as of June 29, 1995 (incorporated by reference
to Exhibit 10.4 to Form 10-Q filed by the registrant on August 14,
1995).

10.4 Third Amendment to the Credit Agreement, Security Agreement and Pledge
Agreement dated as of December 13, 1995 (incorporated by reference to
Exhibit 10.4 to Form 10-K filed by the Registrant on March 29, 1996).

10.5 Fourth Amendment to the Credit Agreement dated as of June 28, 1996
(incorporated by reference to Exhibit 10.1 to Form 10-Q filed by the
Registrant on August 13, 1996).

10.6 Fifth Amendment to the Credit Agreement dated as of December 31, 1996
(FILED HEREWITH).

10.7 Guaranty dated as of December 13, 1995, made by ARM Financial Group,
Inc. in favor of First Bank, FSB, in connection with sale of certain
SBM Certificate Company mortgage loans (incorporated by reference to
Exhibit 10.5 to Form 10-K filed by the Registrant on March 29, 1996).

10.8 Guaranty dated as of December 13, 1995, made by ARM Financial Group,
Inc. in favor of First Bank, FSB, in connection with the sale of
certain State Bond and Mortgage Life Insurance Company mortgage loans
(incorporated by reference to Exhibit 10.6 to Form 10-K filed by the
Registrant on March 29, 1996).

10.9 Assignment and Assumption of Lease dated January 5, 1995, between
Kleinwort Benson International Investments, Ltd., and ARM Capital
Advisors, Inc. Obligations of ARM Capital Advisors, Inc. have been
fully guaranteed by ARM Financial Group, Inc. (incorporated by
reference to Exhibit 10.15 to Form 10-K filed by the Registrant on
March 30, 1995).

EXHIBIT
NUMBER DESCRIPTION
- -----------------------------------------------------------------------------

10.10 Administrative Services Agreement dated as of September 28, 1994,
between ARM Financial Group, Inc. and National Integrity Life
Insurance Company (incorporated by reference to Exhibit 10.10 to Form
S-1 filed by the Registrant on October 23, 1996).

10.11 Administrative Services Agreement dated as of January 1, 1995, between
ARM Financial Group, Inc. and ARM Capital Advisors, Inc. (incorporated
by reference to Exhibit 10.11 to Form S-1 filed by the Registrant on
October 23, 1996).

10.12 Administrative Services Agreement dated as of January 1, 1995, between
ARM Financial Group, Inc. and Integrity Life Insurance Company
(incorporated by reference to Exhibit 10.8 to Form 10-K filed by the
Registrant on March 29, 1996).

10.13 Administrative Services Agreement dated as of June 14, 1995, between
ARM Financial Group, Inc. and SBM Certificate Company (incorporated by
reference to Exhibit 10.10 to Form 10-K filed by the Registrant on
March 29, 1996).

10.14 Administrative Services Agreement dated as of June 14, 1995, between
ARM Financial Group, Inc. and SBM Financial Services, Inc.
(incorporated by reference to Exhibit 10.11 to Form 10-K filed by the
Registrant on March 29, 1996).

10.15 Investment Services Agreement dated as of July 29, 1994, between ARM
Financial Group, Inc. and National Integrity Life Insurance Company
(incorporated by reference to Exhibit 10.15 to Form S-1 filed by the
Registrant on October 23, 1996).

10.16 Investment Services Agreement dated as of January 1, 1995, between ARM
Financial Group, Inc. and Integrity Life Insurance Company
(incorporated by reference to Exhibit 10.12 to Form 10-K filed by the
Registrant on March 29, 1996).

10.17 Investment Advisory Agreement dated as of June 14, 1995, between ARM
Financial Group, Inc. and SBM Certificate Company (incorporated by
reference to Exhibit 10.14 to Form 10-K filed by the Registrant on
March 29, 1996).

10.18 Tax Allocation Agreement dated as of March 21, 1996 by and among ARM
Financial Group, Inc. and certain of its subsidiaries for taxable
periods beginning January 1, 1995 (incorporated by reference to
Exhibit 10.15 to Form 10-K filed by the Registrant on March 29,
1996).

10.19 Lease made as of June 14, 1996, by and between Northwestern National
Life Insurance Company and ARM Financial Group, Inc. (incorporated by
reference to Exhibit 10.1 to Form 10-Q filed by the Registrant on
August 13, 1996).

10.20 Assignment and Assumption Agreement dated as of June 28, 1996, between
Northwestern National Life Insurance Company and ARM Financial Group,
Inc. (incorporated by reference to Exhibit 10.19 to Form S-1 filed by
the Registrant on October 23, 1996).

EXHIBIT
NUMBER DESCRIPTION
- ------------------------------------------------------------------------------

10.21 Employment Agreement dated as of July 1, 1996, between ARM Financial
Group, Inc. and John Franco (incorporated by reference to Exhibit
10.20 to Form S-1 filed by the Registrant on October 23, 1996).

10.22 Employment Agreement dated as of July 1, 1996, between ARM Financial
Group, Inc. and Martin H. Ruby (incorporated by reference to Exhibit
10.21 to Form S-1 filed by the Registrant on October 23, 1996).

10.23 Employment Agreement dated as of July 1, 1996, between ARM Financial
Group, Inc. and David E. Ferguson (incorporated by reference to
Exhibit 10.22 to Form S-1 filed by the Registrant on October 23,
1996).

10.24 Employment Agreement dated as of July 1, 1996, between ARM Financial
Group, Inc. and John R. Lindholm (incorporated by reference to Exhibit
10.23 to Form S-1 filed by the Registrant on October 23, 1996).

21.1 Subsidiaries of the Registrant (FILED HEREWITH).

27 Financial Data Schedule (ELECTRONIC FILING ONLY).

SIGNATURES

Pursuant to the requirements of the Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on March 27, 1997.

ARM FINANCIAL GROUP, INC.

By: /s/ JOHN FRANCO
------------------------------------
John Franco
Co-Chief Executive Officer

By: /s/ MARTIN H. RUBY
------------------------------------
Martin H. Ruby
Co-Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant in the capacities indicated on the 27th day of March, 1997.

Name Title
---- -----

/s/ JOHN FRANCO Co-Chief Executive Officer and Director
- ------------------------------
John Franco (Principal Executive Officer)

/s/ MARTIN H. RUBY Co-Chief Executive Officer and Director
- ------------------------------
Martin H. Ruby (Principal Executive Officer)

/s/ EDWARD L. ZEMAN Executive Vice President - Chief Financial
- ------------------------------
Edward L. Zeman Officer (Principal Financial Officer)

/s/ BARRY G. WARD Controller (Principal Accounting Officer)
- ------------------------------
Barry G. Ward

/s/ JAMES S. COLE Director
- ------------------------------
James S. Cole

/s/ WARREN M. FOSS Director
- ------------------------------
Warren M. Foss

/s/ DUDLEY J. GODFREY, JR. Director
- ------------------------------
Dudley J. Godfrey, Jr.

/s/ EDWARD D. POWERS Director
- ------------------------------
Edward D. Powers

/s/ COLIN F. RAYMOND Director
- ------------------------------
Colin F. Raymond

/s/ FRANK V. SICA Director
- ------------------------------
Frank V. Sica

/s/ IRWIN T. VANDERHOOF Director
- ------------------------------
Irwin T. Vanderhoof

ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES

INDEX TO FINANCIAL STATEMENTS

PAGE
----

Report of Independent Auditors ........................................... F-2

Consolidated Balance Sheets as of December 31, 1996 and 1995.............. F-3
Consolidated Statements of Operations for the Years
Ended December 31, 1996, 1995 and 1994 ................................ F-5
Consolidated Statements of
Shareholders' Equity for the Years
Ended December 31 1996, 1995 and 1994 ................................. F-6
Consolidated Statements of Cash Flows for the Years
Ended December 31, 1996, 1995 and 1994 ................................ F-7
Notes to Consolidated Financial Statements ............................... F-8

F-1

REPORT OF INDEPENDENT AUDITORS

Board of Directors and Shareholders
ARM Financial Group, Inc.

We have audited the accompanying consolidated carrying amount
balance sheets of ARM Financial Group, Inc. and subsidiaries as of December
31, 1996 and 1995, and the related consolidated statements of operations,
shareholders' equity, and cash flows for each of the three years in the
period ended December 31, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by the
Company's management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.

We have also audited in accordance with generally accepted auditing
standards the consolidated supplemental fair value balance sheets of ARM
Financial Group, Inc. and subsidiaries as of December 31, 1996 and 1995. As
described in Note 4, the consolidated supplemental fair value balance sheets
have been prepared by management to present relevant financial information that
is not provided by the carrying amount balance sheets and is not intended to be
a presentation in conformity with generally accepted accounting principles. In
addition, the consolidated supplemental fair value balance sheets do not purport
to present the net realizable, liquidation or market value of ARM Financial
Group, Inc. as a whole. Furthermore, amounts ultimately realized by ARM
Financial Group, Inc. from the disposal of assets may vary significantly from
the fair values presented. In our opinion, the consolidated supplemental fair
value balance sheets referred to above present fairly, in all material respects,
the information set forth therein as described in Note 4.

In our opinion, the financial statements referred to in paragraph one
above present fairly, in all material respects, the consolidated financial
position of ARM Financial Group, Inc. and subsidiaries at December 31, 1996 and
1995, and the consolidated results of their operations and their cash flows for
each of the three years in the period ended December 31, 1996, in conformity
with generally accepted accounting principles.

/s/ Ernst & Young LLP

Louisville, Kentucky
February 12, 1997

F-2

ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

Carrying Amount Fair Value
----------------------- ----------------------
December 31, December 31,
(IN THOUSANDS) 1996 1995 1996 1995
- --------------------------------------------------------------------------------------------------

ASSETS
Cash and investments:

Fixed maturities, available-for-sale, at
fair value (amortized cost:
1996-$3,048,834; 1995-$2,493,403) $3,054,513 $2,550,567 $3,054,513 $2,550,567

Equity securities, at fair value (cost:
1996-$21,268; 1995-$8,196) 22,552 9,093 22,552 9,093
Mortgage loans on real estate 36,879 43,943 36,879 43,943
Policy loans 123,466 117,528 123,466 117,528
Cash and cash equivalents 110,067 76,896 110,067 76,896
---------------------- ----------------------
Total cash and investments 3,347,477 2,798,027 3,347,477 2,798,027

Assets held in separate accounts 1,135,048 809,927 1,135,048 809,927
Accrued investment income 36,233 36,382 36,233 36,382
Value of insurance in force 52,024 51,051 112,389 98,977
Deferred policy acquisition costs 59,001 43,113 -- --
Goodwill 7,636 8,124 7,636 8,124
Deferred federal income taxes 35,604 19,776 42,653 48,642
Other assets 28,641 27,180 28,641 27,180
---------------------- ----------------------

Total assets $4,701,664 $3,793,580 $4,710,077 $3,827,259
======================= =======================

F-3

ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (CONTINUED)

Carrying Amount Fair Value
-------------------------- ------------------------
December 31, December 31,
(IN THOUSANDS) 1996 1995 1996 1995
- ----------------------------------------------------------------------------------------------------

LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Customer deposits $3,294,174 $2,708,260 $3,260,253 $2,742,209
Customer deposits in separate accounts 1,130,159 808,345 1,130,159 808,345
Long-term debt 40,000 40,000 40,000 40,000
Accounts payable and accrued expenses 22,684 15,496 22,684 15,496
Payable for investment securities
purchased 10,431 8,538 10,431 8,538
Payable to reinsurer 10,000 -- 10,000 --
Other liabilities 12,274 24,950 12,274 24,950
------------------------ ----------------------
Total liabilities 4,519,722 3,605,589 4,485,801 3,639,538

Contingencies

Shareholders' equity:
Preferred stock, $.01 par value, $25.00

stated value; 2,300,100 shares
authorized; 2,000,000 shares issued
and outstanding 50,000 50,000

Class A common stock, $.01 par value;
27,280 and 27,100 shares authorized,
respectively; 23,796 and 23,770 shares
issued and outstanding, respectively * *

Class B common stock, $.01 par value;
1,080 shares authorized; 1,000 shares
issued and outstanding * *

Additional paid-in capital 124,609 124,425

Net unrealized gains on available-for-
sale securities 3,669 28,530

Retained earnings 3,664 (14,964)
-------------------------
Total shareholders' equity 181,942 187,991 224,276 187,721
------------------------- -----------------------

Total liabilities and shareholders' equity $4,701,664 $3,793,580 $4,710,077 $3,827,259
========================== =======================

* LESS THAN $1,000.

SEE ACCOMPANYING NOTES.

F-4

ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

Year Ended December 31,
--------------------------------------
(IN THOUSANDS, EXCEPT SHARE
AMOUNTS AND PER SHARE AMOUNTS) 1996 1995 1994
- ----------------------------------------------------------------------------------

Investment income $ 250,031 $ 196,024 $ 149,142

Interest credited on customer deposits (182,161) (146,867) (116,463)
--------------------------------------
Net investment spread 67,870 49,157 32,679

Fee income:

Variable annuity fees 10,786 7,238 4,291
Asset management fees 5,780 3,161 --
Other fee income 1,267 949 4,100
--------------------------------------
Total fee income 17,833 11,348 8,391

Other income and expenses:

Surrender charges 5,024 3,339 2,356
Operating expenses (31,055) (22,957) (21,484)
Commissions, net of deferrals (2,372) (1,557) (2,551)
Interest expense on debt (3,146) (3,461) (3,136)

Amortization:

Deferred policy acquisition costs (6,835) (2,932) (1,296)
Value of insurance in force (7,320) (7,104) (3,830)
Acquisition-related deferred charges (1,503) (9,920) (2,163)

Goodwill (488) (358) --
Non-recurring charges (5,004) -- --
Other, net (5,366) (687) 4,972
---------------------------------------
Total other income and expenses (58,065) (45,637) (27,132)

Realized investment gains (losses) 907 4,048 (36,727)
---------------------------------------

Income (loss) before federal income taxes 28,545 18,916 (22,789)
Federal income tax benefit (expense) (5,167) (7,026) 6,018
---------------------------------------

Net income (loss) 23,378 11,890 (16,771)

Dividends on preferred stock (4,750) (4,750) (4,750)
---------------------------------------
Net income (loss) applicable to
common shareholders $ 18,628 $ 7,140 $ (21,521)
=======================================

Net income (loss) per common share $ 751.58 $ 344.94 $(1,434.73)
=======================================

Average common shares outstanding 24,785 20,699 15,000
=======================================

SEE ACCOMPANYING NOTES.

F-5

ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

Net
Unrealized
Gains
(Losses) on
Class A Class B Additional Available- Total
Preferred Common Common Paid-In for-Sale Retained Shareholders'
(IN THOUSANDS) Stock Stock Stock Capital Securities Earnings Equity
- -------------------------------------------------------------------------------------------------------------------------------

Balance, January 1, 1994 $ 50,000 $ * $ * $ 62,920 $ -- $ (569) $ 112,351

Adjustment to beginning balance
for change in accounting
method, net of income taxes of
$1,579 (7,445) (7,445)
Net loss (16,771) (16,771)
Dividends on preferred stock (4,750) (4,750)
Change in net unrealized losses on
available-for-sale securities (97,504) (97,504)
Change in cumulative translation
adjustment (14) (14)
-------------------------------------------------------------------------------------
Balance, December 31, 1994 50,000 * * 62,920 (104,949) (22,104) (14,133)

Issuance of 9,770 shares of Class
A common stock * 61,505 61,505
Net income 11,890 11,890
Dividends on preferred stock (4,750) (4,750)
Change in net unrealized losses on
available-for-sale securities 133,479 133,479
-------------------------------------------------------------------------------------
Balance, December 31, 1995 50,000 * * 124,425 28,530 (14,964) 187,991

Issuance of 26 shares of Class
A common stock * 184 184
Net income 23,378 23,378
Dividends on preferred stock (4,750) (4,750)
Change in net unrealized gains on
available-for-sale securities (24,861) (24,861)
--------------------------------------------------------------------------------------
Balance, December 31, 1996 $ 50,000 $ * $ * $ 124,609 $ 3,669 $ 3,664 $181,942
======================================================================================

* LESS THAN $1,000.

SEE ACCOMPANYING NOTES.

F-6

ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

Year Ended December 31,
-----------------------------------------
(IN THOUSANDS) 1996 1995 1994
- -------------------------------------------------------------------------------------------------------

CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES:
Net income (loss) $ 23,378 $ 11,890 $ (16,771)
Adjustments to reconcile net income (loss) to
cash flows provided by operating activities:

Interest credited on general account customer deposits 172,202 136,824 108,495
Realized investment (gains) losses (907) (4,048) 36,727
Amortization of value of insurance in
force and deferred policy
acquisition costs 14,155 10,036 5,126
Other amortization 1,374 12,406 9,402
Deferral of policy acquisition and other costs (24,202) (24,505) (25,273)
Deferred tax expense (benefit) 2,554 6,385 (3,823)
(Increase) decrease in accrued investment income 149 (1,609) 2,590
Changes in other assets and liabilities 4,171 (9,020) (10,770)
------------------------------------------
Cash flows provided by operating activities 192,874 138,359 105,703

CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:
Fixed maturity investments:

Purchases (2,716,010) (1,498,623) (835,792)
Maturities and redemptions 241,391 205,319 159,684
Sales 1,922,689 1,197,468 522,175

Other investments:

Purchases (55,995) (7,891) (18,562)
Maturities and redemptions 7,310 24,377 79,236

Sales 42,961 36,119 --
Policy loans, net (5,938) (6,428) (4,637)
Purchase of separate account assets (302,993) (226,812) (306,097)
Proceeds from sale of separate account assets 83,077 45,249 19,895
Cash and cash equivalents acquired in excess of
purchase price paid for:

Integrity Holdings, Inc. -- -- 3,250
Substantially all assets of SBM Company -- 36,490 --
------------------------------------------
Cash flows used in investing activities (783,508) (194,732) (380,848)

CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:
Proceeds from issuance of common stock 184 63,505 --
Organizational, debt and stock issuance costs -- (2,000) (2,104)
Preferred stock dividends (4,750) (4,750) (5,014)
Amounts received from customers 1,072,323 425,628 375,580
Amounts paid to customers (441,944) (406,977) (301,330)

Change in payable to reinsurer 10,000 -- --
Change in repurchase agreement liability (12,008) 12,008 --
------------------------------------------
Cash flows provided by financing activities 623,805 87,414 67,132
------------------------------------------

Net change in cash and cash equivalents 33,171 31,041 (208,013)

Cash and cash equivalents at beginning of year 76,896 45,855 253,868
------------------------------------------

Cash and cash equivalents at end of year $ 110,067 $ 76,896 $ 45,855
==========================================

Supplemental cash flow information:

Interest paid on debt $ 2,613 $ 2,736 $ 2,275
==========================================

Income taxes paid $ 7,230 $ -- $ 3,017
==========================================

SEE ACCOMPANYING NOTES.

F-7

ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION

ARM Financial Group, Inc. (the "Company") specializes in the asset
accumulation business, providing retail and institutional customers with
products and services designed to serve the growing long-term savings and
retirement markets. The Company's retail products include a variety of fixed
and variable annuities and face-amount certificates sold through a broad
spectrum of distribution channels including independent broker-dealers,
independent agents, stockbrokers and financial institutions. The Company
offers asset management services and guaranteed investment contracts ("GICs")
to its institutional clients, which include defined benefit pension plans,
defined contribution or 401(k) pension plans and insurance companies. The
Company markets its institutional products and services directly to bank
trust departments, plan sponsors, cash management funds, other institutional
funds and insurance companies as well as through industry consultants.

The Company derives its earnings from its spread-based and fee-based
products and services. With spread-based products, the Company's insurance and
face-amount certificate subsidiaries agree to return customer deposits with
interest at a specified rate or based on a specified index. As a result, the
Company's insurance and face-amount certificate subsidiaries accept investment
risk in exchange for the opportunity to achieve a spread between what the
Company earns on invested assets and what it pays or credits on customer
deposits. With fee-based products and services, the Company's subsidiaries
receive a fee in exchange for managing deposits, and the customer accepts the
investment risk. Because the investment risk is borne by the customer, this line
of business requires significantly less capital support than spread-based
business.

The Company conducts its different businesses through a variety of
subsidiaries. Retail fixed and variable annuities and institutional GICs are
issued by the Company's insurance subsidiaries Integrity Life Insurance Company
("Integrity") and National Integrity Life Insurance Company ("National
Integrity") (collectively, the "Integrity Companies"). ARM Capital Advisors,
Inc. ("ARM Capital Advisors"), an SEC-registered investment advisor based in New
York City, offers fixed income asset management services (see Note 2 related to
the proposed sale of ARM Capital Advisors). ARM Securities Corporation ("ARM
Securities"), a registered broker-dealer, provides a distribution channel for
selling affiliated and nonaffiliated retail products. SBM Certificate Company is
an issuer of face-amount certificates, a retail product similar to certificates
of deposit issued by banks.

The Company was established in July 1993 by The Morgan Stanley
Leveraged Equity Fund II, L.P. ("MSLEF II") and Analytical Risk Management, Ltd.
(now known as Oldarm L.P.). MSLEF II is an investment fund sponsored by Morgan
Stanley Group Inc. ("Morgan Stanley"). As a result of an additional investment
(described in Note 2), certain other private equity funds sponsored by Morgan
Stanley, together with MSLEF II, own approximately 91% of the outstanding shares
of common stock of the Company. Oldarm L.P., New ARM, LLC and certain employees,
management

F-8

and independent directors of the Company and its subsidiaries own in the
aggregate approximately 9% of the common stock of the Company. The Company had
no significant business activity until November 26, 1993, when it acquired the
Integrity Companies resulting in $2.3 billion of assets under management. Assets
under management have grown to $4.8 billion as of December 31, 1996 after giving
effect to the proposed sale of ARM Capital Advisors.

BASIS OF PRESENTATION

The consolidated financial statements are prepared in accordance with
generally accepted accounting principles ("GAAP") and include the accounts of
the Company and all of its wholly owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated in consolidation.
Certain amounts from prior years have been reclassified to conform to the
current year's presentation. Such reclassifications had no effect on previously
reported net income or shareholders' equity.

The consolidated statements of operations represent a presentation of
the Company's results using the reporting format followed by banks and some
insurance companies whose products involve only minimal amounts of mortality
risk. The Company's focus on products and services for the retirement and
long-term savings markets creates many similarities to non-insurance financial
services companies. Management of the Company believes that these statements of
operations provide financial statement readers with more relevant information
than under the format generally followed by traditional life insurance
companies, which was used by the Company prior to 1995. These statements
highlight the Company's spread-based segment's net investment spread and provide
details of the sources of fee income for the Company's fee-based segment.

The consolidated balance sheets include a dual presentation of carrying
amount and fair value balances. In accordance with Statement of Financial
Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in
Debt and Equity Securities," fixed maturities classified as available-for-sale
are reported at fair value in the carrying amount balance sheets; however,
corresponding customer deposits are reported at historical values. In contrast,
in the fair value balance sheets, both assets and liabilities are reported at
fair value. As permitted by SFAS No. 107, "Disclosures About Fair Value of
Financial Instruments," the fair value balance sheets are presented as a
supplemental disclosure to provide a more meaningful picture of the Company's
financial position. Note 4 describes the methods and assumptions used by the
Company in estimating fair value.

INVESTMENTS

All of the Company's fixed maturities and equity securities are
classified as available-for-sale and stated at fair value. Unrealized gains and
losses on available-for-sale securities are reported as a separate component of
shareholders' equity, net of adjustments to value of insurance in force and
deferred policy acquisition costs equal to the change in amortization that would
have been recorded if these securities had been sold as of the balance sheet
date, and net of deferred income taxes. The amortized cost of fixed maturities
is adjusted for amortization of premiums and accretion of discounts to maturity,
or in the case of mortgage-backed and asset-backed securities, over the
estimated life of the security. Such amortization and accretion is computed
using the interest method and is included in investment income. Anticipated
prepayments on mortgage-backed and

F-9

asset-backed securities are considered in determining the effective yield on
such securities. If a difference arises between anticipated and actual
prepayments, the carrying value of the investment is adjusted with a
corresponding charge or credit to investment income. Interest and dividends are
included in investment income. Mortgage loans on real estate and policy loans
are carried at their unpaid principal balances. Cash and cash equivalents
consist of highly liquid investments with maturities of three months or less at
their time of purchase.

Realized gains and losses on the sale of investments are determined
based upon the average cost method and include provisions for
other-than-temporary impairments where appropriate. In addition, the
amortization of value of insurance in force and deferred policy acquisition
costs is adjusted for gains and losses realized on sales of investments which
support customer deposits. The adjustment to amortization associated with such
realized gains and losses is included in Realized Investment Gains (Losses) in
the statement of operations.

At the time of adoption of SFAS No. 115, the Company classified its
portfolio of privately placed fixed maturity securities as held-to-maturity.
Although the Company had the ability to hold these securities to maturity, its
original intention of holding them as such changed during 1995. Effective April
1, 1995, the Company transferred all if its fixed maturities classified as
held-to-maturity (primarily private placement securities) to the
available-for-sale category. The April 1, 1995 amortized cost of the fixed
maturities transferred was $129.7 million, resulting in an unrealized loss of
$1.9 million, net of deferred income tax assets.

VALUE OF INSURANCE IN FORCE, DEFERRED POLICY ACQUISITION COSTS, AND GOODWILL

A portion of the purchase price paid for the insurance subsidiaries was
allocated to the value of insurance in force based on the actuarially-determined
present value of the expected pretax future profits from the business assuming a
discount rate of 13%. This present value amount was reduced to the extent that
the fair value of the net assets acquired including the value of insurance in
force exceeded the purchase price allocated to the insurance subsidiaries.
Interest is accrued on the balance annually at a rate consistent with the rate
credited on the acquired policies on the acquisition date. Recoverability of the
value of insurance in force is evaluated quarterly by comparing the current
estimate of the present value of expected pretax future profits to the
unamortized asset balance. If such current estimate is less than the existing
asset balance, the difference would be charged to expense. To the extent
recoverable from future gross profits, costs of producing new business
(primarily commissions and certain policy issuance and marketing costs) which
vary with and are primarily related to the production of new business are
deferred. Value of insurance in force and deferred policy acquisition costs are
amortized in proportion to the emergence of future gross profits, including
related realized investment gains and losses, over the estimated term of the
underlying policies. In addition, an adjustment is made to value of insurance in
force and deferred policy acquisition costs equal to the change in amortization
that would have been recorded if unrealized gains and losses on
available-for-sale securities had been realized as of the balance sheet date.

A portion of the purchase price paid for subsidiaries was allocated to
goodwill representing the excess of the purchase price paid over the fair value
of net assets acquired. Goodwill currently recorded is amortized over a period
not exceeding twenty years using the straight-line method.

F-10

Incremental costs directly related to the integration of acquired
companies are deferred, to the extent recoverable from future gross profits of
the acquired companies. Such deferred transition costs are amortized using the
straight-line method over the estimated term of the policies underlying the
acquired companies.

ASSETS HELD IN SEPARATE ACCOUNTS AND CUSTOMER DEPOSITS IN SEPARATE ACCOUNTS

Assets held in separate accounts of the Company's insurance
subsidiaries are segregated from other investments and are not subject to claims
that arise out of any other business of the Company. Separate accounts include
both spread-based and fee-based deposits representing guaranteed and
non-guaranteed business, respectively, primarily of variable annuity customers.
Assets held in separate accounts are carried at estimated fair values. Customer
deposits in guaranteed separate accounts are recorded at customer account
values, plus or minus a market value adjustment calculated using credited rates
for new business. Customer deposits in non-guaranteed separate accounts are
recorded at customer account values before applicable surrender charges, which
reflects the market value of the underlying separate account investments. The
Company receives administrative fees for managing non-guaranteed deposits and
other fees for assuming mortality and certain expense risks. Such fees are
included in Variable Annuity Fees in the statement of operations. Investment
income and interest credited on customer deposits for guaranteed separate
account deposits are included as such in the statement of operations.

During 1996, the Company began offering an equity-indexed annuity
product through its separate accounts which aims to meet consumer demand for
equity investments with downside protection. In connection with this product,
the Company's separate accounts purchased call options based on the Standard &
Poor's 500 Composite Stock Index ("S&P 500"). The options perform as a hedge
against the Company's obligation to pay equity-indexed annuity policyholders
returns tied to the S&P 500. These options are carried at fair value and
unrealized gains and losses increase or decrease obligations to policyholders.

CUSTOMER DEPOSITS

For single and flexible premium deferred annuities, single premium
endowments, face-amount certificates and guaranteed investment contracts,
customer deposits represent account values before applicable surrender charges.
Such account values represent premiums and deposits received, plus interest
credited, less withdrawals and assessed fees. For structured settlements and
other single premium immediate annuities, customer deposits represent the
present value of future benefit payments and maintenance expenses. The interest
rate used in determining such present value was approximately 7.35% as of
December 31, 1996.

RECOGNITION OF FEE INCOME AND EXPENSES

Variable annuity fees and asset management fees are recorded in income
as earned. Other fee income includes marketing partnership fees earned related
to ventures with other insurance companies and certain fees earned by ARM
Securities (primarily net retained commissions). Premiums and deposits received
from customers are not included in the statement of operations. Other expenses
include benefit payments paid in excess of a customer's account value and
related reinsurance costs.

F-11

FEDERAL INCOME TAXES

Deferred income tax reflects the net tax effects of (i) temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes, and (ii)
operating and capital losses.

NET INCOME PER SHARE OF COMMON STOCK

Net income per share is computed by dividing net income or loss, less
dividends on preferred stock, by the weighted average number of common shares
outstanding for the period, considering the effects of any dilutive common stock
equivalents. The rights of the holders of the Company's Class A and Class B
common stock are identical except that the Class A shares have a liquidation
preference over the Class B shares.

USE OF ESTIMATES

The preparation of financial statements in conformity with GAAP
requires management of the Company to make estimates and assumptions that affect
the amounts reported in the consolidated financial statements and accompanying
notes. Actual results could differ from those estimates.

2. ACQUISITIONS

SBM COMPANY

In June 1995, the Company completed the acquisition of substantially
all of the assets and business operations of SBM Company ("SBM"), including
all of the issued and outstanding capital stock of SBM's subsidiaries, State
Bond and Mortgage Life Insurance Company ("SBM Life") and SBM Financial
Services, Inc. (which subsequently changed its name to ARM Securities), SBM
Certificate Company, and SBM's management contracts with six mutual funds
(the "State Bond Mutual Funds"). The designated effective date of the
acquisition was May 31, 1995.

The aggregate purchase price for the acquisition was $38.8 million. The
Company financed the acquisition by issuing a total of 9,770 shares of the
Company's Class A common stock to Morgan Stanley Capital Partners III, L.P.,
Morgan Stanley Capital Investors, L.P., and MSCP III 892 Investors, L.P.
(collectively, the "MSCP Funds"), New ARM, LLC, and certain directors of the
Company for an aggregate sale price of $63.5 million. The MSCP Funds are private
equity funds sponsored by Morgan Stanley. The Company used the proceeds from the
issuance of new common equity in excess of the aggregate purchase price for the
acquisition to (i) make a $19.9 million capital contribution to SBM Life, (ii)
acquire all of the issued and outstanding capital stock of SBM Certificate
Company from SBM Life for a purchase price of $3.3 million and (iii) provide for
fees and expenses related to the acquisition. Transition costs of $1.1 million
and $2.2 million directly related to the acquisition were deferred during 1996
and 1995, respectively.

The capital contribution to SBM Life was used to strengthen SBM Life's
financial position and allowed for a significant investment portfolio
restructuring immediately following the acquisition with no net adverse effect
on statutory adjusted capital and surplus. On December 31, 1995, SBM Life was
merged with and into Integrity to create certain operating efficiencies intended
to benefit the Company and its customers. On December 13, 1996, the Company
transferred its contracts to

F-12

perform management and advisory services for the State Bond Mutual Funds to
Federated Investors for $4.5 million. Asset management fee income of $1.6
million and $1.0 million was recorded by the Company during 1996 and 1995,
respectively, with respect to the management of such funds. The State Bond
Mutual Funds had aggregate assets of $236.9 million on December 13, 1996.

ARM CAPITAL ADVISORS

On January 5, 1995, the Company completed the acquisition of
substantially all the assets and business of the U.S. fixed income unit of
Kleinwort Benson Investment Management Americas Inc. ("KBIMA"). KBIMA provided
investment advisory services to the Company during 1994 and received fees of
$2.1 million for such services. The business acquired became part of the then
newly-formed ARM Capital Advisors. Assets managed by ARM Capital Advisors under
contracts acquired from KBIMA and new contracts with third parties, primarily
defined benefit pension plans, have increased from $0.8 billion as of January 5,
1995 to $2.7 billion as of December 31, 1996. ARM Capital Advisors' management
of third-party accounts generated asset management fees of $4.2 million and $2.2
million during 1996 and 1995, respectively. In addition to providing asset
management services to institutional clients, ARM Capital Advisors manages the
investment portfolios of the Company's subsidiaries. Although third-party assets
managed by ARM Capital Advisors have grown since the acquisition, the Company
believes that market attitudes towards developing an asset management service
for defined benefit pension plans within a holding company structure consisting
predominantly of insurance companies has constrained ARM Capital Advisors'
growth. Accordingly, the Company is in the process of transferring the
operations and assets of ARM Capital Advisors into a newly-formed limited
liability company to be named ARM Capital Advisors, LLC, and thereafter selling
an 80% interest in such company to an entity controlled by Emad A. Zikry,
President of ARM Capital Advisors. Under the proposed terms of the sale, which
are being negotiated, the newly-formed company will continue to provide the
Company's subsidiaries with investment management services through December 31,
1997 on the same basis as in the past. The proposed terms of the sale further
provide that after December 31, 1997, the Company can continue to engage the
newly-formed company as its investment advisor at agreed upon rates, but,
beginning in 1998, the Company may consider retaining other investment
management firms.

INTEGRITY COMPANIES

On November 26, 1993, the Company completed the acquisition of the
Integrity Companies from The National Mutual Life Association of Australasia
Limited ("National Mutual"). In connection with the acquisition, National Mutual
replaced all equity securities, investment real estate and joint ventures and
fixed maturity investments classified as "6" by the National Association of
Insurance Commissioners ("NAIC") with cash in an amount equal to the statutory
book value of such assets as of December 31, 1992 adjusted for any additional
cash investments or distributions during the period from January 1, 1993 to
November 26, 1993. In addition, National Mutual (i) strengthened Integrity's
statutory policyholder reserves and surplus by $24.3 million, (ii) indemnified
the Integrity Companies with respect to the payment of principal and interest
due on all commercial and agricultural mortgage loans and supports the
indemnification with a $23.0 million escrow arrangement, (iii) provided
indemnification as to the availability of net operating and capital loss
carryforwards and of Section 338(h)(10) tax deductions, (iv) provided the
Integrity Companies with indemnification as to future claims for taxes,
assessments from guaranty funds, and claims from

F-13

litigation, which arise from preclosing events, and (v) terminated all surplus
relief reinsurance arrangements.

Income related to National Mutual indemnifications was $2.6 million and
$1.3 million for the years ended December 31, 1996 and 1995, respectively. The
indemnification income is primarily related to indemnified guaranty fund
assessments, franchise taxes and mortgage loan investment income.

3. INVESTMENTS

The amortized cost and estimated fair values of available-for-sale securities
were as follows:

Gross Gross
Unrealized Unrealized Estimated
(IN THOUSANDS) Cost Gains Losses Fair Value
- -------------------------------------------------------------------------------------

DECEMBER 31, 1996:

Fixed Maturities:

U.S. Treasury securities and
obligations of U.S.
government agencies $ 247,041 $ 1,363 $ 1,481 $ 246,923

Obligations of state and
political subdivisions 4,963 3 406 4,560

Foreign governments 45,611 611 462 45,760
Corporate securities 992,003 13,260 13,693 991,570
Asset-backed securities 299,365 686 1,951 298,100
Mortgage-backed securities 1,459,851 19,393 11,644 1,467,600
-------------------------------------------------
Total fixed maturities 3,048,834 35,316 29,637 3,054,513
Equity securities 21,268 1,286 2 22,552
-------------------------------------------------
Total available-
for-sale securities $3,070,102 $ 36,602 $ 29,639 $3,077,065
=================================================

DECEMBER 31, 1995:
Fixed Maturities:

U.S. Treasury securities
and obligations of U.S.
government agencies $ 248,838 $ 4,345 $ 32 $ 253,151

Obligations of state and
political subdivisions 10,126 29 467 9,688

Foreign governments 80,394 3,828 727 83,495
Corporate securities 954,453 38,418 17,776 975,095
Asset-backed securities 150,732 1,730 1,116 151,346
Mortgage-backed securities 1,048,860 30,607 1,675 1,077,792
-------------------------------------------------
Total fixed maturities 2,493,403 78,957 21,793 2,550,567
Equity securities 8,196 897 -- 9,093
-------------------------------------------------
Total available-
for-sale securities $2,501,599 $ 79,854 $ 21,793 $2,559,660
=================================================

F-14

The amortized cost and estimated fair value of available-for-sale
securities, by contractual maturity, are shown below:

December 31, 1996
-----------------------
Estimated
(IN THOUSANDS) Cost Fair Value
- ----------------------------------------------------------------------------

Due in one year or less $ 26,365 $ 26,382
Due after one year through five years 182,680 182,378
Due after five years through ten years 238,769 240,178
Due after ten years 841,804 839,875
Asset-backed securities 299,365 298,100
Mortgage-backed securities 1,459,851 1,467,600
Equity securities 21,268 22,552
---------------------
Total available-for-sale securities $3,070,102 $3,077,065
======================

Expected maturities will differ from contractual maturities because
borrowers may have the right to call or repay obligations with or without call
or prepayment penalties and because mortgage-backed and asset-backed securities
(including floating-rate securities) provide for periodic payments throughout
their lives.

During 1996, 1995 and 1994, gross gains of $33.5 million, $24.1
million and $2.1 million, respectively, and gross losses of $18.9 million,
$15.6 million and $37.2 million, respectively, were realized on sales of
fixed maturities. For the year ended December 31, 1996, the Company recorded
a loss of $15.2 million related to the write-down to fair value of an
investment in a corporate fixed maturity security. For the years ended
December 31, 1996 and 1995, the recognition of realized investment gains
resulted in an increase in the amortization of value of insurance in force of
$1.9 million and $2.6 million, respectively, and in an increase in the
amortization of deferred policy acquisition costs of $28,000 and $318,000,
respectively.

In accordance with SFAS No. 115, net unrealized gains and losses on
investments classified as available-for-sale were reduced by deferred federal
income taxes and adjustments to value of insurance in force and deferred policy
acquisition costs that would have been required had such gains and losses been
realized. Net unrealized gains on available-for-sale securities reflected as a
separate component of shareholders' equity are summarized as follows:

December 31,
---------------------------
(IN THOUSANDS) 1996 1995
- --------------------------------------------------------------------------------

Net unrealized gains on available-
for-sale securities before
adjustments for the following: $ 6,963 $ 58,061

Amortization of value of
insurance in force and
deferred policy acquisition costs (1,318) (14,170)

Deferred federal income taxes (1,976) (15,361)
---------------------------

Net unrealized gains on available-
for-sale securities $ 3,669 $ 28,530
===========================

F-15

Pursuant to the terms of the acquisition of the Integrity Companies,
National Mutual has indemnified principal (up to 100% of the investments'
year-end 1992 statutory book value) and interest with respect to $36.7 million
or 99.6% of the Company's investment in mortgage loans on real estate as of
December 31, 1996. In support of its indemnification obligations, National
Mutual has placed $23.0 million into escrow in favor of the Integrity Companies,
which will remain available until the subject commercial and agricultural loans
have been paid in full.

Investments, aggregated by issuer, in excess of 10% of shareholders'
equity (before net unrealized gains on available-for-sale securities) at
December 31, 1996 and 1995, other than investments in affiliates and investments
issued or guaranteed by the United States government are as follows. Such
securities were 97.4% and 96.7% investment grade at December 31, 1996 and 1995,
respectively.
Carrying
(IN MILLIONS) Amount
- --------------------------------------------------------------------------------
1996
Fixed maturities:
ABN AMRO Bank $ 19.3
Advanta Corporation 20.1
Aircraft Lease Portfolio Securities 27.4
American President Company 18.4
Amresco Residential Mortgage Loan 23.8
Augusta Funding LTD VI 20.0
Augusta Funding LTD VIII 24.8
Bear Stearns Company 30.4
Chevy Chase Master Credit Card Trust 20.0
Commonwealth Edison Company 19.2
Conseco Commercial Mortgage 20.2
Countrywide Home Loans 29.1
Countrywide Mortgage Backed 50.7
Delta Funding Home Equity Loan Trust 17.9
DLJ Acceptance Corporation 58.7
First USA Credit Card Trust 25.0
Ford Motor Corporation 25.0
General Electric Capital Mortgage 91.3
Greenwich Capital Acceptance 36.8
Guardian National Acceptance Corporation 21.4
J.P. Morgan & Company 24.8
LB Mortgage Trust 27.3
Lehman Brothers Holdings 23.5
Matterhorn One, Ltd. 45.2
Merit Securities Corporation 30.0
Mobil Producing Nigeria 19.0
National Westminster Bank 22.3
Paine Webber Group, Incorporated 29.4
Philadelphia Electric 18.5
Residential Funding Mortgage 44.0
Resolution Trust Corporation 47.0

F-16

Carrying
(IN MILLIONS) Amount
- --------------------------------------------------------------------------------

Ryland Mortgage Securities Corporation $34.4
Salomon Brothers Mortgage Securities VII 22.2
Structured Asset Securities Corporation 106.2
TCI Communications, Incorporated 23.9
Tenaga Nasional Berhad 19.2
Time Warner Entertainment Company, L.P. 21.6
TMS Home Equity Loan Trust 48.0
Wilshire Manufactured Housing Trust 22.9
Equity securities:
Santander Finance, Ltd. 19.2

1995
Fixed maturities:
ABN AMRO Bank 18.5
AETNA Life & Casualty 16.5
American President Company 19.7
CNA Financial 21.3
Commonwealth Edison Company 21.2
Conseco Commercial Mortgage 20.7
Contimortgage Home Equity Loan Trust 27.2
Countrywide Mortgage Backed 36.7
General Electric Capital Mortgage 39.6
Georgia Pacific 22.3
Home Holdings 19.3
Hydro-Quebec 23.0
Korea Electric & Power 17.1
Nationwide CSN Trust 17.2
Nomura Asset Security Corporation 24.2
Pohang Iron and Steel 16.0
RJR Nabisco, Incorporated 16.6
Ryland Mortgage Securities Corporation 20.5
Salomon, Incorporated 18.8
Structured Asset Securities Corporation 73.3
Swedish Export Credit 19.9
Telephone & Data Systems, Incorporated 18.7
Time Warner Entertainment Company, L.P. 22.5
Torchmark Corporation 17.2
Western Financial Grantor Trust 17.3

F-17

The components of investment income were:

Year Ended December 31,
----------------------------------
(IN THOUSANDS) 1996 1995 1994
- --------------------------------------------------------------------------------

Fixed maturities $ 228,473 $ 177,123 $ 129,211
Policy loans 8,629 7,579 6,767
Mortgage loans on real estate 4,321 6,712 9,379
Cash and cash equivalents 5,705 3,096 3,222
Income from other investments 2,903 1,514 563
-----------------------------------
Investment income $ 250,031 $ 196,024 $ 149,142
===================================

4. FAIR VALUE BALANCE SHEETS

SFAS No. 107, "Disclosures About Fair Value of Financial Instruments,"
requires disclosure of fair value information about all financial instruments,
including insurance liabilities classified as investment contracts, unless
specifically exempted. The accompanying fair value balance sheets reflect fair
values for those financial instruments specifically covered by SFAS No. 107,
along with fair value amounts for other assets and liabilities for which
disclosure is permitted but not required.

The fair value of a financial instrument is the amount at which the
instrument could be exchanged in a current transaction between willing parties,
other than in a forced or liquidation sale. In cases where quoted market prices
are not available, fair values are based on estimates using present value or
other valuation techniques. Those techniques are significantly affected by the
assumptions used, including the discount rate and estimates of future cash
flows. Accordingly, the aggregate fair value amounts presented do not
necessarily represent the underlying value of the Company.

The Company's management of interest rate risk reduces its exposure to
changing interest rates through a close matching of duration, convexity and cash
flow characteristics of both assets and liabilities while maintaining liquidity
redundancies (i.e., sources of liquidity in excess of projected liquidity
needs). As a result, fair values of the Company's assets and liabilities will
tend to respond similarly to changes in interest rates.

The following methods and assumptions were used in estimating fair
values:

FIXED MATURITIES AND EQUITY SECURITIES

Fair values for fixed maturities and equity securities are based on
quoted market prices, where available. For fixed maturities for which a quoted
market price is not available, fair values are estimated using internally
calculated estimates or quoted market prices of comparable instruments.

F-18

MORTGAGE LOANS ON REAL ESTATE

Pursuant to the terms of the acquisition of the Integrity Companies,
payments of principal and interest on mortgage loans acquired on November 26,
1993 are guaranteed by National Mutual. Principal received in excess of
statutory book value is to be returned to National Mutual. Accordingly, book
value is deemed to be fair value for these mortgage loans.

POLICY LOANS

The carrying amount of policy loans approximates their fair value.

CASH AND CASH EQUIVALENTS AND ACCRUED INVESTMENT INCOME

The carrying amount of cash and cash equivalents and accrued investment
income approximates their fair value given the short-term nature of these
assets.

ASSETS HELD IN SEPARATE ACCOUNTS AND CUSTOMER DEPOSITS IN SEPARATE ACCOUNTS

Fair values of assets held in separate accounts are based on the quoted
market prices of the underlying mutual funds for assets invested in variable
options. The fair value of assets held in separate accounts invested in
guaranteed rate options is primarily based on quoted market prices of fixed
maturity securities. The fair value of customer deposits in separate accounts is
based on the account values of the underlying policies, plus or minus market
value adjustments applicable to certain customers who are guaranteed a fixed
rate of return.

GOODWILL

The carrying amount of goodwill approximates fair value.

DEFERRED FEDERAL INCOME TAXES

The deferred federal income tax asset and related valuation allowance
were adjusted for federal income tax which may be incurred as a result of the
differences between the estimated fair values and carrying amounts of the assets
and liabilities.

CUSTOMER DEPOSITS AND VALUE OF INSURANCE IN FORCE

The fair value of customer deposits for single premium immediate
annuity contracts is based on discounted cash flow calculations using a current
market yield rate for assets with similar durations (i.e., indexed to the U.S.
Treasury yield curve). The fair value of customer deposits for single premium
immediate annuity contracts represents the fair values of those contracts as a
whole which implicitly eliminates the corresponding value of insurance in force.
The fair value amounts of the remaining customer deposits, primarily related to
deferred annuity contracts, single premium endowment contracts, and guaranteed
investment contracts, represent the account values of the underlying contracts
before applicable surrender charges. The fair value of the value of insurance in
force represents the estimated present value of future profits for all customer
deposits, excluding single premium immediate annuity contracts, assuming a
discount rate of 13%. Deferred policy acquisition costs do not appear on the
fair value presentation because those values are implicitly considered in the
determination of the fair value of the corresponding customer deposits and value
of insurance in force.

F-19

LONG-TERM DEBT AND PAYABLE TO REINSURER

The carrying amounts of long-term debt and payable to reinsurer
approximate fair value.

OTHER ASSETS AND LIABILITIES

The fair values of other assets and liabilities are reported at their
financial statement carrying amounts.

5. VALUE OF INSURANCE IN FORCE

The following provides information on the value of insurance in force
during 1996, 1995 and 1994:

Year Ended December 31,
------------------------------
(IN THOUSANDS) 1996 1995 1994
- ---------------------------------------------------------------------------

Amortization excluding effects of
realized and unrealized investment
gains and losses $(10,474) $(10,490) $(5,874)

Interest accrued on unamortized balance 3,154 3,386 2,044
------------------------------
Net amortization as reported in the
statement of operations (7,320) (7,104) (3,830)

Amortization related to realized
investment gains and losses(a) (1,890) (2,562) --

Change in amortization related to
unrealized gains and losses on
available-for-sale securities(b) 13,180 (14,170) --

Addition resulting from the acquisition
of SBM Life -- 61,131 --

Recognition of acquired tax benefits (2,997) (18,004) (5,415)
------------------------------
Net change in value of insurance in force 973 19,291 (9,245)
Balance at beginning of period 51,051 31,760 41,005
------------------------------
Balance at end of period $ 52,024 $ 51,051 $31,760
==============================

(a) Included in Realized Investment Gains (Losses) in the statement of
operations.
(b) Included in Change in Net Unrealized Gains and Losses on Available-for-Sale
Securities in the statement of shareholders' equity.

The interest rates used to accrue interest on the unamortized value of
insurance in force are consistent with the rates credited on acquired policies
and range from 5% to 8%. Net amortization of the value of insurance in force,
excluding the effects of realized and unrealized investment gains and losses, in
each of the following years is estimated to be: 1997 -- $8.2 million; 1998 --
$6.8 million; 1999 -- $5.7 million; 2000 -- $4.9 million; and 2001 -- $4.1
million.

6. NON-RECURRING CHARGES

The Company recorded a $5.0 million non-recurring charge in 1996
including $3.2 million related to the relocation and consolidation of operations
facilities from Columbus, Ohio to Louisville, Kentucky; costs of $1.0 million
for mergers and acquisitions activities that did not result in a transaction;
and costs of $0.8 million related to the Company's filing of a public offering
of common stock.

F-20

During the fourth quarter of 1996, the Company developed a plan to
relocate and consolidate its main processing center. The $3.2 million charge in
1996 relates to certain direct costs associated with the plan. Additional
non-recurring transition costs of approximately $5.0 million which are deemed to
provide future economic benefits to the Company are expected to be incurred in
1997.

7. DEBT

LONG-TERM DEBT

The Company is a party to a Credit Agreement, as amended, providing a
term loan facility in the principal amount of $40 million bearing a floating
interest rate indexed to the London Interbank Offered Rate ("LIBOR"). The loan
matures September 30, 2001, subject to optional prepayment and contingent upon
the Company's compliance with various financial covenants. The loan amount is
secured by a pledge of the shares of common stock of the Company's subsidiaries
(except National Integrity). At December 31, 1996, aggregate maturities of such
debt were as follows: 1997 -- $4 million; 1998 -- $6 million; 1999 -- $8
million; 2000 -- $10 million; 2001 -- $12 million.

REVOLVING CREDIT FACILITY

The Credit Agreement, as amended, also provides a revolving credit
facility. The maximum borrowing allowed under this facility is $20 million. The
facility is available through September 30, 2001, and has an annual commitment
fee of 0.25% on the unused portion. There have been no borrowings under this
facility.

PAYABLE TO REINSURER

The Company holds $10.0 million of funds withheld under a modified
coinsurance reinsurance agreement related to a block of variable annuity
contracts. This liability bears a floating interest rate indexed to the LIBOR.
Repayment is scheduled for equal annual installments over the next five years.

8. FEDERAL INCOME TAXES

The components of the provision for federal income tax expense
(benefit) consist of the following:

Year Ended December 31,
--------------------------------
(IN THOUSANDS) 1996 1995 1994
- --------------------------------------------------------------------------------

Current $ 2,613 $ 641 $ (2,195)
Deferred 2,554 6,385 (3,823)
--------------------------------
Total federal income tax expense (benefit) $ 5,167 $ 7,026 $ (6,018)
================================

F-21

Significant components of the asset related to deferred federal income
taxes as of December 31, 1996 and December 31, 1995 were:

(IN THOUSANDS) 1996 1995
- --------------------------------------------------------------------------------
Deferred tax assets:

Difference between GAAP and tax reserves $ 72,513 $ 68,708
Value of insurance in force 724 --
Capital loss carryforward 2,736 4,483
Net operating loss carryforward 11,783 15,341
Intangibles 1,331 1,618
Alternative minimum tax credit carryforward 2,029 1,209
Other investments 294 --
Other 3,638 5,399
----------------------------
Total deferred tax assets 95,048 96,758
Valuation allowance for deferred tax assets (38,798) (37,336)
----------------------------
Net deferred tax assets 56,250 59,422

Deferred tax liabilities:

Deferred policy acquisition costs 16,910 10,848
Value of insurance in force -- 8,891

Fixed maturities 1,760 1,727
Other investments -- 2,819

Net unrealized gains on available-
for-sale securities 1,976 15,361
----------------------------
Total deferred tax liabilities 20,646 39,646
----------------------------
Total deferred federal income taxes $ 35,604 $ 19,776
============================

In the event that deferred tax assets are recognized on deductible
temporary differences for which a valuation allowance was provided at the date
of an acquisition, such benefits will be applied to first reduce the balance of
intangible assets related to the acquisition, such as value of insurance in
force and goodwill. A full valuation allowance was provided on the difference
between deferred tax assets and liabilities of the Integrity Companies as of
November 26, 1993, resulting in zero deferred federal income taxes at that date.
Based on the Integrity Companies' ability to generate taxable income in the
post-acquisition period and projections of future taxable income, the Integrity
Companies' valuation allowance was reduced by $11.0 million and $27.9 million
during 1996 and 1995, respectively. As a result of realizing such benefits, the
value of insurance in force was reduced by $3.0 million and $18.0 million during
1996 and 1995, respectively. The balance of goodwill was also reduced by $1.0
million during 1995. Additionally, the Company has established a full valuation
allowance on its non-life net operating loss carryforwards. Realization of these
carryforward benefits is dependent on future non-life earnings and the
generation of future capital gains.

The Company files a consolidated federal income tax return with its
non-life subsidiaries, but is not currently eligible to file with its life
insurance subsidiaries. Accordingly, Integrity and National Integrity file a
consolidated federal life insurance income tax return.

F-22

Federal income taxes differ from that computed using the federal income
tax rate of 35% for 1996, 1995 and 1994 as follows:

Year Ended December 31,
-------------------------------
(IN THOUSANDS) 1996 1995 1994
- --------------------------------------------------------------------------------

Income tax expense (benefit) at statutory rate $ 9,991 $ 6,621 $ (7,976)
Increase (decrease) in valuation allowance (5,490) 1,052 1,977
Net operating losses not currently deductible -- (271) --
Other 666 (376) (19)
--------------------------------
Total federal income tax expense (benefit) $ 5,167 $ 7,026 $ (6,018)
================================

The Company had net operating loss carryforwards of approximately $33.7
million, $43.8 million and $47.0 million at December 31, 1996, 1995 and 1994,
respectively, expiring in years 2005 to 2011.

F-23

9. STATUTORY INFORMATION

Following is a reconciliation of income based on statutory accounting
practices prescribed or permitted by insurance regulatory authorities for the
Company's insurance subsidiaries with GAAP net income (loss) reported in the
accompanying statements of operations:

Year Ended December 31,
--------------------------------
(IN THOUSANDS) 1996 1995 1994
- --------------------------------------------------------------------------------

Insurance subsidiaries (statutory-basis)(1) $ 38,769 $ 31,179 $ 27,079
Non-insurance companies(2) 927 255 (1,909)
----------------------------------
Consolidated statutory-basis
pretax operating income 39,696 31,434(3) 25,170

Reconciling items:

Amortization of interest maintenance
reserve (4,091) (3,905) (5,796)
Adjustments to invested asset carrying
values at acquisition date (572) (769) (3,726)

Adjustments to customer deposits (2,324) (5,994) (15,773)
Interest expense on debt (3,146) (3,461) (3,136)
Deferred policy acquisition costs,
net of amortization 16,223 16,650 23,976
Amortization of value of
insurance in force (7,320) (7,104) (3,830)
Amortization of acquisition-related
deferred charges (1,503) (9,920) (2,163)
Amortization of goodwill (488) (358) --
Non-recurring charges (5,004) -- --
Realized investment gains (losses) 907 4,048 (36,727)
Other (3,833) (1,705) (784)
----------------------------------
GAAP-basis:
Income (loss) before federal income taxes 28,545 18,916 (22,789)
Federal income tax benefit (expense) (5,167) (7,026) 6,018
----------------------------------
Net income (loss) 23,378 11,890 (16,771)
Dividends on preferred stock (4,750) (4,750) (4,750)
----------------------------------
Net income applicable to common
shareholders 18,628 7,140 (21,521)
Exclude, net of tax:
Realized investment (gains) losses (590) (2,631) 23,873
Non-recurring charges 4,539 -- --
----------------------------------
Operating earnings(4) $ 22,577 $ 4,509 $ 2,352
----------------------------------
----------------------------------

(1) Insurance company general account and separate account statutory-basis
pretax income excluding realized gains and losses.
(2) Non-insurance company pretax income excluding amortization of
acquisition-related deferred charges, interest expense on debt, realized
investment gains and losses, and non-recurring corporate costs and charges
related to acquisition, financing and restructuring activities.
(3) Includes the results of operations of the acquired SBM businesses for the
seven months ended December 31, 1995.
(4) Net income applicable to common shareholders, excluding, net of tax,
realized investment gains and losses and non-recurring charges.

F-24

On December 30, 1994, Integrity redomesticated from Arizona to Ohio.
Dividends that the Company may receive from Integrity in any year without prior
approval of the Ohio Insurance Director are limited by statute to the greater of
(i) 10% of Integrity's statutory capital and surplus as of the preceding
December 31, and (ii) Integrity's statutory net income for the preceding year.
The maximum dividend payments that may be made by Integrity to the Company
during 1997 are $26.0 million.

The consolidated statutory-basis capital and surplus of the Company's
insurance subsidiaries totaled $163.8 million and $146.0 million at December 31,
1996 and 1995, respectively. In addition, the consolidated statutory-basis asset
valuation reserves of the Company's insurance subsidiaries totaled $28.1 million
and $19.4 million at December 31, 1996 and 1995, respectively. These reserves
are generally added to statutory capital and surplus for purposes of assessing
capital adequacy against various measures used by rating agencies and
regulators.

The NAIC Risk-Based Capital ("RBC") requirements attempt to evaluate
the adequacy of a life insurance company's statutory-basis adjusted capital and
surplus in relation to investment, insurance and other business risks. The RBC
formula is used by the states as an early warning tool to identify possible
weakly capitalized companies for the purpose of initiating regulatory action and
is not designed to be a basis for ranking the financial strength of insurance
companies. In addition, the formula establishes a minimum capital standard which
supplements the prevailing system of low fixed minimum capital and surplus. The
RBC requirements provide for four different levels of regulatory attention
depending on the ratio of the company's adjusted capital and surplus to its RBC.
As of December 31, 1996 and 1995, the adjusted capital and surplus of Integrity
and National Integrity are substantially in excess of the minimum level of RBC
that would require regulatory response.

10. SHAREHOLDERS' EQUITY

PREFERRED STOCK

During 1993, the Company issued 2,000,000 shares of non-voting 9.5%
Cumulative Perpetual Preferred Stock, stated value $25, in connection with the
acquisition of the Integrity Companies. Cash dividends at a rate of 9.5% per
annum per share are payable quarterly. The shares of preferred stock may not be
redeemed prior to December 15, 1998. On or after December 15, 1998, the Company
may, at its option, redeem all or part of the shares at a redemption price of
$25 per share.

PUBLIC OFFERING OF COMMON STOCK

On October 23, 1996, the Company filed a registration statement with
the Securities and Exchange Commission with respect to the public offering (the
"Offering") of a yet to be determined number of shares of Class A common stock,
par value $.01 per share (the "New Class A Common Stock"). The Company's
decision to proceed with the Offering is subject to market and other conditions.
Prior to the consummation of the Offering, the Company expects to amend and
restate its Certificate of Incorporation and By-Laws to effectuate a
recapitalization such that (i) the common equity of the Company will consist of
New Class A Common Stock and Class B Common Stock, par value $.01 per share
(the "New Class B Common Stock," and, together with the New Class A Common
Stock, the "New Common Stock"), (ii) each outstanding share of common stock of
the

F-25

Company will be converted into one share of New Class A Common Stock, (iii)
certain shares of the New Class A Common Stock owned by private equity funds
sponsored by Morgan Stanley (the "Morgan Stanley Stockholders") will be
converted into New Class B Common Stock such that, after giving effect to such
conversion, but not giving effect to the proposed Offering, the Morgan Stanley
Stockholders will own, in the aggregate, 49% of the outstanding New Class A
Common Stock, and (iv) each share of New Class A Common Stock and New Class B
Common Stock will be split into an as yet to be determined number of shares of
New Class A Common Stock and New Class B Common Stock, respectively. Holders of
New Class B Common Stock will have no right to vote on matters submitted to a
vote of stockholders, except in certain circumstances. Shares of the New Class B
Common Stock will have no preemptive or other subscription rights and will be
convertible into an equal number of shares of New Class A Common Stock (1) at
the option of the holder thereof to the extent that, following such conversion,
the Morgan Stanley Stockholders will not, in the aggregate, own more than 49% of
the outstanding shares of New Class A Common Stock, and (2) automatically upon
the transfer of such shares by any Morgan Stanley Stockholder to a person that
is not a Morgan Stanley Stockholder. The registration statement has not yet
become effective.

STOCK OPTIONS

The Company's Stock Option Plan adopted in December 1993, as amended
(the "Plan"), provides for granting of options to purchase up to 3,445 shares of
Class A common stock. A total of 2,668 options were outstanding as of December
31, 1996, of which 897 were exercisable at the average exercise price of $7,213.
Each option has an exercise price set initially at fair market value on the date
of the grant, as determined by the Board of Directors of the Company. The option
price increases at the end of every three month period following the date of
grant at a rate of 12% per annum, compounded annually, while the option remains
issued but unexercised (or if shorter, up to the date the Plan is terminated or
there are certain changes in the ownership of the Company). Such options become
exercisable in equal installments on the first through fifth anniversary of the
date of grant.

The Company has elected to follow Accounting Principles Board Opinion
("APB") No. 25, "Accounting for Stock Issued to Employees" and related
Interpretations in accounting for its employee stock options. Under the variable
plan accounting requirements of APB No. 25, no stock-based compensation expense
has been recognized through December 31, 1996 for the Plan. However, upon the
effective date of the Offering, assuming it is consummated, the Company will
record a one-time stock-based compensation expense charge related to the Plan
equal to the aggregate difference between the initial public offering price of
the New Class A Common Stock and the exercise price of the options.

The Company adopted the disclosure-only option under SFAS No. 123,
"Accounting for Stock-Based Compensation," as of December 31, 1995. If the
accounting provisions of SFAS No. 123 had been adopted as of the beginning of
1995, the effects on 1995 and 1996 net income would have been immaterial.

F-26

Information with respect to the incentive stock option plan is as
follows:

Outstanding
--------------------------
Shares Average
Subject to Exercise
Option Price
--------------------------

Balance at December 31, 1993 1,020 $5,000
Options granted 144 5,600
Options forfeited (8) 5,000
--------------
Balance at December 31, 1994 1,156 5,600
Options granted 1,252 6,475
Options forfeited (20) 6,500
--------------
Balance at December 31, 1995 2,388 6,585
Options granted 340 7,067
Options exercised (5) 6,272
Options forfeited (55) 7,217
--------------
Balance at December 31, 1996 2,668 7,415
--------------
--------------

Shares under options that were exercisable were 434 and 202 as of
December 31, 1995 and 1994, respectively, at an average exercise price of $6,272
and $5,600. At December 31, 1996, outstanding option shares had exercise prices
ranging from $7,025 to $7,754 and average contractual life remaining of 2.9
years. Upon certain events, such as the Offering, options not previously granted
will be automatically granted on a pro rata basis to participants of the Plan.

11. CONTINGENCIES

The Company is a defendant in various lawsuits in connection with the
normal conduct of its operations. Company management believes the ultimate
resolution of such litigation will not result in any material adverse impact to
the financial position of the Company.

The number of insurance companies that are under regulatory supervision
has resulted in and is expected to continue to result in assessments by state
guaranty funds to cover losses to policyholders of insolvent or rehabilitated
companies. The Company has accrued for expected non-indemnified assessments.

F-27

12. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

(IN THOUSANDS,
EXCEPT PER SHARE DATA) 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
- -----------------------------------------------------------------------------------------------------------------

1996:

Net investment spread $ 14,078 $ 17,773 $ 18,003 $ 18,016
Fee income 4,162 4,201 4,964 4,506
Other income and expenses (11,779) (13,967) (16,572) (15,747)
Realized investment gains (losses) (403) (814) (1,115) 3,239
---------------------------------------------------------------------------
Income before federal income taxes 6,058 7,193 5,280 10,014
Federal income tax expense (1,573) (1,190) (956) (1,448)
---------------------------------------------------------------------------
Net income 4,485 6,003 4,324 8,566
Dividends on preferred stock (1,188) (1,188) (1,187) (1,187)
---------------------------------------------------------------------------
Net income applicable to common
shareholders 3,297 4,815 3,137 7,379

Exclude, net of tax:
Realized investment (gains)
losses 262 529 725 (2,106)
Non-recurring charges -- -- 940 3,599
---------------------------------------------------------------------------
Operating earnings $ 3,559 $ 5,344 $ 4,802 $ 8,872
---------------------------------------------------------------------------
---------------------------------------------------------------------------
Per share:
Net Income $ 133.09 $ 194.35 $ 126.51 $ 297.59
Operating earnings $ 143.66 $ 215.70 $ 193.66 $ 357.80

1995:

Net investment spread $ 9,443 $ 11,238 $ 14,582 $ 13,894
Fee income 2,010 2,507 3,363 3,468
Other income and expenses (8,572) (9,523) (17,540) (10,002)
Realized investment gains (losses) (2,511) 5,205 (1,818) 3,172
---------------------------------------------------------------------------
Income (loss) before federal income
taxes 370 9,427 (1,413) 10,532
Federal income tax benefit (expense) (196) (4,742) 332 (2,420)
---------------------------------------------------------------------------
Net income (loss) 174 4,685 (1,081) * 8,112
Dividends on preferred stock (1,188) (1,188) (1,187) (1,187)
---------------------------------------------------------------------------
Net income (loss) applicable to
common shareholders (1,014) 3,497 (2,268) 6,925
Exclude, net of tax:
Realized investment (gains)
losses 1,632 (3,383) 1,182 (2,062)
---------------------------------------------------------------------------
Operating earnings $ 618 $ 114 $ (1,086) $ 4,863
---------------------------------------------------------------------------
---------------------------------------------------------------------------
Per share:
Net Income (loss) $ (67.60) $ 191.54 $ (91.56) $ 279.57
Operating earnings (loss) $ 41.20 $ 6.24 $ (43.84) $ 196.33

* Net loss for the quarter includes an after-tax charge of $4.9 million
related to the amortization of acquisition-related deferred charges due to a
change in accounting estimate.

F-28

13. SEGMENT INFORMATION

The Company classifies its products and services as either spread-based
or fee-based and manages these two distinct segments separately. Corporate and
other revenues represent earnings on cash and investments in excess of customer
deposits (i.e., surplus assets) and fee-income from broker-dealer operations. In
addition to normal operating expenses associated with these revenue generating
activities, corporate and other pretax income includes unallocated corporate
overhead, non-recurring charges and realized investment gains and losses.
Consolidated federal income taxes and dividends on preferred stock are included
in corporate and other operating earnings. Segment information is presented for
the years ended December 31, 1996, 1995 and 1994 as follows:

Corporate
(IN THOUSANDS) Spread-Based Fee-Based and Other Consolidated
- -------------------------------------------------------------------------------------------------------------------

YEAR ENDED DECEMBER 31, 1996:

Revenues $ 243,506 $ 17,032 $ 7,326 $ 267,864
Operating earnings (loss) 33,876 5,050 (16,349) 22,577
Income (loss) before federal income taxes 33,876 5,050 (10,381) 28,545
Assets 3,681,562 883,483 136,619 4,701,664

Amortization 10,804 3,839 1,503 16,146

YEAR ENDED DECEMBER 31, 1995:

Revenues $ 188,476 $ 10,682 $ 8,214 $ 207,372
Operating earnings (loss) 22,322 3,525 (21,338) 4,509
Income (loss) before federal income taxes 22,322 3,525 (6,931) 18,916
Assets 3,031,076 647,132 115,372 3,793,580
Amortization 8,422 1,837 10,055 20,314

YEAR ENDED DECEMBER 31, 1994:

Revenues $ 143,890 $ 4,459 $ 9,184 $ 157,533
Operating earnings (loss) 16,200 2,141 (15,989) 2,352
Income (loss) before federal income taxes 16,200 2,141 (41,130) (22,789)
Assets 1,948,240 409,291 90,357 2,447,888
Amortization 3,956 900 2,433 7,289

F-29

ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES

INDEX TO FINANCIAL STATEMENT SCHEDULES

PAGE

Report of Independent Auditors on Financial Statement Schedules . . . . . S-2
Schedule I -- Summary of Investments (Other than Investments in
Related Parties) . . . . . . . . . . . . . . . . . . . . . . S-3
Schedule II--Condensed Financial Information of Registrant . . . . . . . . S-4
Schedule III--Supplementary Insurance Information. . . . . . . . . . . . . S-8
Schedule IV--Reinsurance . . . . . . . . . . . . . . . . . . . . . . . . . S-9
Schedule V--Valuation and Qualifying Accounts. . . . . . . . . . . . . . .S-10

Schedules required by Article 7 of Regulation S-X other than those listed are
omitted because they are not required, are not applicable, or equivalent
information has been included in the financial statements and notes thereto, or
elsewhere herein.

S-1

REPORT OF INDEPENDENT AUDITORS
ON FINANCIAL STATEMENT SCHEDULES

Board of Directors and Shareholders
ARM Financial Group, Inc.

We have audited the consolidated financial statements of ARM Financial
Group, Inc. as of December 31, 1996 and 1995, and for each of the three years in
the period ended December 31, 1996, and have issued our report thereon dated
February 12, 1997, included elsewhere in this Annual Report (Form 10-K). Our
audits also included the financial statement schedules listed in the Index at
Item 14 of this Annual Report (Form 10-K). These schedules are the
responsibility of the Company's management. Our responsibility is to express an
opinion based on our audits.

In our opinion, the financial statement schedules referred to above, when
considered in relation to the basic financial statements taken as a whole,
present fairly in all material respects the information set forth therein.

/s/ ERNST & YOUNG LLP

Louisville, Kentucky
February 12, 1997

S-2

ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES

SCHEDULE I--SUMMARY OF INVESTMENTS
(OTHER THAN INVESTMENTS IN RELATED PARTIES)

DECEMBER 31, 1996

Amount at
Which
Shown in the
Balance
Type of Investment Cost Value Sheet
- -----------------------------------------------------------------------------------------
(IN THOUSANDS)

Fixed maturities:
Bonds:
U.S. government and
government agencies and
authorities $ 906,674 $ 913,343 $ 913,343

States, municipalities and political
subdivisions 4,963 4,560 4,560
Foreign governments 45,611 45,760 45,760
Public utilities 100,208 99,485 99,485
Industrial and miscellaneous 1,991,378 1,991,365 1,991,365
------------------------------------
Total fixed maturities 3,048,834 3,054,513 3,054,513

Equity securities:
Non-redeemable preferred stocks 21,156 22,440 22,440
Common stocks 112 112 112
Mortgage loans on real estate 36,879 36,879 36,879
Policy loans 123,466 123,466 123,466
Cash and cash equivalents 110,067 110,067 110,067
------------------------------------
Total cash and investments $3,340,514 $3,347,477 $3,347,477
------------------------------------
------------------------------------

S-3

ARM FINANCIAL GROUP, INC. (PARENT COMPANY)

SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEETS

December 31,
---------------------------
(IN THOUSANDS) 1996 1995
- ----------------------------------------------------------------------------------------

ASSETS
Fixed maturities, available-for-sale, at fair value $ -- $ 1,537
Equity securities, available-for-sale, at fair value 109 109
Cash and cash equivalents 3,317 2,484
Investments in subsidiaries* 212,423 222,465
Receivable from subsidiaries* 5,185 1,155
Goodwill 2,670 2,816
Other assets 8,550 4,971
-----------------------------
Total assets $ 232,254 $ 235,537
-----------------------------
-----------------------------

LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Accounts payable and other liabilities $ 10,312 $ 7,546
Long-term debt 40,000 40,000
-----------------------------
Total liabilities 50,312 47,546

Shareholders' equity:
Preferred stock 50,000 50,000
Common stock ** **
Additional paid-in capital 124,609 124,425
Net unrealized gains on available-for-sale securities 3,669 28,530
Retained earnings (including undistributed net income of
subsidiaries*: 1996--$19,110; 1995--$4,293) 3,664 (14,964)
-----------------------------
Total shareholders' equity 181,942 187,991
-----------------------------

Total liabilities and shareholders' equity $ 232,254 $ 235,537
-----------------------------
-----------------------------

* Eliminated in consolidation.
** Less than $1,000.

SEE ACCOMPANYING NOTE.

S-4

ARM FINANCIAL GROUP, INC. (PARENT COMPANY)

SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
CONDENSED STATEMENTS OF OPERATIONS

Year Ended December 31,
---------------------------------------
(IN THOUSANDS) 1996 1995 1994
- ---------------------------------------------------------------------------------------------

Revenues:
Dividends from subsidiary* $ 16,000 $ 12,800 $ --
Management and service fee income* 28,901 19,040 19,090
Investment and other income 1,332 689 694
Realized investment gains (losses) 3,712 (45) --
----------------------------------------
Total revenues 49,945 32,484 19,784
Expenses:
Operating expenses 31,813 22,735 19,453
Interest expense 3,161 3,461 3,136
Amortization of acquisition-related deferred
charges 1,503 9,695 2,163
Amortization of goodwill 145 84 --
Non-recurring charges 5,004 -- --
----------------------------------------
Total expenses 41,626 35,975 24,752
----------------------------------------
Income (loss) before federal income tax benefit
and equity in undistributed net income (loss) of
subsidiaries 8,319 (3,491) (4,968)
Federal income tax benefit 242 271 --
----------------------------------------
Income (loss) before equity in undistributed
net income (loss) of subsidiaries 8,561 (3,220) (4,968)
Equity in undistributed net income (loss) of
subsidiaries* 14,817 15,110 (11,803)
----------------------------------------
Net income (loss) $23,378 $11,890 $(16,771)
----------------------------------------
----------------------------------------

* Eliminated in consolidation.

SEE ACCOMPANYING NOTE.

S-5

ARM FINANCIAL GROUP, INC. (PARENT COMPANY)

SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
CONDENSED STATEMENTS OF CASH FLOWS

Year Ended December 31,
-------------------------------------
(IN THOUSANDS) 1996 1995 1994
- ----------------------------------------------------------------------------------------------------------

Net cash flows provided by (used in) operating
activities $ 2,962 $ 1,175 $ (19,211)

Cash flows provided by (used in) investing activities:
Net sales (purchases) of investments 2,437 5,986 (6,847)
Acquisition of subsidiaries -- (42,134) 3,250
Contribution of capital to subsidiaries -- (21,100) --
-------------------------------------
Net cash flows provided by (used in) investing
activities 2,437 (57,248) (3,597)

Cash flows provided by (used in) financing activities:
Proceeds from issuance of common stock 184 63,505 --
Organization, debt and stock issuance costs -- (2,000) --
Preferred stock dividends (4,750) (4,750) (5,014)
-------------------------------------
Net cash flows provided by (used in) financing
activities (4,566) 56,755 (5,014)
-------------------------------------

Net change in cash and cash equivalents 833 682 (27,822)

Cash and cash equivalents at beginning of year 2,484 1,802 29,624
-------------------------------------

Cash and cash equivalents at end of year $3,317 $2,484 $1,802
-------------------------------------
-------------------------------------

SEE ACCOMPANYING NOTE.

S-6

ARM FINANCIAL GROUP, INC. (PARENT COMPANY)

SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)

NOTE TO CONDENSED FINANCIAL STATEMENTS

DECEMBER 31, 1996

1. BASIS OF PRESENTATION

The accompanying condensed financial statements should be read in conjunction
with the consolidated financial statements and notes of ARM Financial Group,
Inc. and subsidiaries for the year ended December 31, 1996 included herein.

S-7

ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
SCHEDULE III--SUPPLEMENTARY INSURANCE INFORMATION

Customer
Deposits and
Deferred Separate Interest
Policy Account Credited on Other Income
Acquisition Customer Investment Customer and
Segment Costs Deposits Income* Deposits Fee Income Expenses*
- ------------------------------------------------------------------------------------------------------------------------
(IN THOUSANDS)

December 31, 1996:
Spread-Based $ 19,919 $ 3,538,116 $ 243,389 $ 181,471 $ 117 $ (28,159)
Fee-Based 39,082 844,330 -- -- 17,032 (11,982)
Corporate and Other -- 41,887 6,642 690 684 (17,924)
-------------------------------------------------------------------------------------------------

Consolidated $ 59,001 $ 4,424,333 $ 250,031 $182,161 $ 17,833 $ (58,065)
-------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------

December 31, 1995:
Spread-Based $ 14,787 $ 2,859,339 $ 188,476 $146,141 $ -- $ (20,013)
Fee-Based 28,326 617,312 -- -- 10,682 (7,157)
Corporate and Other -- 39,954 7,548 726 666 (18,467)
-------------------------------------------------------------------------------------------------

Consolidated $ 43,113 $ 3,516,605 $ 196,024 $146,867 $ 11,348 $ (45,637)
-------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------

December 31, 1994:
Spread-Based $ 9,526 $ 1,977,758 $ 143,890 $115,771 $ -- $ (11,919)
Fee-Based 17,141 388,888 -- -- 4,459 (2,318)
Corporate and Other -- 34,594 5,252 692 3,932 (12,895)
-------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------

Consolidated $ 26,667 $ 2,401,240 $ 149,142 $116,463 $ 8,391 $ (27,132)
-------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------

* Allocation of "investment income" and "other income and expenses" is based
on a number of assumptions and estimates, the results of which would change
if different methods were applied.

S-8

ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES

SCHEDULE IV--REINSURANCE

Percentage
Ceded to Assumed of Amount
Gross Other from Other Assumed to
Amount Companies Companies Net Amount Net Amount
- --------------------------------------------------------------------------------------------------------------------
(IN THOUSANDS EXCEPT PERCENTAGES)

Year Ended December 31, 1996
Life insurance in force $1,214,895 $2,056,073 $1,852,732 $1,011,554 183.2%

Year Ended December 31, 1995
Life insurance in force $1,309,604 $1,728,116 $985,870 $567,358 173.8%

Year Ended December 31, 1994
Life insurance in force $1,301,723 $1,166,982 $810,450 $945,191 85.7%

S-9

ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES

SCHEDULE V--VALUATION AND QUALIFYING ACCOUNTS

Additions
--------------------------
Charged to
Beginning Charged to Other End of
Description of Year Expense Accounts Deductions Year
- ----------------------------------------------------------------------------------------------------------
(IN THOUSANDS)
Valuation allowance on deferred tax
assets:

1995 $66,489 $5,895 $3,956 (1) $(39,004) (2) $ 37,336
1996 $37,336 $2,517 $9,949 (3) $(11,004) (2) $ 38,798

(1) Related to deferred tax assets on acquired capital losses established
on May 31, 1995 in connection with the SBM acquisition.

(2) In the event that deferred tax assets are recognized on deductible
temporary differences for which a valuation allowance was provided at
the date of an acquisition, such benefits are applied to first reduce
the balance of intangible assets related to the acquisition, and then
income tax expense. As such, the Company reduced its valuation
allowance with an offsetting reduction to acquisition-related
intangible assets such as value of insurance in force and goodwill. In
addition, after acquisition-related intangible assets were reduced to
zero for one of the Company's insurance subsidiaries, a portion of the
reduction in valuation allowance resulted in a reduction of income
taxes. The portion of the December 31, 1994 valuation allowance
related to deferred tax assets for net unrealized losses on
available-for-sale securities was reduced to zero as of December 31,
1995. The Company's available-for-sale portfolios had net unrealized
gains at December 31, 1996 and 1995 which did not require a valuation
allowance.

(3) As the acquisition-related valuation allowance described in (2) above
was initially released, the reduction in the intangible assets related
to the acquisition generated additional deferred tax assets. A
valuation allowance was provided for these additional deferred tax
assets.

Information required in Schedule V for 1994 is ascertainable from the notes to
the consolidated financial statements.

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