-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, PceGoRFVmo3n3+H1O8gCQrH8pRTZ4kphO5hBdPDqKmR3PzkDBtmXkDmIh4o7Gq/2 vHh+gOGoVjbWeOQvfJUW4g== 0000909012-06-000463.txt : 20060501 0000909012-06-000463.hdr.sgml : 20060501 20060501170609 ACCESSION NUMBER: 0000909012-06-000463 CONFORMED SUBMISSION TYPE: 485BPOS PUBLIC DOCUMENT COUNT: 14 FILED AS OF DATE: 20060501 DATE AS OF CHANGE: 20060501 EFFECTIVENESS DATE: 20060501 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NATIONAL VARIABLE ANNUITY ACCOUNT II CENTRAL INDEX KEY: 0001029122 IRS NUMBER: 000000000 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 485BPOS SEC ACT: 1933 Act SEC FILE NUMBER: 333-19583 FILM NUMBER: 06796022 BUSINESS ADDRESS: STREET 1: ONE NATIONAL LIFE DRIVE CITY: MONTPELIER STATE: VT ZIP: 05604 BUSINESS PHONE: 8022297402 MAIL ADDRESS: STREET 1: ONE NATIONAL LIFE DRIVE CITY: MONTPELIER STATE: VT ZIP: 05604 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NATIONAL VARIABLE ANNUITY ACCOUNT II CENTRAL INDEX KEY: 0001029122 IRS NUMBER: 000000000 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 485BPOS SEC ACT: 1940 Act SEC FILE NUMBER: 811-08015 FILM NUMBER: 06796023 BUSINESS ADDRESS: STREET 1: ONE NATIONAL LIFE DRIVE CITY: MONTPELIER STATE: VT ZIP: 05604 BUSINESS PHONE: 8022297402 MAIL ADDRESS: STREET 1: ONE NATIONAL LIFE DRIVE CITY: MONTPELIER STATE: VT ZIP: 05604 0001029122 S000011181 NATIONAL VARIABLE ANNUITY ACCOUNT II C000030849 Sentinel Advantage 485BPOS 1 t302510.txt SENTINEL ADVANTAGE As filed with the Securities and Exchange Commission on May 1, 2006 Registration No. 333-19583 Registration No. 811-08015 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM N-4 REGISTRATION UNDER THE SECURITIES ACT OF 1933 Post-Effective Amendment No. 19 and REGISTRATION UNDER THE INVESTMENT COMPANY ACT OF 1940 Amendment No. 21 ------------------------------- NATIONAL VARIABLE ANNUITY ACCOUNT II (Exact name of Registrant) NATIONAL LIFE INSURANCE COMPANY One National Life Drive Montpelier, VT 05604 (Complete name and address of depositor's principal executive offices) (802) 229-7410 ----------------------------- Kerry A. Jung Senior Counsel National Life Insurance Company One National Life Drive Montpelier, Vermont 05604 (name and complete address of agent for service) ------------------------------- Copy to: Stephen E. Roth, Esq. Sutherland Asbill & Brennan LLP 1275 Pennsylvania Avenue, NW Washington, DC 20004-2415 ------------------------------- It is proposed that this filing will become effective: ___ immediately upon filing pursuant to paragraph (b) _X_ on May 1, 2006 pursuant to paragraph (b) ___ 60 days after filing pursuant to paragraph (a)(1) ___ on (date) pursuant to paragraph (a)(1) of Rule 485 ___ This post-effective amendment designates a new effective date for a previously filed post-effective amendment. Title of Securities Being Registered: Interests in a Variable Account under individual flexible premium variable annuity contracts. ------------------------------- Sentinel Advantage Variable Annuity P R O S P E C T U S DATED MAY 1, 2006 NATIONAL LIFE INSURANCE COMPANY o HOME 0FFICE: NATIONAL LIFE DRIVE, MONTPELIER, VERMONT 05604 O 1-800-732-8939 The Sentinel Advantage Contracts described in this prospectus are individual flexible premium variable annuity contracts supported by National Variable Annuity Account II (the "Variable Account"), a separate account of National Life Insurance Company ("National Life, "we," "our," or "us"). We allocate net Premium Payments to either the Variable Account, the Fixed Account, or the Guaranteed Accounts. The Variable Account is currently divided into 49 Subaccounts. Each Subaccount invests in shares of a corresponding underlying Fund option (each a "Fund") described below:
- --------------------------------- ----------------------------------- --------------------------------- ---------------------------- SENTINEL ASSET MANAGEMENT, INC. AIM ADVISORS, INC. FRED ALGER MANAGEMENT, INC. AMERICAN CENTURY INVESTMENT MANAGEMENT, INC. AND AMERICAN CENTURY GLOBAL INVESTMENT MANAGEMENT, INC. - --------------------------------- ----------------------------------- --------------------------------- ---------------------------- Sentinel Variable Products Trust AIM Variable Insurance Funds Alger American Fund American Century Variable Balanced V.I. Dynamics Growth Portfolios, Inc. Bond V.I. Global Health Care Leveraged AllCap VP Income & Growth Common Stock V.I. Technology Small Capitalization VP Value Growth Index VP Ultra(R) Mid Cap Growth VP Vista Money Market VP International Small Company VP Inflation Protection - --------------------------------- ----------------------------------- --------------------------------- ---------------------------- THE DREYFUS CORPORATION FIDELITY MANAGEMENT & RESEARCH FRANKLIN TEMPLETON INVESTMENTS J.P. MORGAN INVESTMENT COMPANY MANAGEMENT INC. - --------------------------------- ----------------------------------- --------------------------------- ---------------------------- Dreyfus Variable Investment Fund Fidelity(R) Variable Insurance Franklin Templeton Variable J.P. Morgan Series Trust II DVIF Appreciation Products Insurance Products Trust International Equity DVIF Developing Leaders Contrafund(R) Mutual Shares Securities Small Company DVIF Quality Bond Equity Income Small Cap Value Securities Dreyfus Socially Responsible Growth Small-Midcap Growth Securities Growth Fund, Inc. High Income Foreign Securities Index 500 Real Estate Investment Grade Bond Mid Cap Overseas - --------------------------------- ----------------------------------- --------------------------------- ---------------------------- NEUBERGER BERMAN MANAGEMENT, INC. DEUTSCHE INVESTMENT MANAGEMENT T. ROWE PRICE ASSOCIATES, INC. WELLS FARGO FUNDS AMERICAS, INC. MANAGEMENT, LLC - --------------------------------- ----------------------------------- --------------------------------- ---------------------------- Neuberger Berman Advisers Scudder Variable Series II T. Rowe Price Equity Series, Inc. Wells Fargo Variable Trust Management Trust Dreman High Return Equity Blue Chip Growth VT Discovery Partners Dreman Small Cap Value Equity Income VT Opportunity Mid-Cap Growth Health Sciences Fasciano Limited Maturity Bond - --------------------------------- ----------------------------------- ---------------------------------` ---------------------------
This Prospectus provides you with the basic information you should know before investing. You should read it and keep it for future reference. A Statement of Additional Information dated May 1, 2006 containing further information about the Contracts and the Variable Account is filed with the Securities and Exchange Commission. You can obtain a copy without charge from National Life by calling 1-800-732-8939, by writing to National Life at the address above, or by accessing the SEC's website at http://www.sec.gov. You may also obtain prospectuses for each of the underlying Fund options identified above without charge by calling or writing to the same telephone number or address. This Prospectus must be accompanied by current prospectuses or profiles for the Funds. Investments in these contracts are not deposits or obligations of, and are not guaranteed or endorsed by, the adviser of any of the underlying funds identified above, the U.S. government, or any bank or bank affiliate. Investments are not federally insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other governmental agency. It may not be a good decision to purchase a Contract as a replacement for another type of variable annuity if you already own another flexible premium deferred variable annuity. The Securities and Exchange Commission has not approved or disapproved these securities or passed upon the accuracy or adequacy of the Prospectus. Any representation to the contrary is a criminal offense. The Statement of Additional Information, dated May 1, 2006, is incorporated herein by reference. The Table of Contents for the Statement of Additional Information appears on the last page of the Prospectus. Table of Contents Page SUMMARY ......................................................................1 SUMMARY OF CONTRACT EXPENSES..................................................5 UNDERLYING FUND ANNUAL EXPENSES...............................................6 ACCUMULATION UNIT VALUES......................................................9 NATIONAL LIFE, THE VARIABLE ACCOUNT, AND THE FUNDS............................15 National Life........................................................15 The Variable Account.................................................15 The Funds............................................................16 Other Information....................................................18 DETAILED DESCRIPTION OF CONTRACT PROVISIONS...................................19 Issuance of a Contract...............................................19 Premium Payments.....................................................20 Transfers............................................................21 Value of a Variable Account Accumulation Unit........................23 Annuitization........................................................24 Annuitization - Variable Account.....................................25 Annuitization - Fixed Account........................................26 Annuity Payment Options..............................................26 Stretch Annuity Payment Option.......................................27 Death of Owner.......................................................27 Death of Annuitant Prior to the Annuitization Date...................28 Generation-Skipping Transfers........................................28 Ownership Provisions.................................................28 CHARGES AND DEDUCTIONS........................................................29 Deductions from the Variable Account.................................30 Contingent Deferred Sales Charge.....................................30 Annual Contract Fee..................................................31 Transfer Charge......................................................31 Premium Taxes........................................................32 Charge for Optional Enhanced Death Benefit Rider.....................32 Other Charges........................................................32 CONTRACT RIGHTS AND PRIVILEGES................................................32 Free Look............................................................32 Loan Privilege -Tax Sheltered Annuities..............................33 Surrender and Withdrawal.............................................35 Payments.............................................................36 Surrenders and Withdrawals Under a Tax-Sheltered Annuity Contract....37 Telephone Transaction Privilege......................................37 Optional "Illuminations" Investment Advisory Service.................38 Available Automated Fund Management Features.........................39 Contract Rights Under Certain Plans..................................41 THE FIXED ACCOUNT.............................................................41 Minimum Guaranteed and Current Interest Rates........................42 Enhanced Fixed Account...............................................42 THE GUARANTEED ACCOUNTS.......................................................44 Investments in the Guaranteed Accounts...............................44 Termination of a Guaranteed Account..................................44 Market Value Adjustment..............................................45 Other Matters Relevant to the Guaranteed Accounts....................47 Preserver Plus Program...............................................48 OPTIONAL ENHANCED DEATH BENEFIT RIDER.........................................48 OPTIONAL ACCELERATED BENEFIT RIDERS...........................................49 FEDERAL INCOME TAX CONSIDERATIONS.............................................49 Taxation of Non-Qualified Contracts..................................49 Taxation of Qualified Contracts......................................51 Federal Estate Taxes.................................................52 Possible Tax Law Changes.............................................53 GENDER NEUTRALITY.............................................................53 VOTING RIGHTS.................................................................53 CHANGES TO VARIABLE ACCOUNT...................................................53 DISTRIBUTION OF THE CONTRACTS.................................................54 FINANCIAL STATEMENTS..........................................................55 STATEMENTS AND REPORTS........................................................55 OWNER INQUIRIES...............................................................55 LEGAL PROCEEDINGS.............................................................55 GLOSSARY 56 TABLE OF CONTENTS OF STATEMENT OF ADDITIONAL INFORMATION......................59 THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFERING IN ANY JURISDICTION IN WHICH SUCH OFFERING MAY NOT LEGALLY BE MADE. SUMMARY This summary provides a brief description of some of the features and charges of the Contract. You will find more detailed information in the rest of this Prospectus, the Statement of Additional Information and the Contract. Please keep the Contract and its riders or endorsements, if any, together with the application. Together they are the entire agreement between you and us. How Do I Purchase a Contract? - ----------------------------- Generally, you may purchase a Contract if you are age 85 and younger (on an age on nearest birthday basis). See "Issuance of a Contract," below. The initial Premium Payment must be at least $5,000 for Non-Qualified Contracts, and at least $1500 for Qualified Contracts. We may at our discretion permit initial Premium Payments lower than these minimums. Can I Make Additional Premium Payments? - --------------------------------------- You may make additional Premium Payments at any time (except for Contracts purchased in Oregon and Massachusetts) but they must be at least $100 ($50 for IRA's). We may accept lower Premium Payments at our discretion if the Premium Payments are remitted electronically. The total of all Premium Payments under Contracts issued on the life of any one Owner (or Annuitant if the owner is not a natural person) may not exceed $1,000,000 without our prior consent (see "Premium Payments," below). How Does the "Free Look" Right to Examine the Contract Work? - ------------------------------------------------------------ To be sure that you are satisfied with the Contract, you have a ten day free look right to examine the Contract. Some states may require a longer period. Within ten days of the day you receive the Contract, you may return the Contract to our Home Office at the address shown on the cover page of this Prospectus. When we receive the Contract, we will void the Contract and refund the Contract Value plus any charges assessed when the Contract was issued, unless otherwise required by state and/or federal law. In the case of IRA's and Contracts issued in states that require the return of Premium Payments, you may revoke the Contract during the free look period and we will refund Premium Payments. What is the Purpose of the Variable Account? - -------------------------------------------- The Variable Account is a separate investment account that consists of 49 Subaccounts. Amounts in the Variable Account will vary according to the investment performance of the Fund(s) in which your elected Subaccounts are invested. You may allocate Net Premium Payments among the Fixed Account, the Guaranteed Accounts and the 49 Subaccounts of the Variable Account. The assets of each Subaccount are invested in the corresponding portfolios of the Funds that are listed on the cover page of this Prospectus (see "The Variable Account" and "Underlying Fund Options," below). We cannot give any assurance that any Subaccount will achieve its investment objectives. You bear the entire investment risk on the value of your Contract which you allocate to the Variable Account. The value your Contract may be more or less than the premiums paid. How Does the Fixed Account Work? - -------------------------------- You may allocate all or part of your Net Premium Payments or make transfers from the Variable Account or the Guaranteed Accounts to the Fixed Account. Contract Value held in the Fixed Account will earn an effective annual interest rate of at least the minimum required by your state. (see "The Fixed Account", below.) -1- How Do the Guaranteed Accounts Work? - ------------------------------------ You may allocate all or part of your Net Premium Payments or make transfers from the Variable Account (or to a limited extent from the Fixed Account) to a Guaranteed Account with a duration of 5, 7 or 10 years. These Guaranteed Accounts guarantee a specified interest rate for the entire period of an investment, if the Contract Value remains in the Guaranteed Account for the specified period of time. If you surrender your Contract or withdraw or transfer Contract value out of a Guaranteed Account prior to the end of the specified period, a market value adjustment will be applied to such Contract Value surrendered, withdrawn or transferred. (see "The Guaranteed Accounts", below). When Will I Receive Payments? - ----------------------------- After the Contract Value is transferred to a payment option, we will pay proceeds according to the Annuity Payment Option you select. If the Contract Value at the Annuitization Date is less than $3,500, the Contract Value may be distributed in one lump sum instead of annuity payments. If any annuity payment would be less than $100, we have the right to change the frequency of payments to intervals that will result in payments of at least $100. In no event will annuity payments be less frequent than annually (see "Annuitization - Frequency and Amount of Annuity Payments," below). What Happens if an Owner Dies Before Annuitization? - --------------------------------------------------- For Contracts issued on or after November 1, 2003, if (1) any Owner dies before the Contract Value is transferred to a payment option ("Annuitization"); (2) the Enhanced Death Benefit Rider is not elected; and (3) the Owner (or the oldest of Joint Owners) dies prior to the Contract Anniversary on which your age, on an age nearest birthday basis, is 81, we will pay the Beneficiary the greater of (a) the Contract Value, or (b) the Net Premium Payments made to the Contract (less all withdrawals, and less all outstanding loans and accrued interest), and adjusted such that if you effect a Withdrawal (including a systematic Withdrawal) at a time when the Contract Value is less than the amount of the Death Benefit that would then be payable to you, the Death Benefit will be reduced by the same proportion that the Withdrawal reduces the Contract Value (this adjustment will have the effect of reducing the Death Benefit by more than the amount of the Withdrawal, where a Withdrawal is taken at a time when the Death Benefit is greater than the Contract Value). If you die after the Contract Anniversary on which your age, on an age nearest birthday basis, is 81 (or in the case of Joint Owners, where the first of Joint Owners to die dies after the Contract Anniversary on which the age of the oldest Joint Owner, on an age on nearest birthday basis, is 81), then the Death Benefit shall be equal to the Contract Value. For Contracts issued prior to November 1, 2003 only, we are currently providing a Death Benefit that is equal to the greater of (a) or (b) above even if you die after the Contract Anniversary on which your age, on an age nearest birthday basis, is 81, as long as your age, on an age on nearest birthday basis, was less than 81 on the Date of Issue of the Contract. We currently intend to pay this Death Benefit even though its terms are more favorable to you than what is guaranteed in the Contract. We will notify you if we discontinue this Death Benefit. For these Contracts, or if your state did not approve such adjustment in time for it to apply to your Contract, the adjustment referred to in (b) above will not be made. All amounts paid will be reduced by premium tax charges, if any. For more information, see "Death of Owner," below. What Happens if the Annuitant Dies Before Annuitization? - -------------------------------------------------------- If the Annuitant (who is not an Owner) dies before the Contract Value is transferred to a payment option, we will pay the Beneficiary a Death Benefit equal to the Cash Surrender Value, unless the Owner selects another available option (see "Death of Annuitant Prior to the Annuitization Date," below). -2- Can I Make a Withdrawal from my Contract? - ----------------------------------------- You may withdraw part or all of the Cash Surrender Value at any time before the Contract is Annuitized (see "Surrender and Withdrawal," below). A Withdrawal or a surrender may be restricted under certain qualified Contracts and result in federal income tax, including a federal penalty tax (see "Federal Income Tax Considerations," below). You may have to pay a surrender charge and/or (in the case of Contract Value allocated to a Guaranteed Account) a market value adjustment on the Withdrawal. What Charges Will I Pay? - ------------------------ Contingent Deferred Sales Charge. We do not deduct a sales charge from Premium Payments. However, if you surrender the Contract or make a Withdrawal, we will generally deduct from the Contract Value a Contingent Deferred Sales Charge not to exceed 7% of the lesser of the total of all Net Premium Payments made within 84 months prior to the date of the request to surrender or the amount surrendered (see "Contingent Deferred Sales Charge," below). Market Value Adjustment. We deduct, or add, a market value adjustment to any amount you surrender, withdraw, or transfer from a Guaranteed Account before its termination date (see "The Guaranteed Accounts," below). Annual Contract Fee. We deduct an Annual Contract Fee of $30.00 payable on each Contract Anniversary as long as the Contract Value is less than $50,000 (see "Annual Contract Fee," below). Administration Charge. We also deduct an Administration Charge each day at an annual rate of 0.15% from the assets of the Variable Account (see "Deductions from the Variable Account," below). Mortality and Expense Risk Charge. We deduct a mortality and expense risk charge each day from the assets of the Variable Account at an annual rate of 1.25% (see "Deductions from the Variable Account," below). Charge for Optional Enhanced Death Benefit Rider. If elected, we deduct an annual charge of 0.20% of the Contract Value at the time of deduction for this option (see "Charge for Optional Enhanced Death Benefit Rider," below). Premium Taxes. If a governmental entity imposes premium taxes, we will make a deduction for premium taxes in a corresponding amount. Certain states impose a premium tax. Premium taxes may range up to 3.5% (see "Premium Taxes," below). Transfer Charge. We reserve the right to make a charge of $25 for each transfer in excess of 12 transfers in a Contract Year. However, we are not currently assessing transfer charges. Investment Management Fees and Fund Operating Expenses. Charges for investment management services and operating expenses are deducted daily from each portfolio of each Fund (see "Underlying Fund Annual Expenses," below, and the accompanying Fund prospectuses). We pay compensation to broker-dealers who sell the Contracts. (See "Distribution of Contracts," below). Can I Transfer My Contract Value Among the Different Investment Options? - ------------------------------------------------------------------------ You may transfer the Contract Value among the Subaccounts of the Variable Account, between the Variable Account and the Fixed Account (subject to specific limitations), and between the Guaranteed Accounts and either the Fixed Account (subject to specific limitations) or the Subaccounts of the Variable Account, by making a written transfer request. In the case of transfers out of a Guaranteed Account prior to its termination date, a market value adjustment will be applied. If you elect the telephone transaction privilege, you may make transfers by telephone. Please note that frequent, large, or short-term transfers among Subaccounts, such as those associated with "market timing" transactions, can adversely affect the underlying Funds and the returns achieved by Owners. Such transfers may dilute the value of underlying Fund shares, interfere with the efficient management of the underlying Fund's portfolio, and increase brokerage and administrative costs of the Underlying Funds. To protect Owners and underlying Funds from such effects, we have developed market timing procedures. See "Disruptive Trading" below. -3- Are There any Other Contract Provisions? - ---------------------------------------- For information concerning other important Contract provisions, see "Contract Rights and Privileges," below, and the remainder of this Prospectus. How Will the Contract be Taxed? - ------------------------------- For a brief discussion of our current understanding of the federal tax laws concerning us and the Contract, see "Federal Income Tax Considerations," below. What is the "Illuminations" Program? - ------------------------------------ We offer all Contract Owners the opportunity to participate in "Illuminations". Under this investment advisory program, National Life has arranged for Fund Quest, Incorporated, a registered investment adviser firm which is independent of National Life, to provide an investment advisory service under which FundQuest maintains an allocation of the Contract Value of your Contract among the available options which is suited to your investment objective, financial situation and risk tolerance. There is no charge for participation in Illuminations. What if I Have Questions? - ------------------------- We will be happy to answer your questions about the Contract or our procedures. Call or write to us at the phone number or address on the cover page. All inquiries should include the Contract number and the names of the Owner and the Annuitant. If you have questions concerning your investment strategies, please contact your registered representative. -4- SUMMARY OF CONTRACT EXPENSES The following tables describe the fees and expenses that you will pay when buying, owning, taking a Withdrawal from, and surrendering the Contract. The first table describes the fees and expenses that you will pay at the time that you buy the Contract, take a Withdrawal from or surrender the Contract, or transfer Contract Value between investment options or for certain Qualified Contracts, take a loan. Contract Owner Transaction Expenses - ----------------------------------- Sales Load Imposed on Purchases ....................................... None Premium Taxes ..................................................... See below(1) Contingent Deferred Sales Charge (as a percentage of Net Premium Payments surrendered or withdrawn)(2) Maximum ...................................................... 7% Transfer Charge ....................................................... $25(3) Loan Interest Spread (effective annual rate) .......................... 2.5%(4) The next two tables describe the fees and expenses that you will pay periodically during the time that you own the Contract, not including portfolio company fees and expenses. Variable Account Annual Expenses (deducted daily as a percentage of Variable Account Contract Value) - -------------------------------------------------------------------------------- Mortality and Expense Risk Charge 1.25% Administration Charge 0.15% Total Basic Variable Account Annual Percentage Expenses 1.40% Annual Contract Fee(5) $30 -5- Optional Rider Expenses Annual Charge for Optional Enhanced Death Benefit Rider 0.20% of Contract Value at the time of deduction (1) States may assess premium taxes on premiums paid under the Contract. Where National Life is required to pay this premium tax when a Premium Payment is made, it may deduct an amount equal to the amount of premium tax paid from the Premium Payment. National Life currently intends to make this deduction from Premium Payments only in South Dakota. In the remaining states which assess premium taxes, a deduction will be made only upon Annuitization, death of the Owner, or surrender. See "Premium Taxes," below. (2) The Contingent Deferred Sales Charge ("CDSC") declines 1% for each completed year from the date of the affected premium payment, reaching zero after the premium payment has been in the Contract for seven years. Each Contract Year after the first one, the Owner may withdraw without a CDSC an amount equal to 15% of the Contract Value as of the most recent Contract Anniversary. In addition, any amount withdrawn in order for the Contract to meet minimum Distribution requirements under the Code shall be free of CDSC. Withdrawals may be restricted for Contracts issued pursuant to the terms of a Tax-Sheltered Annuity or under an annuity issued in conjunction with certain qualified pension or profit sharing plans. This CDSC-free Withdrawal privilege does not apply in the case of full surrenders and is non-cumulative; that is, free amounts not taken during any given Contract Year cannot be taken as free amounts in a subsequent Contract Year. In addition, New Jersey and Washington do not permit this CDSC-free Withdrawal provision, in which case a different CDSC-free Withdrawal provision will apply (see "Contingent Deferred Sales Charge," below). After annuitization, we will assess the CDSC, as applicable, on surrenders under Payment Option 1. (3) We reserve the right to make a $25 charge on each transfer in excess of 12 transfers in a Contract Year. However, no such charge is currently applied. (4) The Loan Interest Spread is the difference between the amount of interest we charge on loans and the amount of interest we credit to amounts held in the Collateral Fixed Account to secure the loan. (5) The Annual Contract Fee is assessed only upon Contracts which as of the applicable Contract Anniversary, have a Contract Value of less than $50,000 and is not assessed on Contract Anniversaries after the Annuitization Date. -6- The next item shows the minimum and maximum total operating expenses charged by portfolio companies that you may pay periodically during the time you own the Contract. The fees and expenses are for the fiscal year ended December 31, 2005. More detail concerning each portfolio company's fees and expenses is contained in the prospectus for each portfolio company.
UNDERLYING FUND ANNUAL EXPENSES (AS A PERCENTAGE OF UNDERLYING FUND AVERAGE NET ASSETS) - ------------------------------------------------------------------ ----------------------------- ----------------------------- Minimum Maximum - ------------------------------------------------------------------ ----------------------------- ----------------------------- Total Annual Portfolio Company Operating Expenses (expenses that 0.10% 2.10% are deducted from portfolio company assets, including management fees, distribution and/or service 12b-1 fees, and other expenses). - ------------------------------------------------------------------ ----------------------------- ----------------------------- The annual expenses as of December 31, 2005 (unless otherwise noted) of each individual portfolio company, before any fee waivers or expense reimbursements, are shown below.(1) Portfolio Management 12b-1 Other Gross Fee Fees(2) Expenses Total Annual Expenses Sentinel Variable Products Trust Balanced Fund 0.55% 0.00% 0.33% 0.88%(3) Bond Fund 0.40% 0.00% 0.31% 0.71%(3) Common Stock Fund 0.40% 0.00% 0.27% 0.67%(3) Growth Index Fund 0.30% 0.00% 1.59% 1.89%(3) Mid Cap Growth Fund 0.48% 0.00% 0.33% 0.81%(3) Money Market Fund 0.25% 0.00% 0.31% 0.56%(3) Small Company Fund 0.41% 0.00% 0.31% 0.72%(3) AIM Variable Insurance Funds AIM V.I. Dynamics Fund - Series I Shares 0.75% 0.00% 0.42% 1.17%(3) AIM V.I. Global Health Care Fund- Series I Shares 0.75% 0.00% 0.33% 1.08%(3) AIM V.I. Technology Fund- Series I Shares 0.75% 0.00% 0.37% 1.12%(3) The Alger American Fund Alger American Growth Portfolio - Class O Shares 0.75% 0.00% 0.06% 0.81% Alger American Leveraged AllCap Portfolio - Class O Shares 0.85% 0.00% 0.06% 0.91% Alger American Small Capitalization Portfolio - Class O Shares 0.85% 0.00% 0.06% 0.91% American Century Variable Portfolios, Inc. VP Income & Growth Portfolio 0.70% 0.00% 0.00% 0.70% VP Value Portfolio 0.93% 0.00% 0.00% 0.93% VP Ultra(R) Portfolio 1.00% 0.00% 0.01% 1.01% VP Vista Portfolio 1.00% 0.00% 0.01% 1.01% VP International Portfolio 1.23% 0.00% 0.00% 1.23% VP Inflation Protection Portfolio 0.49% 0.00% 0.01% 0.50% Dreyfus Variable Investment Fund DVIF Appreciation Portfolio - Initial Shares 0.75% 0.00% 0.05% 0.80% DVIF Developing Leaders Portfolio - Initial Shares 0.75% 0.00% 0.06% 0.81% DVIF Quality Bond Portfolio - Initial Shares 0.65%(3) 0.00% 0.10% 0.75% Dreyfus Socially Responsible Growth Fund, Inc. 0.75% 0.00% 0.06% 0.81% -7- Fidelity(R) Variable Insurance Products Initial Class Contrafund(R) Portfolio 0.57% 0.00% 0.09% 0.66%(3) Equity Income Portfolio 0.47% 0.00% 0.09% 0.56%(3) Growth Portfolio 0.57% 0.00% 0.10% 0.67%(3) High Income Portfolio 0.57% 0.00% 0.13% 0.70% Index 500 Portfolio 0.10% 0.00% 0.00% 0.10%(3),(7) Investment Grade Bond Portfolio 0.36% 0.00% 0.13% 0.49% Mid Cap Portfolio 0.57% 0.00% 0.12% 0.69%(3) Overseas Portfolio 0.72% 0.00% 0.17% 0.89%(3) Franklin Templeton Variable Insurance Products Trust Class 2 shares, Mutual Shares Securities Fund 0.60% 0.25%(5) 0.18% 1.03% Class 2 shares, Franklin Small Cap Value Securities Fund 0.52% 0.25%(5) 0.17% 0.94%(3) Class 2 shares, Franklin Small-Midcap Growth Securities Fund 0.48% 0.25%(5) 0.28% 1.01%(3) Class 2 shares, Templeton Foreign Securities Fund 0.65% 0.25% 0.17% 1.07%(3) Class 2 shares, Franklin Real Estate Fund 0.47%(4) 0.25%(5) 0.02% 0.74% J.P. Morgan Series Trust II JPMorgan International Equity Portfolio 0.60% 0.00% 0.60% 1.20% JPMorgan Small Company Portfolio 0.60% 0.00% 0.55% 1.15% Neuberger Berman Advisers Management Trust I Class, Partners Portfolio 0.83% 0.00% 0.07% 0.90%(3) I Class, Mid Cap Growth Portfolio 0.83% 0.00% 0.10% 0.93%(3) S Class, Fasciano Portfolio 1.15% 0.25% 0.70% 2.10%(3) I Class Limited Maturity Bond Portfolio 0.65% 0.00% 0.10% 0.75%(3) -8- Scudder Variable Series II Class B shares, DWS Dreman High Return Equity VIP 0.73% 0.25% 0.19% 1.17%(3) Class B shares, DWS Dreman Small Cap Value VIP 0.75% 0.25% 0.19% 1.19%(3) T. Rowe Price Equity Series, Inc. Blue Chip Growth Portfolio II 0.85% 0.25% 0.00% 1.10% Equity Income Portfolio II 0.85% 0.25% 0.00% 1.10% Health Sciences Portfolio II 0.95% 0.25% 0.00% 1.20% Wells Fargo Variable Trust Wells Fargo Advantage VT Discovery Fund 0.75% 0.25% 0.22% 1.22%(6) Wells Fargo Advantage VT Opportunity Fund 0.72% 0.25% 0.20% 1.17%(6) (1)The portfolio fees and expenses used to prepare the table above, and the example below, were provided to us by the Funds. We have not independently verified such information. Current or future expenses may be greater or less than those shown. In addition, certain portfolios may impose a redemption fee of no more than 2% of the amount of portfolio shares redeemed. We may be required to implement a portfolio's redemption fee. The redemption fee will be assessed against your Contract Value. For more information, please see each portfolio's prospectus. (2)Our affiliate, Equity Services, Inc., the principal underwriter for the Contracts, will receive 12b-1 fees deducted from certain portfolio assets attributable to the Contracts for providing distribution and shareholder support services to some portfolios. (3)Certain of the portfolios receive voluntarily and/or contractual waivers of fees and/or reimbursements of expenses from their investment advisers or other affiliates. However, there may be no legal obligation to continue these arrangements for any particular period of time. We are aware that (1) a National Life affiliate has committed to maintain the reimbursement arrangements for the named Sentinel Variable Products Funds until at least December 31, 2006, (2) A I M Advisors, Inc. has contractually agreed to waive advisory fees and/or reimburse expenses to the extent necessary to limit Total Annual Fund Operating Expenses for the AIM V.I. Dynamics, Global Health Care, and Technology Funds-Series I to 1.30% (excluding certain expenses) through April 30, 2007 and to waive a portion of its advisory fees for the AIM V.I. Dynamics and Global Health Care Funds-Series I from January 1, 2005 through June 30, 2006, (3) The Dreyfus Corporation has agreed to waive receipt of a portion of the Fund's management fee, in the amount of .15 of 1% of the Quality Bond Portfolio's average daily assets, until June 30, 2006, (4) pursuant to their respective agreements with DWS Variable Series II, the investment manager, the underwriter, and the accounting agent have agreed, for the one year period commencing May 1, 2005, to limit their respective fees and to reimburse other expenses to the extent necessary to limit total operating expenses of the Class B shares of the DWS Dreman High Return Equity VIP and the DWS Dreman Small Cap Value VIP to 1.27% and 1.24%, respectively, (5) a portion of the brokerage commission the Fidelity Contrafund, Equity-Income, Growth, Mid Cap and Overseas Portfolios pay may be reimbursed and used to reduce the Portfolio's expense; and through arrangements with the Portfolio's custodian, credits realized as a result of uninvested cash balances are used to reduce the Fidelity Contrafund, Growth, Mid Cap and Overseas Portfolios' custodian expenses, management fees for the Index 500 Portfolio have been reduced to 0.10%, and class expenses are limited to 0.10% (these limits do not apply to interest, taxes, brokerage commissions, security lending fees, or extraordinary expenses), this limit is contractual and may not be increased without approval of the Portfolio's shareholders and Board of Trustees, (6) the Franklin Small-Mid Cap Growth Securities, Franklin Small Cap Value Securities and Templeton Foreign Securities Funds' manager has agreed in advance to reduce its fees with respect to assets invested by the Fund in a Franklin Templeton Money Market Fund, which is required by the Fund's Board of Trustees and an exemptive order by the Securities and Exchange Commission, (7) Neuberger Berman Management, Inc. ("NBMI") has undertaken through December 31, 2009 to waive fees and/or reimburse certain operating expenses, excluding taxes, interest, extraordinary expenses, brokerage commissions and transaction costs, that exceed, in the aggregate, 1.00% of the average daily net asset value of the Limited Maturity Bond, Mid-Cap Growth and Partners Portfolios; 1.40% for the Fasciano Portfolio and (8) Wells Fargo Funds Management, LLC has committed to maintain the waiver/reimbursement arrangements for the Wells Fargo Advantage VT Discovery and VT Opportunity Funds through April 30, 2007. If these arrangements are terminated, the affected portfolio's expenses may increase. Taking these waiver/reimbursement arrangements into account, annual operating expenses of those portfolios having such arrangements are shown below.
-9-
Portfolio Net Total Annual Expenses Sentinel Variable Products Trust Balanced Fund 0.79% Bond Fund 0.67% Common Stock Fund 0.65% Growth Index Fund 0.60% Mid Cap Growth Fund 0.79% Money Market Fund 0.40% Small Company Fund 0.70% AIM Variable Insurance Funds AIM V.I. Dynamics Fund - Series I Shares 1.16% Dreyfus Variable Investment Fund DVIF Quality Bond Portfolio - Initial Shares 0.60% Fidelity(R) Variable Insurance Products Initial Class Contrafund(R) Portfolio 0.64% Equity Income Portfolio 0.55% Growth Portfolio 0.63% Mid Cap Portfolio 0.64% Overseas Portfolio 0.82% Franklin Templeton Variable Insurance Products Trust Class 2 shares, Franklin Small Cap Value Securities Fund 0.89% Class 2 shares, Franklin Small-Midcap Growth Securities Fund 0.99% Class 2 shares, Templeton Foreign Securities Fund 1.02% Neuberger Berman Advisers Management Trust S Class, Fasciano Portfolio 1.41% Wells Fargo Variable Trust Wells Fargo Advantage VT Discovery Fund 1.15% Wells Fargo Advantage VT Opportunity Fund 1.07% (4)The Franklin Real Estate Fund's administration fee is paid indirectly through the management fee. (5)While the maximum amount payable under the Fund's Class 2 rule 12b-1 plan is 0.35% per year of the Fund's Class 2 average net assets, the Fund's Board of Trustees has set the current rate at 0.25% per year. (6) Other expenses may include expenses payable to affiliates of Wells Fargo & Company. Other expenses for the Wells Fargo Advantage VT Discovery and VT Opportunity Funds are based on estimates for the current fiscal year. (7) The annual class operating expenses for the Index 500 Portfolio are based on historical expenses adjusted to reflect current fees.
For information concerning compensation paid in connection with the sale of the Policies, see "Distribution of the Policies." -10- Example The Example is intended to help you compare the cost of investing in the Contract with the cost of investing in other variable annuity contracts. These costs include Contract Owner transaction expenses, Contract fees, Variable Account annual expenses, and portfolio company fees and expenses. The Example assumes that you invest $10,000 in the Contract for the time periods indicated. The Example also assumes that your investment has a 5% return each year, that the maximum fees and expenses of any of the portfolio companies apply as of December 31, 2005, and that you elected the Optional Enhanced Death Benefit Rider. Although your actual costs may be higher or lower, based on these assumptions, your costs would be: (1) If you surrender your Contract at the end of the applicable time period: 1 Year 3 Years 5 years 10 years $1,068 $1,619 $2,188 $3,894 (2) If you annuitize your Contract at the end of the applicable time period or if you do not surrender your Contract: 1 Year(3) 3 Years 5 years 10 years $368 $1,119 $1,888 $3,894 (3)The Contract may not be annuitized in the first two years from the Date of Issue. ACCUMULATION UNIT VALUE (in dollars) The following table sets forth for each period since inception for an accumulation unit outstanding throughout the period, (1) the accumulation unit value at the beginning of each period; (2) the accumulation unit value at the end of each period; and (3) the number of accumulation units outstanding at the end of each period.
Subaccount Accumulation Accumulation Number of Accumulation Accumulation Number of Accumulation Accumulation Number of Unit Value Unit Value Accumulation Unit Value Unit Value Accumulation Unit Value Unit Value Accumulation at 6/20/97 at 12/31/97 Units at 1/2/98 at 12/31/98 Units at 1/4/99 at 12/31/99 Units Outstanding Outstanding Outstanding at 12/31/97 at 12/31/98 at 12/31/99 Sentinel VPT 10.00 10.68 198,364.24 10.69 11.96 681,315.40 11.96 12.14 1,054,556 Common Stock Sentinel VPT 10.00 11.16 36,358.13 11.14 12.71 167,349.38 12.63 17.40 351,290 Mid Cap Growth Sentinel VPT 10.00 10.74 12,575.62 10.76 11.43 67,028.38 11.29 13.07 95,954 Small Company Sentinel VPT 10.00 10.20 133,462.26 10.20 10.59 464,682.04 10.59 10.96 874,549 Money Market Sentinel VPT 10.00 10.42 16,645.42 10.47 11.12 258,757.60 11.09 10.60 454,241 Bond Sentinel VPT 10.00 10.64 86,880.05 10.65 11.80 321,764.26 11.80 11.74 555,721 Balanced Alger American 10.00 10.65 35,788.21 10.63 15.55 174,624.86 15.47 20.51 620,933 Growth Alger American 10.00 11.00 91,673.97 10.89 12.53 180,967.55 12.41 17.73 243,153 Small Capitalization Fidelity VIP 10.00 10.84 106,376.57 10.86 11.93 446,646.08 11.88 12.51 704,688 Fund-Equity Income -11- Fidelity VIP 10.00 10.71 20,134.41 10.75 14.74 128,908.47 14.73 19.97 558,722 Fund-Growth Fidelity VIP 10.00 10.83 79,304.18 10.85 10.22 316,357.63 10.24 10.90 398,907 Fund-High Income Fidelity VIP 10.00 9.45 31,089.33 9.50 10.51 137,169.62 10.82 14.78 238,593 Fund-Overseas Fidelity VIP 10.00 10.95 59,153.41 10.93 14.04 220,659.55 13.93 17.20 495,265 Fund - -Contrafund(R) Fidelity VIP 10.00 10.88 123,048.43 10.94 13.77 644,354.40 13.75 16.37 1,479,594 Fund - Index 500 Wells Fargo 10.00 11.26 594,648.07 11.16 14.29 79,046.28 14.08 26.76 318,572 Advantage VT Discovery Wells Fargo 10.00 11.16 340,375.32 11.15 12.50 125,380.26 12.55 16.63 200,977 Advantage VT Opportunity Subaccount Accumulation Accumulation Number of Accumulation Accumulation Number of Accumulation Accumulation Number of Unit Value Unit Value Accumulation Unit Value Unit Value Accumulation Unit Value Unit Value Accumulation at 1/3/00 at 12/31/00 Units at 1/2/01 at 12/31/01 Units at 1/2/02 at 12/31/02 Units Outstanding Outstanding Outstanding at 12/31/00 at 12/31/01 at 12/31/02 - ------------------------------------------------------------------------------------------------------------------------------------ Sentinel VPT 11.90 13.15 1,080,323.09 12.98 11.91 1,550,727.39 11.93 9.71 1,800,411.01 Common Stock - ------------------------------------------------------------------------------------------------------------------------------------ Sentinel VPT 17.64 17.01 816,621.11 15.66 12.70 1,037,504.10 12.77 9.51 1,000,052.44 Mid Cap Growth - ------------------------------------------------------------------------------------------------------------------------------------ Sentinel VPT 12.88 17.84 337,481.08 17.06 18.54 641,556.80 18.42 15.73 937,943.44 Small Company - ------------------------------------------------------------------------------------------------------------------------------------ Sentinel VPT 10.96 11.47 946,420.61 11.47 11.73 1,339,572.89 11.73 11.72 1,551.827.66 Money Market - ------------------------------------------------------------------------------------------------------------------------------------ Sentinel VPT 10.55 11.46 480,176.92 11.56 12.14 831,321.19 12.08 10.22 916,629.63 Bond - ------------------------------------------------------------------------------------------------------------------------------------ -12- - ------------------------------------------------------------------------------------------------------------------------------------ Sentinel VPT 11.58 12.60 597,642.88 12.56 11.55 742,241.96 11.52 13.06 1,213.264.09 Balanced - ------------------------------------------------------------------------------------------------------------------------------------ Alger American 20.53 17.24 1,085,900.24 16.62 14.99 1,176,016.07 15.02 9.91 1,112,587.18 Growth - ------------------------------------------------------------------------------------------------------------------------------------ Alger American 17.64 12.73 600,592.69 11.62 8.85 713,337.23 8.76 6.44 627,551.21 Small Capitalization - ------------------------------------------------------------------------------------------------------------------------------------ Fidelity VIP 12.18 13.38 877,837.96 13.22 12.54 1,100,806.66 12.56 10.27 1,336,207.03 Fund-Equity Income - ------------------------------------------------------------------------------------------------------------------------------------ Fidelity VIP 19.93 17.54 1,030,524.99 16.81 14.24 1,161,109.49 14.33 9.82 1,116,957.82 Fund-Growth - ------------------------------------------------------------------------------------------------------------------------------------ Fidelity VIP 10.86 8.33 501,300.74 8.32 7.25 572,401.28 7.28 7.40 683,024.78 Fund-High Income - ------------------------------------------------------------------------------------------------------------------------------------ Fidelity VIP 14.84 11.79 764,738.39 11.73 9.16 943,360.18 9.23 7.20 956,027.37 Fund-Overseas - ------------------------------------------------------------------------------------------------------------------------------------ Fidelity VIP 16.93 15.84 757,511.71 15.33 13.71 802,651.88 13.63 12.26 895,933.04 Fund - -Contrafund(R) - ------------------------------------------------------------------------------------------------------------------------------------ Fidelity VIP 16.21 14.64 2,023,959.28 14.23 12.69 2,179,936.83 12.76 9.73 2,177,585.47 Fund - Index 500 - ------------------------------------------------------------------------------------------------------------------------------------ Wells Fargo 26.94 22.48 594,648.07 20.44 15.34 649,737.70 15.42 9.45 593,006.69 Advantage VT Discovery - ------------------------------------------------------------------------------------------------------------------------------------ Wells Fargo 16.34 17.48 340,375.32 17.13 16.60 422,080.77 16.59 11.98 593,692.26 Advantage VT Opportunity - ------------------------------------------------------------------------------------------------------------------------------------ -13- Subaccount Accumulation Accumulation Number of Accumulation Accumulation Number of Accumulation Accumulation Number of Unit Value Unit Value Accumulation Unit Value Unit Value Accumulation Unit Value Unit Value Accumulation at 1/2/03 at 12/31/03 Units at 1/2/04 at 12/31/04 Units at 1/3/05 at 12/31/05 Units Outstanding Outstanding Outstanding at 12/31/03 at 12/31/04 at 12/31/05 - ------------------------------------------------------------------------------------------------------------------------------------ Sentinel VPT 9.96 12.59 2,081,352.52 12.59 13.61 2,530,565.26 13.46 14.45 2,669,872.15 Common Stock - ------------------------------------------------------------------------------------------------------------------------------------ Sentinel VPT Mid 9.77 13.30 1,190,675.96 13.30 14.74 1,136,704.15 14.48 15.08 969,791.11 Cap Growth - ------------------------------------------------------------------------------------------------------------------------------------ Sentinel VPT 16.08 21.64 1,242,053.68 21.73 24.73 1,502,266.70 24.37 26.40 1,366,987.15 Small Company - ------------------------------------------------------------------------------------------------------------------------------------ Sentinel VPT 11.72 11.64 1,010,025.42 11.64 11.59 956,343.80 11.59 11.76 798,945.46 Money Market - ------------------------------------------------------------------------------------------------------------------------------------ Sentinel VPT 12.98 13.63 1,303,319.09 13.58 14.07 1,287455.21 14.08 14.14 1,285,059.33 Bond - ------------------------------------------------------------------------------------------------------------------------------------ Sentinel VPT 10.35 12.47 1,134,775.52 12.46 13.21 1,253,469.20 13.13 13.77 1,223,837.89 Balanced - ------------------------------------------------------------------------------------------------------------------------------------ Alger American 10.23 13.21 1,147,661.68 13.17 13.74 981,988.91 13.57 15.18 767,708.64 Growth - ------------------------------------------------------------------------------------------------------------------------------------ Alger American 6.57 9.04 638,099.31 9.06 10.39 608,040.56 10.18 11.97 478,400.24 Small Capitalization - ------------------------------------------------------------------------------------------------------------------------------------ Fidelity VIP 10.59 13.20 1,458,610.93 13.18 14.51 1,393,766.91 14.38 15.15 1,221,652.93 Fund-Equity Income - ------------------------------------------------------------------------------------------------------------------------------------ Fidelity VIP 10.15 12.86 1,247,702.59 12.88 13.11 1,202,786.06 12.99 13.68 1,011,888.11 Fund-Growth - ------------------------------------------------------------------------------------------------------------------------------------ Fidelity VIP 7.41 9.29 926,868.19 9.29 10.04 1,010,663.00 10.05 10.17 988,225.90 Fund-Hig Income - ------------------------------------------------------------------------------------------------------------------------------------ Fidelity VIP 7.33 10.19 1,064,456.93 10.31 11.41 1,185,510.33 11.34 13.40 1,141,752.38 Fund-Overseas - ------------------------------------------------------------------------------------------------------------------------------------ Fidelity VIP Fund 12.49 15.53 1,052,447.55 15.50 17.68 1,069,940.50 17.45 20.39 1,007,625.08 - -Contrafund(R) - ------------------------------------------------------------------------------------------------------------------------------------ Fidelity VIP Fund 10.05 12.32 2,313,638.44 12.28 13.44 2,088,000.22 13.33 13.89 1,911,723.93 - -Index 500 - ------------------------------------------------------------------------------------------------------------------------------------ -14- - ------------------------------------------------------------------------------------------------------------------------------------ Wells Fargo 9.86 12.51 639,147.81 12.47 14.70 543,989.20 14.39 15.89 449,988.64 Advantage VT Discovery - ------------------------------------------------------------------------------------------------------------------------------------ Wells Fargo 12.35 16.18 597,575.44 16.14 18.87 583,347.52 18.59 20.07 485,070.63 Advantage VT Opportunity - ------------------------------------------------------------------------------------------------------------------------------------ -15- The following provides the information for Subaccounts which began operations on August 3, 1998. Subaccount Accumulation Accumulation Number of Accumulation Accumulation Number of Accumulation Accumulation Number of Unit Value at Unit Value Accumulation Unit Value Unit Value Accumulation Unit Value Unit Value Accumulation 8/3/98 at 12/31/98 Units at 1/1/99 at 12/31/99 Units at 1/1/00 at 12/31/00 Units Outstanding Outstanding Outstanding at 12/31/98 at 12/31/99 at 12/31/00 - ------------------------------------------------------------------------------------------------------------------------------------ American Century 10.00 10.96 2,561.63 10.98 12.76 183,326 12.62 11.25 325,390.25 VP Income & Growth - ------------------------------------------------------------------------------------------------------------------------------------ American Century 10.00 10.41 480.38 10.41 10.18 63,007 9.92 11.86 233,597.13 VP Value - ------------------------------------------------------------------------------------------------------------------------------------ JPMorgan 10.00 9.69 0 9.93 13.06 25,478 13.10 10.84 79,538.84 International Equity - ------------------------------------------------------------------------------------------------------------------------------------ JPMorgan Small 10.00 9.98 10,554.25 9.93 14.21 30,934 14.08 12.43 84,711.61 Company - ------------------------------------------------------------------------------------------------------------------------------------ Neuberger Berman 10.00 10.19 9,444.56 10.18 10.79 47,306 10.65 10.72 72,340.65 Partners - ------------------------------------------------------------------------------------------------------------------------------------ Subaccount Accumulation Accumulation Number of Accumulation Accumulation Number of Accumulation Accumulation Number of Unit Value Unit Value Accumulation Unit Value Unit Value Accumulation Unit Value Unit Value Accumulation at 1/1/01 at 12/31/01 Units at 1/1/02 at 12/31/02 Units at 1/1/03 at 12/31/0 3 Units Outstanding Outstanding Outstanding at 12/31/01 at 12/31/02 at 12/31/03 - ------------------------------------------------------------------------------------------------------------------------------------ American 10.96 10.17 513,559.72 10.21 8.08 647,417.35 8.33 10.31 767,740.19 Century VP Income & Growth - ------------------------------------------------------------------------------------------------------------------------------------ American 11.64 13.19 497,921.29 13.15 11.37 816,576.88 11.66 14.46 963,627.66 Century VP Value - ------------------------------------------------------------------------------------------------------------------------------------ JPMorgan 10.82 8.64 129,932.62 8.68 6.96 158,604.86 7.03 9.09 228,845.55 Inter- national Equity - ------------------------------------------------------------------------------------------------------------------------------------ JPMorgan Small 11.76 11.27 94,501.13 11.18 8.71 115,400.73 8.92 11.68 118,426.03 Company - ------------------------------------------------------------------------------------------------------------------------------------ Neuberger 10.44 10.27 92,299.75 10.26 7.68 134,673.28 7.92 10.23 168,915.13 Berman Partners - ------------------------------------------------------------------------------------------------------------------------------------ -16- Subaccount Accumulation Accumulation Number of Accumulation Accumulation Number of Accumulation Unit Value at Unit Value at Accumulation Units Unit Value at Unit Value at Units Outstanding at 1/1/04 12/31/04 Outstanding at 1/1/05 12/31/05 12/31/05 12/31/04 - ------------------------------------------------------------------------------------------------------------------------------------ American Century VP Income 10.30 11.49 765,569.07 11.36 11.86 693,013.97 & Growth - ------------------------------------------------------------------------------------------------------------------------------------ American Century VP Value 14.42 16.30 1,108,091.56 16.15 16.88 1,137,146.95 - ------------------------------------------------------------------------------------------------------------------------------------ JPMorgan International 0/13 10.62 285,762.15 10.53 11.59 293,409.83 Equity - ------------------------------------------------------------------------------------------------------------------------------------ JPMorgan Small Company 11.68 14.65 138,936.30 14.38 14.94 135,781.41 - ------------------------------------------------------------------------------------------------------------------------------------ Neuberger Berman Partners 10.18 12.01 181,388.86 11/81 13.98 247,078.58 - ------------------------------------------------------------------------------------------------------------------------------------ The following information is for Subaccounts which began operations on December 1, 2000. Subaccount Accumulation Unit Accumulation Number of Accumulation Accumulation Unit Number of Value at 12/1/00 Unit Value at Accumulation Unit Value at Value at 12/31/01 Accumulation 12/31/00 Units 1/1/01 Units Outstanding Outstanding at at 12/31/01 12/31/00 - ------------------------------------------------------------------------------------------------------------------------------------ Sentinel VPT Growth Index 10.00 9.45 6,231.81 9.04 8.07 152,290.12 - ------------------------------------------------------------------------------------------------------------------------------------ Alger American Leveraged 10.00 10.02 4,084.23 9.45 8.30 122,328.68 AllCap - ------------------------------------------------------------------------------------------------------------------------------------ Dreyfus Socially Responsible 10.00 10.00 202.71 9.62 7.64 64,416.84 Growth Fund, Inc. - ------------------------------------------------------------------------------------------------------------------------------------ Fidelity VIP Fund Investment 10.00 10.69 68,296.49 10.26 10.89 759,750.40 Grade Bond - ------------------------------------------------------------------------------------------------------------------------------------ AIM V.I Dynamics 10.00 10.58 6,055.31 9.75 7.26 185,977.17 - ------------------------------------------------------------------------------------------------------------------------------------ AIM V.I Global Health Care 10.00 10.07 19,839.77 10.25 9.12 185,979.64 - ------------------------------------------------------------------------------------------------------------------------------------ AIM V.I Technology 10.00 10.18 7,402.18 8.92 5.38 140,047.82 - ------------------------------------------------------------------------------------------------------------------------------------ -17- Subaccount Accumulation Accumulation Number of Accumulation Accumulation Number of Unit Value at Unit Value at Accumulation Unit Value at Unit Value at Accumulation 1/1/02 12/31/02 Units Outstanding 1/1/03 12/31/03 Units at 12/31/02 Outstanding at 12/31/03 - ------------------------------------------------------------------------------------------------------------------------------------ Sentinel VPT Growth Index 8.15 6.04 357,764.90 6.24 7.39 395,952.58 - ------------------------------------------------------------------------------------------------------------------------------------ Alger American Leveraged 8.28 5.41 183,800.39 5.58 7.19 292,149.77 AllCap - ------------------------------------------------------------------------------------------------------------------------------------ Dreyfus Socially Responsible 7.70 5.35 148,267.80 5.52 6.65 159,344.69 Growth Fund, Inc. - ------------------------------------------------------------------------------------------------------------------------------------ Fidelity VIP Fund Investment 10.85 11.85 1,702,427.77 11.77 12.30 1,885,368.96 Grade Bond - ------------------------------------------------------------------------------------------------------------------------------------ AIM V.I Dynamics 7.33 4.88 321,110.70 5.50 6.63 381,357.65 - ------------------------------------------------------------------------------------------------------------------------------------ AIM V.I Global Health Care 9.00 6.79 414,706.10 6.94 8.56 534,106.75 - ------------------------------------------------------------------------------------------------------------------------------------ AIM V.I Technology 5.53 2.82 283,490.20 2.95 4.04 547,768.82 - ------------------------------------------------------------------------------------------------------------------------------------ Subaccount Accumulation Unit Accumulation Number of Accumulation Accumulation Number of Value at 1/1/04 Unit Value at Accumulation Unit Value at Unit Value at Accumulation 12/31/04 Units 1/1/05 12/31/05 Units Outstanding at Outstanding at 12/31/04 12/31/05 - ------------------------------------------------------------------------------------------------------------------------------------ Sentinel VPT Growth 7.36 7.68 369,520.69 7.62 7.80 306,766.11 Index - ------------------------------------------------------------------------------------------------------------------------------------ Alger American 7.18 7.67 226,660.10 7.58 8.66 227,328.44 Leveraged AllCap - ------------------------------------------------------------------------------------------------------------------------------------ Dreyfus Socially 6.64 6.96 146,825.11 6.91 7.12 127,070.56 Responsible Growth Fund, Inc. - ------------------------------------------------------------------------------------------------------------------------------------ Fidelity VIP Fund 12.24 12.67 1,968,755.52 12.67 12.77 1,880,488.62 Investment Grade Bond - ------------------------------------------------------------------------------------------------------------------------------------ AIM V.I Dynamics 6.61 7.41 365,842.99 7.30 8.09 319,611.45 - ------------------------------------------------------------------------------------------------------------------------------------ AIM V.I Global Health 8.58 9.08 520,475.69 8.99 9.68 487,457.78 Care - ------------------------------------------------------------------------------------------------------------------------------------ AIM V.I Technology 4.05 4.17 525,974.29 4.12 4.20 506,008.05 - ------------------------------------------------------------------------------------------------------------------------------------ The following information is for Subaccounts which began operations on May 1, 2004. -18- Subaccount Accumulation Unit Accumulation Unit Number of Accumulation Accumulation Unit Number of Value at 5/1/04 Value at 12/1/04 Accumulation Units Unit Value at Value at 12/1/05 Accumulation Outstanding at 1/1/05 Units 12/31/04 Outstanding at 12/31/05 - ------------------------------------------------------------------------------------------------------------------------------------ American Century VP 10.00 10.75 7,351,49 10.64 10.84 7,270.33 Ultra(R) - ------------------------------------------------------------------------------------------------------------------------------------ American Century VP 10.00 10.80 369,192.37 10.62 11.52 607,473.22 Vista - ------------------------------------------------------------------------------------------------------------------------------------ American Century VP 10.00 11.29 212,294.68 11.29 12.61 401,457.14 International - ------------------------------------------------------------------------------------------------------------------------------------ American Century VP 10.00 10.53 464,504.55 10.52 10.57 891,225.74 Inflation Protection - ------------------------------------------------------------------------------------------------------------------------------------ Dreyfus Appreciation 10.00 10.31 247,910.98 10.24 10.62 596,450.11 - ------------------------------------------------------------------------------------------------------------------------------------ Dreyfus Developing 10.00 10.89 2,938,61 10.72 11.36 9,328.03 Leaders - ------------------------------------------------------------------------------------------------------------------------------------ Dreyfus Quality Bond 10.00 10.42 21,381.13 10.41 10.53 51,108.90 - ------------------------------------------------------------------------------------------------------------------------------------ Franklin Templeton 10.00 10.97 34,866.28 10.91 11.96 85,355.60 Mutual Shares Securities - ------------------------------------------------------------------------------------------------------------------------------------ Franklin Small Cap 10.00 12.00 43,564.48 11.82 12.88 86,582.43 Value Securities - ------------------------------------------------------------------------------------------------------------------------------------ Franklin Small-Midcap 10.00 10.95 8,615.04 10.79 11.32 18,483.52 Growth Securities - ------------------------------------------------------------------------------------------------------------------------------------ Templeton Foreign 10.00 11.53 233,297.54 11.51 12.53 465,272.38 Securities - ------------------------------------------------------------------------------------------------------------------------------------ Franklin Real Estate 10.00 13.58 71,208.32 13.45 15.20 193,126.58 - ------------------------------------------------------------------------------------------------------------------------------------ Fidelity Mid Cap 10.00 12.26 107,584.38 12.04 14.31 266,877.22 - ------------------------------------------------------------------------------------------------------------------------------------ Neuberger Berman Mid Cap 10.00 11,52 6,084.77 11.33 12.92 21,984.12 Growth - ------------------------------------------------------------------------------------------------------------------------------------ Neuberger Berman 10.00 19,84 143,490.34 10.82 11.10 293,062.65 Fasciano - ------------------------------------------------------------------------------------------------------------------------------------ Neuberger Berman Limited 10.00 9.97 586,111.12 9.97 9.97 1,138,952.51 Maturity Bond - ------------------------------------------------------------------------------------------------------------------------------------ Scudder Dreman High 10.00 11.23 21,818.25 11.12 11.91 43,214.24 Return Equity - ------------------------------------------------------------------------------------------------------------------------------------ Scudder Dreman Small Cap 10.00 11.93 122,129.24 11.73 12.91 134,345.17 Value - ------------------------------------------------------------------------------------------------------------------------------------ T. Rowe Price Equity 10.00 11.21 41,206.25 11.10 11.46 86,284.42 Income Portfolio II - ------------------------------------------------------------------------------------------------------------------------------------ T. Rowe Price Blue Chip 10.00 10.79 279,899.33 10.69 11.24 897,520.42 Growth Portfolio II - ------------------------------------------------------------------------------------------------------------------------------------ T. Rowe Price Health 10.00 10.36 106,209.89 10.23 11.56 136,594.78 Sciences Portfolio II - ------------------------------------------------------------------------------------------------------------------------------------
-19- NATIONAL LIFE, THE VARIABLE ACCOUNT, AND THE FUNDS National Life National Life is authorized to transact life insurance and annuity business in Vermont and in 50 other jurisdictions. National Life was originally chartered as a mutual life insurance company in 1848 under Vermont law. It is now a stock life insurance company, all of the outstanding stock of which is indirectly owned by National Life Holding Company, a mutual insurance holding company established under Vermont law on January 1, 1999. All policyholders of National Life, including all the Owners of the Contracts, are voting members of National Life Holding Company. National Life assumes all mortality and expense risks under the Contracts and its assets support the Contract's benefits. Financial Statements for National Life are contained in the Statement of Additional Information. The Variable Account - -------------------- The Variable Account was established by National Life on November 1, 1996, pursuant to the provisions of Vermont law. National Life has caused the Variable Account to be registered with the Securities and Exchange Commission as a unit investment trust pursuant to the provisions of the Investment Company Act. Such registration does not involve supervision of the management of the Variable Account or National Life by the Securities and Exchange Commission. The Variable Account is a separate investment account of National Life and, as such, is not chargeable with liabilities arising out of any other business National Life may conduct. National Life does not guarantee the investment performance of the Variable Account. Obligations under the Contracts are obligations of National Life. Income, gains and losses, whether or not realized, from the assets of the Variable Account are credited to or charged against the Variable Account without regard to other income, gains, or losses of National Life. Net Premium Payments are allocated within the Variable Account among one or more Subaccounts made up of shares of the Fund options designated by the Owner. A separate Subaccount is established within the Variable Account for each of the Fund options. -20- The Funds - --------- You may choose from among a number of different Subaccount options. The investment experience of each of the Subaccounts depends on the investment performance of the underlying Fund. The investment objectives and policies of certain Funds are similar to the investment objectives and policies of other mutual fund portfolios that may be managed by the same investment adviser or manager. The investment results of the Funds, however, may be higher or lower than the results of such other portfolios. There can be no assurance, and no representation is made, that the investment results of any of the Funds will be comparable to the investment results of any other portfolios, even if the other portfolio has the same investment adviser or manager. The Variable Account purchases and redeems shares of the portfolios at net asset value. The Variable Account automatically reinvests all dividend and capital gain distributions of the portfolios in shares of the distributing portfolios at their net asset value on the date of distribution. In other words, the Variable Account does not pay portfolio dividends or portfolio distributions out to you as additional units, but instead reflects them in unit values. Before choosing to allocate your Premium Payments and Contract Value, carefully read the prospectus for each Fund, along with this Prospectus. There is no assurance that any of the portfolios will meet their investment objectives. We do not guarantee any minimum value for the amounts allocated to the Variable Account. You bear the investment risk of investing in the portfolios. You should know that during extended periods of low interest rates, the yields of the Sentinel Variable Products Trust Money Market Fund may also become extremely low and possibly negative. Not all portfolios may be available in all states or in all markets. The following table provides certain information on each portfolio, including its fund type, and its investment adviser (and subadviser, if applicable). THERE IS NO ASSURANCE THAT ANY OF THE PORTFOLIOS WILL ACHIEVE THEIR INVESTMENT OBJECTIVE(S). You can find detailed information about the portfolios, including a description of risks and expenses, in the prospectuses for the portfolios that accompany this prospectus. You should read these prospectuses carefully and keep them for future reference.
- ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Portfolio Type of Fund Investment Adviser Subadviser - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Sentinel Variable Products Trust: - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Common Stock Fund Large Value Equity Sentinel Asset Management, Inc. None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Growth Index Fund(1) Index Equity Sentinel Asset Management, Inc. None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Mid Cap Growth Fund Mid Cap Growth Equity Sentinel Asset Management, Inc. None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Money Market Fund Money Market Sentinel Asset Management, Inc. None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Small Company Fund Small Blend Equity Sentinel Asset Management, Inc. None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Bond Fund Investment-Grade Bond Sentinel Asset Management, Inc. None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Balanced Fund Hybrid Equity and Debt Sentinel Asset Management, Inc. None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- AIM Variable Insurance Funds, Inc.: - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- AIM V.I. Dynamics Fund - Series I Shares Mid Cap Growth Equity A I M Advisors, Inc. None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- AIM V.I. Global Health Care Fund - Series I Sector Equity A I M Advisors, Inc. None Shares - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- AIM V.I. Technology Fund - Series I Shares Sector Equity A I M Advisors, Inc. None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- The Alger American Fund: - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Growth Portfolio - Class O Shares Large Growth Equity Fred Alger Management, Inc. None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Leveraged AllCap Portfolio - Class O Shares Growth Equity Fred Alger Management, Inc. None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Small Capitalization Portfolio - Class O Shares Small Growth Equity Fred Alger Management, Inc. None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- American Century Variable Portfolios, Inc.: - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- VP Income & Growth Portfolio Large Value Equity American Century Investment None Management, Inc. - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- -21- - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- VP Value Portfolio Mid Cap Value Equity American Century Investment None Management, Inc. - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- VP Ultra(R) Portfolio Large Growth Equity American Century Investment None Management, Inc. - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- VP Vista Portfolio Mid Cap Growth Equity American Century Investment None Management, Inc. - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- VP International Portfolio International Equity American Century Global Investment None Management, Inc. - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- VP Inflation Protection Portfolio Fixed Income American Century Investment None Management, Inc. - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Dreyfus Variable Investment Fund - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Appreciation Portfolio Large Blend The Dreyfus Corporation Fayez Sarofim & Co. - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Developing Leaders Portfolio Aggressive Growth The Dreyfus Corporation None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Quality Bond Portfolio Investment Grade Bond The Dreyfus Corporation None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Dreyfus Socially Responsible Growth Fund, Inc. Large Cap Growth The Dreyfus Corporation None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Fidelity(R) Variable Insurance Products Initial Class: - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Equity-Income Portfolio Large Value Equity Fidelity Management & Research Company None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Growth Portfolio Large Growth Equity Fidelity Management & Research Company None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- High Income Portfolio Below Investment Grade Fidelity Management & Research Bond Company None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Overseas Portfolio International Equity Fidelity Management & Research FMR U.K., FMR Company Far East, and Fidelity International Investment Advisers; Fidelity Investments Japan Limited - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- -22- - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Contrafund(R) Portfolio Large Growth Equity Fidelity Management & Research Company None - ------------------------------------------------------ ------------------------ ---------------------------------------- ----------- Index 500 Portfolio Index Equity Fidelity Management & Research Geode Capital Company Management, LLC - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Investment Grade Bond Portfolio Investment Grade Bond Fidelity Management & Research Company None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Mid Cap Portfolio Mid Cap Blend Fidelity Management & Research Company None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Franklin Templeton Variable Insurance Products Trust - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Class 2 shares, Mutual Shares Securities Fund Mid Cap Value Franklin Mutual Advisors, LLC None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Class 2 shares, Franklin Small Cap Value Securities Small Cap Value Franklin Advisory Services, LLC None Fund - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Class 2 shares, Franklin Small-Midcap Growth Small-Mid Cap Growth Franklin Advisors, Inc. None Securities Fund - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Class 2 shares, Templeton Foreign Securities Fund Foreign Templeton Investment Counsel, LLC None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Class 2 shares, Franklin Real Estate Fund Sector Equity Franklin Advisors, Inc. None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- J.P. Morgan Series Trust II: - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- JPMorgan International Equity Portfolio International Equity J.P. Morgan Investment Management Inc. None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- JPMorgan Small Company Portfolio Small Cap Blend Equity J.P. Morgan Investment Management Inc. None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Neuberger Berman Advisers Management Trust - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- I Class, Partners Portfolio Large Value Neuberger Berman Management, Inc. None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- I Class, Mid Cap Growth Portfolio Mid Cap Growth Equity Neuberger Berman Management, Inc. None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- S Class, Fasciano Portfolio Small Cap Blend Neuberger Berman Management, Inc. None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- I Class, Limited Maturity Bond Portfolio Short-Term Neuberger Berman Management, Inc. None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Scudder Variable Series II: - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Class B shares, Dreman High Return Equity VIP Large Value Deutsche Investment Management Dreman Value Americas, Inc. Management, LLC - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Class B shares, Dreman Small Cap Value VIP Small Cap Value Deutsche Investment Management Dreman Value Americas, Inc. Management, LLC - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- T. Rowe Price Equity Series, Inc. - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Equity Income Portfolio II Large Value T. Rowe Price Associates, Inc. None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Blue Chip Growth Portfolio II Large Growth T. Rowe Price Associates, Inc. None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Health Sciences Portfolio II Sector Equity T. Rowe Price Associates, Inc. None - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Wells Fargo Variable Trust - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Wells Fargo Advantage VT Discovery Fund Mid Cap Growth Equity Wells Fargo Funds Management, LLC Wells Capital Management, Incorporated - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- Wells Fargo Advantage VT Opportunity Fund Mid Cap Blend Wells Fargo Funds Management, LLC Wells Capital Management, Incorporated - ------------------------------------------------------ ------------------------ ----------------------------------- ---------------- -23- (1)On or about October 28, 2005, National Life filed an application with the Securities and Exchange Commission seeking an order to approve a substitution of shares of the Fidelity VIP Index 500 Portfolio for shares of the SVPT Growth Index Fund. If the appropriate approvals are obtained, the substitution is expected to occur later this year. After the substitution, the Sentinel Variable Products Growth Index Fund will no longer be an available investment option. Between October 28, 2005 until the date of the proposed substitution, you may make one transfer of all amounts under your Contract invested in the SVPT Growth Index Fund to another available under your Contract without that transfer counting as a "free" transfer permitted under the Contract. If the proposed substitution is carried out, each Contract owner affected by the substitution will be sent a written notice informing them of the fact and details of the substitution.
-24- Other Information - ----------------- Contractual Arrangements. National Life has entered into or may enter into agreements with Funds pursuant to which the adviser or distributor pays National Life a fee based upon an annual percentage of the average net asset amount invested on behalf of the Variable Account and our other separate accounts. These percentages may differ and we may be paid a greater percentage by some investment advisers or distributors than other advisers or distributors. These agreements reflect administrative services we provide. National Life receives compensation from the adviser or distributor of the Funds in connection with administration, distribution, or other services provided with respect to the Fund and its availability through the Contract. The amount of this compensation with respect to the Contract during 2005, including the 12b-1 fees referred to in the next paragraph, ranged from $4,304 to $87,311 per adviser, and the percentages of assets ranged from 0.05% to 0.25%. For more information on the compensation we receive, see "Contractual Arrangement between National Life and the Funds' Investment Advisors or Distributors" in the Statement of Additional Information. Our affiliate, Equity Services, Inc. ("ESI"), the principal underwriter for the Contracts, will receive 12b-1 fees deducted from certain portfolio assets for providing distribution and shareholder support services to some of the portfolios. Because 12b-1 fees are paid out of a portfolio's assets on an ongoing basis, over time they will increase the cost of an investment in portfolio shares. Conflicts of Interest. The Funds may also be available to registered separate accounts offering variable annuity and variable life products of other participating insurance companies, as well as to the Variable Account and other separate accounts of National Life. Although we do not anticipate any disadvantages to this, there is a possibility that a material conflict may arise between the interest of the Variable Account and one or more of the other separate accounts participating in the underlying Funds. A conflict may occur due to a change in law affecting the operations of variable life and variable annuity separate accounts, differences in the voting instructions of the Owners and those of other companies, or some other reason. In the event of conflict, we will take any steps necessary to protect Owners and variable annuity payees, including withdrawal of the Variable Account from participation in the underlying Fund or Funds which are involved in the conflict. DETAILED DESCRIPTION OF CONTRACT PROVISIONS We describe our basic Contract below. There may be differences in your Contract (such as differences in fees, charges or benefits) from the one described in this prospectus because of the requirements of the state where we issued your Contract. Please consult your Contract for its specific terms. Issuance of a Contract - ---------------------- The Contract is available to Owners up to and including age 85, on an age on nearest birthday basis, on the Date of Issue. If the Contract is issued to Joint Owners, then the oldest Joint Owner must be 85 years of age or younger on the Date of Issue, again on an age on nearest birthday basis. If the Owner is not a natural person, then the age of the Annuitant must meet the requirements for Owners. At our discretion, we may issue Contracts at ages higher than age 85. In order to purchase a Contract, an individual must forward an application to us through a licensed National Life agent who is also a registered representative of ESI, the principal underwriter of the Contracts, or another broker/dealer having a Selling Agreement with ESI or a broker/dealer having a Selling Agreement with such a broker/dealer. If you are purchasing the Contract in connection with a tax-favored arrangement, including an IRA and a Roth IRA, you should carefully consider the costs and benefits of the Contract (such as annuitization benefits) before purchasing a Contract since the tax-favored arrangement itself provides for tax-sheltered growth. -25- Tax Free "Section 1035" Exchanges. You can generally exchange one variable annuity contract for another in a "tax-free exchange" under Section 1035 of the Code. Before making the exchange, you should compare both contracts carefully. Remember that if you exchange another contract for the one described in this prospectus, you might have to pay a surrender charge on your old contract. There will be a new surrender charge period for this Contract and other charges might be higher (or lower) and the benefits may be different. If the exchange does not qualify for Section 1035 treatment, you may have to pay federal income and penalty taxes on the exchange. You should not exchange another contract for this one unless you determine, after knowing all the facts, that the exchange is in your best interests. You should be aware that your insurance agent will generally earn a commission if you buy this Contract through an exchange or otherwise. Important Information About Procedures for Opening a New Account. To help the government fight the funding of terrorism and money laundering activities, Federal law requires all financial institutions to obtain, verify, and record information that identifies each person who opens an account. What this means for you: When you open an account (i.e., purchase a Contract), we will ask for your name, address, date of birth and other information that will allow us to identify you. We may also ask to see your driver's license or other identifying documents. Premium Payments - ---------------- The Initial Premium Payment. The initial Premium Payment must be at least $5,000 for Non-Qualified Contracts, and must be at least $1500 for Qualified Contracts. We may at our discretion permit initial Premium Payments lower than these minimums. For Contracts purchased in South Carolina, the initial Premium Payment for Qualified Contracts must be at least $3000. Subsequent Premium Payments. Subsequent Premium Payments may be made at any time, but must be at least $100 ($50 for Individual Retirement Annuities). We may accept lower Premium Payments at our discretion if the Premium Payments are remitted electronically. Subsequent Premium Payments to the Variable Account will purchase Accumulation Units at the price next computed for the appropriate Subaccount after we receive the additional Premium Payment. For Contracts purchased in the States of Oregon and Massachusetts, we are not permitted to accept subsequent Premium Payments on or after the third Contract Anniversary. Effective March 2, 2005, we may accept subsequent premium payments on or after the third Contract Anniversary for new Contracts purchased in the State of Oregon. The total of all Premium Payments under Contracts issued on the life of any one Owner (or Annuitant if the owner is not a natural person) may not exceed $1,000,000 without our prior consent. Transactions will not be processed on the following days: New Year's Day, Presidents' Day, Martin Luther King, Jr. Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving, and Christmas Day. In addition, Premium Payments will not be allocated and transactions will not be effected to the Money Market Subaccount on Columbus Day and Veterans Day. Please remember that we must receive a transaction request at our Home Office before 4:00 p.m. Eastern Time to process the transaction on that Valuation Day. A Valuation Day ends at the close of regular trading of the New York Stock Exchange. Allocation of Net Premium Payments. In the application for the Contract, the Owner will indicate how Net Premium Payments are to be allocated among the Subaccounts of the Variable Account, the Fixed Account and/or the Guaranteed Accounts. These allocations may be changed at any time by the Owner by written notice to us at our Home Office or, if the telephone transaction privilege has been elected, by telephone instructions (see "Telephone Transaction Privilege," below). ). However, if your Contract is participating in the Illuminations program described under "Optional `Illuminations' Investment Advisory Service", below, making a change to your premium allocations on your own will be treated as a termination of your Contract's participation in the Illuminations program. The percentages of Net Premium Payments that may be allocated to any Subaccount, the Fixed Account, or any Guaranteed Account must be in whole numbers of not less than 1%, and the sum of the allocation percentages must be 100%. We allocate the initial Net Premium Payment within two business days after receipt at our home office, if the application and all information necessary for processing the order are complete. We do not begin processing your purchase order until we receive the application and initial premium payment at our home office from your agent's broker-dealer. -26- If the application is not properly completed, we retain the initial Premium Payment for up to five business days while attempting to complete the application. If the application is not complete at the end of the five day period, we inform the applicant of the reason for the delay and the initial Premium Payment will be returned immediately, unless the applicant specifically consents to our retaining the initial Premium Payment until the application is complete. Once the application is complete, we allocate the initial Net Premium Payment as designated by the Owner within two business days. We allocate subsequent Net Premium Payments as of the Valuation Date we receive Net Premium Payments at our Home Office, based on your allocation percentages then in effect. Please note that if you submit your Premium Payment to your agent, we will not begin processing the Premium Payment until we have received it from your agent's selling firm. At the time of allocation, we apply Net Premium Payments to the purchase of Fund shares. The net asset value of the shares purchased is converted into Accumulation units. The Subaccount values will vary with their investment experience, and you bear the entire investment risk. You should periodically review your allocation percentages in light of market conditions and your overall financial objectives. We offer a one-time credit in the amount of 3% of the initial Net Premium Payment to Owners whose initial Net Premium Payment comes from the surrender of an annuity contract issued by National Life's affiliate, Life Insurance Company of the Southwest. We pay this credit after the free look right with respect to the Contract has expired. When all or a portion of a premium payment is received without a clear subaccount designation or allocated to a subaccount that is not available for investment, we may allocate the undesignated portion or the entire amount, as applicable, into the Sentinel VPT Money Market Subaccount. You may at any time after the deposit direct us to redeem or exchange units in the Sentinel VPT Money Market Subaccount, which will be completed at the next appropriate net asset value. All transactions will be subject to any applicable fees or charges. Transfers - --------- You may transfer the Contract Value among the Subaccounts of the Variable Account and among the Variable Account, the Fixed Account (subject to the limitations set forth below) and the Guaranteed Accounts by making a written transfer request. If you elect the telephone transaction privilege, you may make transfers by telephone. See "Telephone Transaction Privilege," below. Transfers are made as of the Valuation Day that the request for transfer is received at the Home Office. Please remember that a Valuation Day ends at the close of regular trading of the New York Stock Exchange, currently 4:00 p.m. Eastern Time. Transfers to or from the Subaccounts may be postponed under certain circumstances. See "Payments," below. A market value adjustment will be applied to transfers out of a Guaranteed Account prior to its termination date; see "The Guaranteed Accounts," below. We currently allow transfers to the Fixed Account and the Guaranteed Accounts of all or any part of the Variable Account Contract Value, without charge or penalty. We reserve the right to restrict transfers to the Fixed Account and/or the Guaranteed Accounts to 25% of the Variable Account Contract Value during any Contract Year. For Contracts issued in Massachusetts only, we will enforce the above restrictions on your ability to move Contract Value into the Fixed Account and the Guaranteed Accounts only when the yield on investment would not support the statutory minimum interest rate. In addition, we will enforce these restrictions only in a manner that would not be unfairly discriminatory. You may, (only one each year and within 45 days after the end of the calendar year) transfer a portion of the unloaned value in the Fixed Account to the Variable Account. Prior to the end of the calendar year, we determine the maximum percentage that may be transferred from the Fixed Account. This percentage will be at least 10% of the Contract Value in the Fixed Account (25% in New York). After a transfer from the Fixed Account to the Variable Account or a Guaranteed Account, we reserve the right to require that the value transferred remain in the Variable Account or the Guaranteed Account for at least one year before it may be transferred back to the Fixed Account. We will allow Owners electing Illuminations for the first time to transfer value from the Fixed Account outside of the normally permitted transfer window of 45 days after the end of the calendar year. Unless otherwise restricted, all or a portion of value in the Fixed Account may be transferred upon the initial election of Illuminations. Once this one-time initial transfer is effected, no other transfer from the Fixed Account will be permitted outside of the normal 45-day transfer window. -27- For Contracts issued after July 1, 2004, where this provision has been approved by your state insurance regulator, if you transfer Contract Value out of any Guaranteed Account, you may not transfer Contract Value back into any Guaranteed Account until one year has elapsed from the time of the transfer out of a Guaranteed Account. We do not permit transfers between the Variable Account and the Fixed Account after the Annuitization Date. We have no current intention to impose a transfer charge in the foreseeable future. However, we reserve the right, upon prior notice, to impose a transfer charge of $25 for each transfer in excess of twelve transfers in any one Contract Year. We may do this if the expense of administering transfers becomes burdensome. See "Transfer Charge," below. If your Contract is in the Illuminations program described under "Optional 'Illuminations' Investment Advisory Service", below, you will be allowed to implement fund transfers. Please note, however, if you implement fund transfers, your allocations will depart from the FundQuest recommendations, and, if you keep the Contract in the Illuminations program, your transfers will end up being reversed by the next semi-annual rebalancing within the program. Disruptive Trading Policy. The Contracts are intended for long-term investment by Owners. They were not designed for the use of market timers or other investors who make programmed, large, frequent, or short-term transfers. Market timing and other programmed, large, frequent, or short-term transfers among the Subaccounts or between the Subaccounts and the Fixed Account or the Guaranteed Account can cause risks with adverse effects for other Owners (and beneficiaries and Funds). These risks include: o the dilution of interests of long-term investors in a if purchases or transfers into or out of a Fund are made at prices that do not reflect an accurate value for the Fund's investments; o an adverse effect on portfolio management, such as impeding a portfolio manager's ability to sustain an investment objective, causing a Fund to maintain a higher level of cash than would otherwise be the case, or causing a Fund to liquidate investments prematurely (or at an otherwise inopportune time) to pay withdrawals or transfers out of the Fund; and o increased brokerage and administrative expenses. The risks and costs are borne by all Owners invested in those Subaccounts, not just those making the transfers. We have developed policies and procedures with respect to market timing and other transfers (the "Procedures") and we do not make special arrangements or grant exceptions to accommodate market timing or other potentially disruptive or harmful trading. Do not invest in this Contract if you intend to conduct market timing or other potentially disruptive trading. Detection. We employ various means to attempt to detect and deter market timing and disruptive trading. However, despite our monitoring, we may not be able to detect or stop all harmful trading. In addition, because other insurance companies (and retirement plans) with different policies and procedures may invest in the Funds, we cannot guarantee that all harmful trading will be detected or that a Fund will not suffer harm from programmed, large, frequent, or short-term transfers among the Subaccounts of variable products issued by these companies or retirement plans. Deterrence. Once an Owner has been identified as a "market timer" under the Procedures, we notify the Owner that we will not accept instructions for such market timing or other similar programmed, large, frequent or short-term transfers in the future. We also will mark the Contract on our administrative system so that the system will have to be overridden by the Variable Products services staff to process any transfers. We will only permit the Owner to make transfers when we believe the Owner is not "market timing." -28- In our sole discretion, we may revise the Procedures at any time, without prior notice, as necessary to (i) better detect and deter frequent, large, or short-term transfers that may adversely affect other Owners or Fund shareholders, (ii) comply with state or federal regulatory requirements, or (iii) impose additional or alternate restrictions on market timers (such as dollars or percentage limits on transfers). We also reserve the right, to the extent permitted or required by applicable law, to (1) implement and administer redemption fees imposed by one or more Funds in the future, (2) deduct redemption fees imposed by the Funds, and (3) suspend the transfer privilege at any time we are unable to purchase or redeem shares of the Funds. We currently do not impose redemption fees on transfers. Further, for transfers between or among the Subaccounts, we currently do not expressly allow a certain number of transfers in a given period or limit the size of transfers in a given period. Redemption fees, transfer limits, and other procedures or restrictions may be more or less successful than our Procedures in deterring market timing or other disruptive trading and in preventing or limiting harm from such trading. Our ability to detect and deter such transfer activity is limited by our operational and technological systems, as well as by our ability to predict strategies employed by Owners (or those acting on their behalf) to avoid detection. Accordingly, despite our best efforts, we cannot guarantee that the Procedures will detect or deter frequent or harmful transfers by such Owners or intermediaries acting on their behalf. We apply the Procedures consistently to all Owners without waiver or exception. Fund Frequent Trading Policies. The Funds may have adopted their own policies and procedures with respect to frequent purchases and redemptions of their respective shares. The prospectuses for the Funds describe any such policies and procedures. The frequent trading policies and procedures of a Fund may be different, and more or less restrictive, than the frequent trading policies and procedures of other Funds and the policies and procedures we have adopted to discourage market timing and other programmed, large, frequent, or short-term transfers. You should be aware that we may not have the operational capacity to apply the frequent trading policies and procedures of the respective Funds that would be affected by the transfers. Accordingly, Owners and other persons who have material rights under the Contracts should assume that the sole protections they may have against potential harm from frequent transfers are the protections, if any, provided by the Procedures. Omnibus Orders. Owners and other persons with material rights under the Contracts also should be aware that the purchase and redemption orders received by the Funds generally are "omnibus" orders from intermediaries such as retirement plans and separate accounts funding variable insurance contracts. The omnibus orders reflect the aggregation and netting of multiple orders from individual owners of variable insurance contracts and individual retirement plan participants. The omnibus nature of these orders may limit each Fund's ability to apply its respective frequent trading policies and procedures. We cannot guarantee that the Fund will not be harmed by transfer activity relating to the retirement plans or other insurance companies that may invest in the Funds. These other insurance companies are responsible for their own policies and procedures regarding frequent transfer activity. If their policies and procedures fail to successfully discourage harmful transfer activity, it will affect other owners of Fund shares, as well as the owners of all of the variable annuity or variable life insurance policies whose variable investment options correspond to the affected Funds. In addition, if a Fund believes that an omnibus order we submit may reflect one or more transfer requests from Owners engaged in market timing and other programmed, large, frequent, or short-term transfers, the Fund may reject the entire omnibus order and thereby delay or prevent us from implementing your request. As a result of our discretion to permit Owners previously identified as "market timers" to make transfers that we do not believe involve "market timing," and as a result of operational and technological limitations, differing fund procedures, and the omnibus nature of purchase and redemption orders, some Owners may still be able to engage in market timing, while other Owners bear any adverse effects of that market timing activity. To the extent we are unable to detect and deter market timing or other similar programmed, large, frequent, or short-term transfers, the performance of the Subaccount and the Fund could be adversely affected, including by (1) requiring the Fund to maintain larger amounts of cash or cash-type securities than the Fund's manager might otherwise choose to maintain or to liquidate portfolio holdings at disadvantageous times, thereby increasing brokerage, administrative, and other expenses and (2) diluting returns to long-term shareholders. -29- Value of a Variable Account Accumulation Unit - --------------------------------------------- We set the value of a Variable Account Accumulation Unit for each Subaccount at $10 when the Subaccounts commenced operations. We determine the value for any subsequent Valuation Period by multiplying the value of an Accumulation Unit for each Subaccount for the immediately preceding Valuation Period by the Net Investment Factor for the Subaccount during the subsequent Valuation Period. The value of an Accumulation Unit may increase or decrease from Valuation Period to Valuation Period. No minimum value of an Accumulation Unit is guaranteed. The number of Accumulation Units will not change as a result of investment experience. Net Investment Factor. Each Subaccount of the Variable Account has its own Net Investment Factor. o The Net Investment Factor measures the daily investment performance of that Subaccount. o The Net Investment Factor may be greater or less than one; therefore, the value of an Accumulation Unit may increase or decrease. o Changes in the Net Investment Factor may not be directly proportional to changes in the net asset value of Fund shares, because of the deduction for the Mortality and Expense Risk Charge and Administration Charge. Fund shares are valued at their net asset value. The Net Investment Factor allows for the monthly reinvestment of daily dividends that are credited by some Funds (the Sentinel Variable Products Money Market Portfolio). Determining the Contract Value. The Contract Value is the sum of: 1) the value of all Variable Account Accumulation Units, plus 2) amounts allocated and credited to the Fixed Account, plus 3) amounts allocated and credited to a Guaranteed Account, minus 4) any outstanding loans on the Contract and accrued interest on such loans. When charges or deductions are made against the Contract Value, we deduct an appropriate number of Accumulation Units from the Subaccounts and an appropriate amount from the Fixed Account in the same proportion that the your interest in the Subaccounts and the unloaned value in the Fixed Account bears to the total Contract Value. We will not deduct charges or deductions from a Guaranteed Account unless there is not sufficient Contract Value in the Subaccounts of the Variable Account and in the Fixed Account. If we need to deduct charges or deductions from the Guaranteed Accounts, we will do so pro rata from all Guaranteed Accounts, and within Guaranteed Accounts of the same duration, on a first-in-first-out basis; that is, the Contract Value with the earliest date of deposit will be deducted first. Value held in the Fixed Account and the Guaranteed Accounts is not subject to Variable Account charges (Mortality and Expense Risk and Administration Charges), but may be subject to Contingent Deferred Sales Charges, the Annual Contract Fee, optional Enhanced Death Benefit Rider charge, and premium taxes, if applicable. Annuitization - ------------- Maturity Date. The Maturity Date is the date on which annuity payments are scheduled to begin. You may indicate the Maturity Date on the application. The earliest Maturity Date must be at least 2 years after the Date of Issue, unless otherwise approved (10 years after the Date of Issue in the States of Oregon and Massachusetts). If no specific Maturity Date is selected, the Maturity Date will be your 90th birthday, the 90th birthday of the oldest of Joint Owners, or the Annuitant's 90th birthday if the Owner is not a natural person; or, if later, 10 years after the Date of Issue. You may elect a single payment equal to the Cash Surrender Value on the Maturity Date, rather than annuity payments. You may also settle the contract under a Payment Option prior to the scheduled maturity date. You may contact either your Registered Representative or the Home Office for requirements to settle the contract. -30- If you request in writing (see "Ownership Provisions," below), and we approve the request, the Maturity Date may be accelerated or deferred. However, we will not permit an acceleration of a Contract's Maturity Date to any date before the 30 day window prior to the termination date of any Guaranteed Account held by the Contract. If an Owner of such a Contract desires to accelerate that Contract's Maturity Date, the Owner must first transfer the Contract Value in all Guaranteed Accounts the termination dates of which would occur more than 30 days after the accelerated Maturity Date into the Fixed Account or the Variable Account. A market value adjustment will be applied to such Contract Value transferred out of the Guaranteed Accounts. See "The Guaranteed Accounts," below. Election of Payment Options. You may, with prior written notice and, at any time prior to the Annuitization Date, elect one of the Annuity Payment Options. We apply the Contract Value in each Subaccount (less any premium tax previously unpaid) to provide a Variable Annuity payment. We apply the Contract Value in the Fixed Account (less any premium tax previously unpaid) to provide a Fixed Annuity payment. If an election of an Annuity Payment Option is not on file with National Life on the Annuitization Date, we will pay the proceeds as Option 3 - Payments for Life with 120 months certain. You may elect, revoke or change an Annuity Payment Option at any time before the Annuitization Date with 30 days prior written notice. The Annuity Payment Options available are described below. Frequency and Amount of Annuity Payments. The amount of your annuity payment depends in part on the frequency and duration of annuity payments. If you would like the amount of your annuity payments to be as large as possible, you should select an option that pays less frequently and for a shorter duration. On the other hand, if it is important for you to receive annuity payments as often and for as long a time period as possible, you should select an annuity payment option that pays more frequently and for a longer period of time. Please note that, in general, the more frequent or the longer the duration is for annuity payments, the smaller the amount that each annuity payment will be. We pay annuity payments as monthly installments, unless you select annual, semi-annual or quarterly installments. If the amount to be applied under any Annuity Payment Option is less than $3,500, we have the right to pay such amount in one lump sum in lieu of the payments otherwise selected. In addition, if the payments selected would be or become less than $100, we have the right to change the frequency of payments that will result in payments of at least $100. In no event will we make payments under an annuity option less frequently than annually. Annuitization - Variable Account - -------------------------------- We will determine the dollar amount of the first Variable Annuity payment by dividing the Variable Account Contract Value on the Annuitization Date by 1,000 and applying the result as set forth in the applicable Annuity Table. The amount of each Variable Annuity payment depends on the age of the Chosen Human Being on his or her birthday nearest the Annuitization Date, and the sex of the Chosen Human Being, if applicable, unless otherwise required by law. o Variable Annuity payments vary in amount in accordance with the investment performance of the Variable Account; o To establish the number of Annuity Units representing each monthly annuity payment, o the dollar amount of the first annuity payment as determined above is divided by the value of an Annuity Unit on the Annuitization Date; o The number of Annuity Units remains fixed during the annuity payment period; o The dollar amount of the second and subsequent payments is not predetermined and may change from payment to payment; and o The dollar amount of each subsequent payment is determined by multiplying the fixed number of Annuity Units by the value of an Annuity Unit for the Valuation Period in which the payment is due. Once payments have begun, future payments will not reflect any changes in mortality experience. -31- Value of an Annuity Unit. The value of an Annuity Unit for a Subaccount is set at $10 when the first Fund shares are purchased. The value of an Annuity Unit for a Subaccount for any subsequent Valuation Period is determined by multiplying the value of an Annuity Unit for the immediately preceding Valuation Period by the applicable Net Investment Factor for the Valuation Period for which the value of an Annuity Unit is being calculated and multiplying the result by an interest factor to neutralize the assumed investment rate of 3.5% per annum (see "Net Investment Factor," above). Assumed Investment Rate. A 3.5% Assumed Investment Rate is built into the Annuity Tables contained in the Contracts. We may make assumed investment rates available at rates other than 3.5%. A higher assumption would mean a higher initial payment but more slowly rising or more rapidly falling subsequent payments. A lower assumption would have the opposite effect. If the actual investment return, as measured by the Net Investment Factor, is at a constant annual rate of 3.5%, the annuity payments will be level. Annuitization - Fixed Account - ----------------------------- A Fixed Annuity is an annuity with payments which are guaranteed as to dollar amount during the annuity payment period. We determine the amount of the periodic Fixed Annuity payments by applying the Fixed Account Contract Value to the applicable Annuity Table in accordance with the Annuity Payment Option elected. This is done at the Annuitization Date using the age of the Chosen Human Being on his or her nearest birthday, and the sex of the Chosen Human Being, if applicable. The applicable Annuity Table will be based on our expectation of investment earnings, expenses and mortality (if payments depend on whether the Chosen Human Being is alive) on the Annuitization Date. The applicable Annuity Table will provide a periodic Fixed Annuity payment at least as great as the guarantee described in your Contract. We do not credit discretionary interest to Fixed Annuity payments during the annuity payment period for annuity options based on life contingencies. The Annuitant must rely on the Annuity Tables applicable to the Contracts to determine the amount of Fixed Annuity payments. Annuity Payment Options - ----------------------- Any of the following Annuity Payment Options may be elected: Option 1-Payments for a Stated Time. We will make monthly payments for the number of years selected, which may range from 5 years to 30 years. Option 2-Payments for Life. An annuity payable monthly during the lifetime of a Chosen Human Being (who may be named at the time of election of the Payment Option), ceasing with the last payment due prior to the death of the Chosen Human Being. It would be possible under this option for the payee to receive only one annuity payment if the annuitant dies before the second annuity payment date, two annuity payments if the Annuitant dies before the third annuity payment date, and so on. Option 3-Payments for Life with Period Certain-Guaranteed. An annuity that if at the death of the Chosen Human Being payments have been made for less than 10 or 20 years, as selected, we guarantee to continue annuity payments during the remainder of the selected period. We may allow other Annuity Payment Options, including, if applicable, the Stretch Annuity Payment Option described below. Some of the stated Annuity Payment Options may not be available in all states. You may request an alternative non-guaranteed option by giving notice in writing prior to Annuitization. If a request is approved by us, it will be permitted under the Contract. Qualified Contracts (except Roth IRA's before the Owner's death) are subject to the minimum distribution requirements set forth in the Code. Payment Option 1 may not satisfy these requirements. Please consult a tax advisor. Under Payment Option 1, you may change to any other Payment Option at any time. At the time of the change, remaining value will be applied to the new Payment Option to determine the amount of the new payments. Under Payment Option 1, you may also fully surrender the Contract at any time. Upon surrender in this situation, the Owner will receive the remaining value of the Contract, which is the value of the Contract used to determine the most recent payment amount, adjusted for investment performance through the date of surrender. A surrender is subject to any applicable Contingent Deferred Sales Charge at the time of the surrender. -32- Stretch Annuity Payment Option - ------------------------------ We offer the Stretch Annuity Payment Option to Contracts which have paid Net Premium Payments, less any Withdrawals (including the impact of any CDSC associated with such Withdrawals), of at least $25,000 per beneficiary participating in the payment option. Under this payment option, we will make annual payments for a period determined by the joint life expectancy of an initial payee and a beneficiary, as calculated based on Table VI of Section 1.72-9 of the Income Tax Regulations (but if the Contract is a Qualified Contract, no less than the minimum required distribution under the Code). The beneficiary may be a much younger person than the initial payee, such as a grandchild, so that under this payment option, payments may be made over a lengthy period of years. Please consult your authorized National Life representative for more information on the Stretch Annuity Payment Option. You should consult your tax advisor about potential income, gift, estate and generation-skipping transfer tax consequences of electing the Stretch Annuity Payment Option. Death of Owner - -------------- If you or a Joint Owner dies prior to the Annuitization Date, then we will pay (unless the Enhanced Death Benefit Rider has been elected) a Death Benefit to the Beneficiary. The Contract provides that if you or a Joint Owner dies prior to the Contract Anniversary on which your age, on an age on nearest birthday basis, is 81, the Death Benefit will be equal to the greater of: (a) the Contract Value, or (b) the Net Premium Payments made to the Contract, minus all Withdrawals (including any CDSC deducted in connection with such Withdrawals), and minus any outstanding loans on the Contract and accrued interest, and adjusted such that if you effect a Withdrawal (including a systematic Withdrawal) at a time when the Contract Value is less than the amount of the Death Benefit that would then be payable to you, the Death Benefit will be reduced by the same proportion that the Withdrawal reduces the Contract Value (this adjustment will have the effect of reducing the Death Benefit by more than the amount of the Withdrawal, where a Withdrawal is taken at a time when the Death Benefit is greater than the Contract Value), and (c) in each case minus any applicable premium tax charge to be assessed upon distribution. For Contracts issued prior to November 1, 2003 only, or if your state approved the adjustment referred to in (b) above for cases where a Withdrawal is taken at a time when the Death Benefit is greater than the Contract Value after that date, or has not yet approved that adjustment, that adjustment will not be made. In the case of these Contracts, a Withdrawal will reduce the Death Benefit only by the amount of the Withdrawal. The Contract further provides that if you die after the Contract Anniversary on which your age, on an age nearest birthday basis, is 81 (or in the case of Joint Owners, where the first of Joint Owners to die dies after the Contract Anniversary on which the age of the oldest Joint Owner, on an age on nearest birthday basis, is 81), then the Death Benefit shall be equal to the Contract Value, minus any applicable premium tax charge. -33- For Contracts issued prior to November 1, 2003 only, we are currently providing a Death Benefit that is equal to the greater of (a) or (b) above even if you die after the Contract Anniversary on which your age, on an age nearest birthday basis, is 81, as long as your age, on an age on nearest birthday basis, was less than 81 on the Date of Issue of the Contract. We currently intend to pay this Death Benefit even though its terms are more favorable to you than what is guaranteed in the Contract. We will notify you if we discontinue this Death Benefit. Unless the Beneficiary is the deceased Owner's (or Joint Owner's) spouse, the Death Benefit must be distributed within five years of such Owner's death. The Beneficiary may elect to receive Distribution in the form of a life annuity or an annuity for a period not exceeding his or her life expectancy. Such annuity must begin within one year following the date of the Owner's death and is currently available only as a Fixed Annuity. If the Beneficiary is the spouse of the deceased Owner (or, if applicable, a Joint Owner), then the Contract may be continued without any required Distribution. If the deceased Owner (or Joint Owner) and the Annuitant are the same person, the death of that person will be treated as the death of the Owner for purposes of determining the Death Benefit payable. Qualified Contracts may be subject to specific rules set forth in the Plan, Contract, or Code concerning Distributions upon the death of the Owner. Death of Annuitant Prior to the Annuitization Date - -------------------------------------------------- If an Annuitant who is not an Owner dies prior to the Annuitization Date, a Death Benefit equal to the Cash Surrender Value of the Contract will be payable to the Beneficiary. If the Owner is a natural person and a contingent Annuitant has been named or the Owner names a contingent Annuitant within 90 days of the Annuitant's death, the Contract may be continued without any required Distribution. If no Beneficiary is named (or if the Beneficiary predeceases the Annuitant), then the Death Benefit will be paid to the Owner. If the Owner is not a natural person, then the death of the Annuitant will be treated as if it were the death of the Owner, and the disposition of the Contract will follow the death of the Owner provisions set forth above. In any case where a Death Benefit is paid, the value of the Death Benefit will be determined as of the Valuation Day coinciding with or next following the date we receive at our home office in writing: o due proof of the Annuitant's or an Owner's (or Joint Owner's) death; o an election for either a single sum payment or an Annuity Payment Option (currently only Fixed Annuities are available in these circumstances); and o any form required by state insurance laws. If a single sum payment is requested, we will make payment in accordance with any applicable laws and regulations governing the payment of Death Benefits. If an Annuity Payment Option is requested, the Beneficiary must make an election during the 90-day period commencing with the date we receive written notice and as otherwise required by law. If no election has been made by the end of such 90-day period commencing with the date we receive written notice or as otherwise required by law the Death Benefit will be paid in a single sum payment. Generation-Skipping Transfers - ----------------------------- We may determine whether the Death Benefit or any other payment constitutes a direct skip as defined in Section 2612 of the Code, and the amount of the tax on the generation-skipping transfer resulting from such direct skip. If applicable, the payment will be reduced by any tax National Life is required to pay by Section 2603 of the Code. A direct skip may occur when property is transferred to or a Death Benefit is paid to an individual two or more generations younger than the Owner. -34- Ownership Provisions - -------------------- Unless otherwise provided, the Owner has all rights under the Contract. If the purchaser names someone other than himself or herself as owner, the purchaser will have no rights under the contract. If Joint Owners are named, each Joint Owner possesses an undivided interest in the Contract. The death of any Joint Owner triggers the provisions of the Contract relating to the death of the Owner. Unless otherwise provided, when Joint Owners are named, the exercise of any ownership right in the Contract (including the right to surrender the Contract or make a Withdrawal, to change the Owner, the Annuitant, a Contingent Annuitant, the Beneficiary, the Annuity Payment Option or the Maturity Date) requires a written indication of an intent to exercise that right, signed by all Joint Owners. Prior to the Annuitization Date, the Owner may name a new Owner. Such change may be subject to state and federal gift taxes, and may also result in current federal income taxation (see "Federal Income Tax Considerations," below). Any change of Owner will automatically revoke any prior Owner designation. Any request for change of Owner must be (1) made by proper written application, (2) received and recorded by National Life at its Home Office, and (3) may include a signature guarantee as specified in the "Surrender and Withdrawal" provision below. The change is effective on the date the written request is signed. A new choice of Owner will not apply to any payment made or action we take prior to the time it was received and recorded. The Owner may request a change in the Annuitant or contingent Annuitant before the Annuitization Date. Such a request must be made in writing on a form acceptable to us and must be signed by the Owner, and the person to be named as Annuitant or contingent Annuitant. Any such change is subject to underwriting and approval by us. CHARGES AND DEDUCTIONS All of the charges described in this section apply to Variable Account allocations. Allocations to the Fixed Account are subject to Contingent Deferred Sales Charges, the Annual Contract Fee and Premium Tax deductions and the charge for the Enhanced Death Benefit Rider, if applicable. The Fixed Account and the Guaranteed Accounts are not subject to the Mortality and Expense Risk Charge and the Administration Charge. We deduct the charges described below to cover our costs and expenses, services provided and risks assumed under the Contracts. We incur certain costs and expenses for the distribution and administration of the Contracts and for providing the benefits payable thereunder. More particularly, the administrative services include: o processing applications for and issuing the Contracts; o processing purchases and redemptions of Fund shares as required (including automatic withdrawal services); o maintaining records; o administering annuity payouts; o furnishing accounting and valuation services (including the calculation and monitoring of daily Subaccount values); o reconciling and depositing cash receipts; o providing Contract confirmations; o providing toll-free inquiry services; and o furnishing telephone transaction privileges. -35- The risks we assume include: o the risk that the actual life-span of persons receiving annuity payments under Contract guarantees will exceed the assumptions reflected in our guaranteed rates (these rates are incorporated in the Contract and cannot be changed); o the risk that Death Benefits, or the Enhanced Death Benefit under the optional Enhanced Death Benefit Rider, will exceed the actual Contract Value; o the risk that more Owners than expected will qualify for and exercise waivers of the Contingent Deferred Sales Charge; and o the risk that our costs in providing the services will exceed our revenues from the Contract charges (which we cannot change). The amount of a charge will not necessarily correspond to the costs associated with providing the services or benefits indicated by the designation of the charge. For example, the Contingent Deferred Sales Charge collected may not fully cover all of the distribution expenses we incur. We may also realize a profit on one or more of these charges. We may use any profits for any corporate purpose, including sales expenses. Deductions from the Variable Account - ------------------------------------ We deduct from the Variable Account an amount, computed daily, which is equal to an annual rate of 1.40% of the daily net asset value. The charge consists of a 0.15% Administration Charge and a 1.25% Mortality and Expense Risk Charge. Contingent Deferred Sales Charge - -------------------------------- We may pay a commission up to 6.5% (up to 7.0% during certain promotional periods) for the sale of a Contract; however, we make no deduction for a sales charge from the Premium Payments for these Contracts. However, if a Withdrawal is made or a Contract is surrendered, we will with certain exceptions, deduct a Contingent Deferred Sales Charge ("CDSC"). The CDSC is calculated by multiplying the applicable CDSC percentages noted below by the Net Premium Payments that are withdrawn or surrendered. For purposes of calculating the CDSC Withdrawals or surrenders are considered to come first from the oldest Net Premium Payment made to the Contract, then the next oldest Net Premium Payment and so forth, and last from earnings on Net Premium Payments. No CDSC is ever assessed with respect to a Withdrawal or surrender of earnings on Net Premium Payments. For tax purposes, a surrender is usually treated as a withdrawal of earnings first. This charge will apply in the amounts set forth below to Net Premium Payments within the time periods set forth. The CDSC applies to Net Premium Payments as follows:
Number of Completed Contingent Deferred Number of Completed Contingent Deferred Years from Date of Sales Charge Years from Date of Sales Charge Net Premium Payment Percentage Net Premium Payment Percentage 0 7% 4 3% 1 6% 5 2% 2 5% 6 1% 3 4% 7 0%
In any Contract Year after the first Contract Year (except in the states referred to in the last sentence of this paragraph), you may make Withdrawals without a CDSC of an aggregate amount equal to 15% of the Contract Value as of the most recent Contract Anniversary. This CDSC-free Withdrawal privilege does not apply to full surrenders of the Contract, and if a full surrender is made within one year of exercising a CDSC-free Withdrawal, then the CDSC which would have been assessed at the time of the Withdrawal will be assessed at the time of surrender. The CDSC-free feature is also non-cumulative. This means that free amounts not taken during any given Contract Year cannot be taken as free amounts in a subsequent Contract Year. In addition, any amount withdrawn in order to meet minimum Distribution requirements under the Code shall be free of CDSC. -36- In the first Contract Year a CDSC-free Withdrawal is available in an amount not exceeding 1/12th of 15% (10% in New Jersey and Washington) of each Premium Payment for each completed month since each Premium Payment. Two ways to access these CSDC-free amounts in the first Contract Year are by setting up a monthly systematic Withdrawal program for an amount not exceeding the annual CDSC-free Withdrawal amount (see "Available Automated Fund Management Features-Systematic Withdrawals," below), or by making a Withdrawal which is part of a series of substantially equal periodic payments over the life of the Owner or the joint lives of the Owner and his or her spouse, to which section 72(t)(2)(A)(iv) of the Code applies. Regardless of the method of Withdrawal, systematic or otherwise, at no point in the first Contract Year will total CDSC-free Withdrawals be available in an amount that exceeds 1/12th of 15% of each premium payment times the number of completed months since each premium payment. You may be subject to a tax penalty if you take Withdrawals prior to age 59 1/2 (see "Federal Income Tax Considerations," below). In New Jersey and Washington, the CDSC-free provision will apply to full surrenders and Withdrawals but will be limited to 10% of the Contract Value as of the most recent Contract Anniversary for both Withdrawals and full surrenders. In addition, no CDSC will be deducted: o upon the Annuitization of Contracts, o upon payment of a death benefit pursuant to the death of the Owner, or o from any values which have been held under a Contract for at least 84 months. No CDSC applies upon the transfer of value among the Subaccounts or between the Fixed Account or a Guaranteed Account and the Variable Account; however, a Market Value Adjustment may apply to transfers out of a Guaranteed Account before the termination date of such account. When a Contract is held by a charitable remainder trust, the amount which may be withdrawn from this Contract without application of a CDSC after the first Contract Year, shall be the larger of (a) or (b), where (a) is the amount which would otherwise be available for Withdrawal without application of a CDSC; and where (b) is the difference between the Contract Value as of the last Contract Anniversary and the Net Premium Payments made to the Contract, less all Withdrawals and less any outstanding loan and accrued interest, as of the last Contract Anniversary. We will waive the CDSC if the Owner dies or if the Owner annuitizes. However, if the Owner elects a settlement under Payment Option 1, and subsequently surrenders the Contract prior to seven years after the date of the last Premium Payment, the surrender will be subject to a CDSC. We will also waive the CDSC if, following the first Contract Anniversary, you are confined to an eligible nursing home for at least the 90 consecutive days ending on the date of the Withdrawal request. This waiver is not available in the States of New Jersey and New York. Annual Contract Fee - ------------------- For Contracts with a Contract Value of less than $50,000 as of any Contract Anniversary prior to the Annuitization Date, we will assess an Annual Contract Fee of $30.00. This fee will be assessed annually on each Contract Anniversary on which the Contract Value is less than $50,000. No Annual Contract Fee will be assessed after the Annuitization Date. This fee will be taken pro rata from all Subaccounts of the Variable Account and the unloaned portion of the Fixed Account. -37- Transfer Charge - --------------- Currently, unlimited free transfers are permitted among the Subaccounts and the Guaranteed Accounts, and transfers among the Fixed Account, the Variable Account and the Guaranteed Accounts are permitted free of charge within the limits described above under "Transfers" (however, a market value adjustment will be applied to any transfer out of a Guaranteed Account prior to its termination date; see "The Guaranteed Accounts," below). We have no present intention to impose a transfer charge in the foreseeable future. However, we reserve the right to impose in the future a transfer charge of $25 on each transfer in excess of twelve transfers in any Contract Year. We may do this if the expense of administering transfers becomes burdensome. We would not anticipate making a profit on any future transfer charge. If we impose a transfer charge, we will deduct it from the amount being transferred. All transfers requested on the same Valuation Day are treated as one transfer transaction. Any future transfer charge will not apply to transfers made pursuant to the Dollar Cost Averaging and Portfolio Rebalancing features, transfers resulting from loans, or if there has been a material change in the investment policy of the Fund from which the transfer is being made. These transfers will not count against the twelve free transfers in any Contract Year. Premium Taxes - ------------- If a governmental entity imposes premium taxes, we make a deduction for premium taxes in a corresponding amount. Certain states impose a premium tax, currently ranging up to 3.5%. We will pay premium taxes at the time imposed under applicable law. Where we are required to pay this premium tax, we may deduct an amount equal to premium taxes from the Premium Payment. We currently intend to make this deduction from Premium Payments only in South Dakota. In the remaining states which assess premium taxes, we currently expect to make deductions for premium taxes at the time of Annuitization, death of the Owner, or surrender, although we also reserve the right to make such a deduction at the time we pay premium taxes to the applicable taxing authority. Charge for Optional Enhanced Death Benefit Rider - ------------------------------------------------ Annual charges are made if you elect the optional Enhanced Death Benefit Rider. See "Optional Enhanced Death Benefit Rider," below. The annual charge for the Enhanced Death Benefit Rider is 0.20% of Contract Value as of the date the charge is deducted. The annual charge will be deducted at issue (or at the time of election, if elected after issue), and then on each Contract Anniversary thereafter, up to and including the Contract Anniversary on which you are age 80 on an age on nearest birthday basis. After such Contract Anniversary, we will discontinue the charge. We will make the charge pro rata from the Subaccounts of the Variable Account and the unloaned portion of the Fixed Account. Other Charges - ------------- The Variable Account purchases shares of the Funds at net asset value. The net asset value of those shares reflect management fees and expenses already deducted from the assets of the Funds. Information on the fees and expenses for the Funds is set forth in "Underlying Fund Annual Expenses" above. More detailed information is contained in the Funds' prospectuses which accompany this prospectus. We sell the Contracts through registered representatives of broker-dealers. These registered representatives are also appointed and licensed as insurance agents of ours. We pay commissions to the broker-dealers for selling the Contracts. You do not pay directly these commissions. We do. We intend to recoup commissions and other sales expenses through fees and charges imposed under the Contracts. (See "Distribution of Contracts", below). -38- CONTRACT RIGHTS AND PRIVILEGES Free Look - --------- You may revoke the Contract at any time between the Date of Issue and the date 10 days after receipt of the Contract and receive a refund of the Contract Value plus any charges assessed at issue, including the Annual Contract Fee, charge for the optional Enhanced Death Benefit Rider, and any premium tax, unless otherwise required by state and/or federal law. Some states may require a longer free look period. Where the Contract Value is refunded, you will have borne the investment risk and been entitled to the benefit of the investment performance of the chosen Subaccounts during the time the Contract was in force. In the case of IRA's and states that require the return of Premium Payments, you may revoke the Contract during the free look period and we will refund Premium Payments. In order to revoke the Contract, it must be mailed or delivered to our Home Office. Mailing or delivery must occur on or before 10 days after receipt of the Contract for revocation to be effective. In order to revoke the Contract, if it has not been received, written notice must be mailed or delivered to the Home Office. The liability of the Variable Account under this provision is limited to the Contract Value in each Subaccount on the date of revocation. Any additional amounts refunded to you will be paid by us. Loan Privilege - Tax Sheltered Annuities - ---------------------------------------- Subject to approval in your state, if you own a section 403(b) Tax-Sheltered Annuity Contract, loans will be available on your Contract. Loans will be subject to the terms of the Contract and the Code. If a loan provision is included in your Tax-Sheltered Annuity Contract, loans will be available anytime prior to the Annuitization Date. We may limit the number of loans available on a single contract. You will be able to borrow a minimum of $1500 (we may permit lower amounts). The maximum loan balance which may be outstanding at any time on your Contract is 90% of the sum of Contract Value, outstanding loans and accrued interest on loans minus the CDSC that would apply if you surrendered your Contract (if you have Contract Value allocated to one or more Guaranteed Accounts, at the time you wish to take a loan, you must first transfer all such Contract Value out of those Guaranteed Accounts - see "The Guaranteed Accounts," below). In no event may the aggregate amount borrowed from all your Tax-Sheltered Annuities or other Qualified Contracts, including this Contract, exceed the lesser of: (a) 50% of the combined nonforfeitable account balances of all your Tax-Sheltered Annuities or other Qualified Contracts (or $10,000 if greater); or (b) $50,000. The $50,000 limit will be reduced by the excess (if any) of the highest loan balances owed during the prior one-year period over the loan balance on the date the loan is made. The highest loan balance owed during the prior one-year period may be more than the amount outstanding at the time of the loan, if an interest payment or principal repayment has been made. If you take a loan from your Contract, it will not be eligible for the Illuminations program described under "Optional `Illuminations' Investment Advisory Service," below, while the loan is outstanding. If your Contract is participating in the Illuminations program, then you would first have to terminate the Contract's participation in Illuminations before being able to take a loan. Loans may also not be taken if you have elected systematic withdrawals. All loans will be made from the Collateral Fixed Account. When a loan is taken an amount equal to the principal amount of the loan will be transferred to the Collateral Fixed Account. We will transfer to the Collateral Fixed Account an amount equaling the loan from the Subaccounts of the Variable Account and unloaned portion of the Fixed Account in the same proportion that such amounts bear to the total Contract Value. No CDSC is deducted at the time of the loan or on any transfers to the Collateral Fixed Account. Until the loan is repaid in full, that portion of the Collateral Fixed Account equal to the outstanding loan balance shall be credited with interest at an annual rate we declare from time to time, but will never be less than the minimum annual rate guaranteed for your Contract's Fixed Account. On each Contract Anniversary and on each date that a loan repayment is received, any amount of interest credited on the Collateral Fixed Account will be allocated among the Fixed Account and the Subaccounts of the Variable Account in accordance with the allocation of Net Premium Payments then in effect. -39- Loans must be repaid in substantially level payments, not less frequently than quarterly, within five years. Loans used to purchase your principal residence must be repaid within 20 years. During the loan term, the outstanding balance of the loan will continue to accrue interest at annual rates specified in the loan agreement or an amendment to the loan agreement. The maximum interest rate will be the greater of: o the Moody's Corporate Bond Yield Average - Monthly Average Corporates, as published by Moody's Investors Service, Inc., or its successor, (or if that average is no longer published, a substantially similar average), for the calendar month ending two months before the date the rate is determined; or o 4%. The loan interest rate is subject to change on each Contract Anniversary. If the loan interest rate changes, we will send you a notice of the new loan interest rate and new level payment amount. We must reduce the loan interest if on a Contract Anniversary the maximum loan interest rate is lower than the interest rate for the previous Contract Year by 0.50% or more. We may increase the loan interest rate if the maximum loan interest rate is at least 0.50% higher than the loan interest rate for the previous Contract Year. The loan interest rate we charge will be equal to or less than the maximum loan interest rate at the time it is determined, and will never be higher than 15%. Twenty days prior to the due date of each loan repayment, as set forth in the loan agreement or an amendment to the loan agreement, we will send you a notice of the amount due. Corresponding to the due date of each loan repayment, we will establish a "billing window" defined as the period beginning on the date that we mail the repayment notice (20 days prior to the payment due date) and extending 31 days after the due date. Loan repayments received within the billing window that are sufficient to satisfy the amount due will be applied to the Contract as interest and repayment of principal. The amounts of principal and interest set forth in the loan agreement or an amendment to the loan agreement, are the amounts if all loan repayments are made exactly on the due date. The actual amount of a repayment allocated to interest will be determined based on the actual date the repayment is received, the amount of the outstanding loan, and the number of days since the last repayment date. The amount of principal will be the repayment amount minus the interest. The loan principal repayment will, on the date it is received, be allocated among the Fixed Account and Subaccounts of the Variable Account in accordance with the allocation of Net Premium Payments then in effect. Loan repayments received outside of the billing window will be processed as a repayment of principal only. Only repayments received within the billing window may satisfy the amount due. If a payment received within the billing window is less than the amount due, it will be returned to you. If a loan repayment that is sufficient to satisfy the amount due is not made within the billing window, then the entire balance of the loan will be considered in default. This amount may be taxable to the borrower, and may be subject to the early withdrawal tax penalty. If you are not eligible to take a distribution pursuant to the Contract or plan provisions, the deemed distribution will be reportable for tax purposes, but will not be offset against the Contract Value until such time as a distribution may be made. On each Contract Anniversary, while a loan is in default, interest accrued on loans will be added to the outstanding loans. If you surrender your Contract while a loan is outstanding, you will receive the Cash Surrender Value, which is reduced to reflect the loan outstanding plus accrued interest. If the Owner/Annuitant dies while the loan is outstanding, the Death Benefit will also be reduced to reflect the amount of the loan outstanding plus accrued interest. If annuity payments start while the loan is outstanding, the Contract Value will be reduced by the amount of the outstanding loan plus accrued interest. Until the loan is repaid, we may restrict any transfer of the Contract which would otherwise qualify as a transfer as permitted in the Code. -40- Loans may also be subject to additional limitations or restrictions under the terms of the employer's plan. Loans permitted under this Contract may still be taxable in whole or part if the participant has additional loans from other plans or contracts. We will calculate the maximum nontaxable loan based on the information provided by the participant or the employer. In addition, if the section 403(b) Tax-Sheltered Annuity Contract is subject to the Employee Retirement Income Security Act of 1974 ("ERISA"), a loan will be treated as a "prohibited transaction" subject to certain penalties unless additional ERISA requirements are satisfied. You should seek competent legal advice before requesting a loan. We are not responsible for determining whether a loan meets the requirements of ERISA, including the requirement that a loan bear a reasonable rate of interest. If a loan is outstanding, all payments received from you will be considered loan repayments. Any payments received from your employer will be considered premium payments. We reserve the right to modify the terms or procedures associated with the loan privilege in the event of a change in the laws or regulations relating to the treatment of loans. We also reserve the right to assess a loan processing fee. IRA's, Non-Qualified Contracts and Qualified Contracts other than section 403(b) Tax-Sheltered Annuity Contracts are not eligible for loans. Surrender and Withdrawal - ------------------------ At any time prior to the Annuitization Date (or thereafter if Payment Option 1 has been elected) you may, upon proper written application deemed by us to be in good order, surrender the Contract. "Proper written application" means that you must request the surrender in writing. We may require that the signature(s) be guaranteed by a member firm of a major stock exchange or other depository institution qualified to give such a guaranty. We will, upon receipt of any such written request, pay to you the Cash Surrender Value. The Cash Surrender Value will reflect any applicable CDSC (see "Contingent Deferred Sales Charge," above), any outstanding loan and accrued interest, and, in certain states, a premium tax charge (see "Premium Taxes", above). The Cash Surrender Value may be more or less than the total of Premium Payments you made, depending on the market value of the underlying Fund shares, the amount of any applicable CDSC, and other factors. We will normally not permit Withdrawal or Surrender of Premium Payments made by check within the 15 calendar days prior to the date the request for Withdrawal or Surrender is received. At any time before the death of the Owner and before the Contract is annuitized, the Owner may make a Withdrawal of a portion of the Contract Value. The minimum Withdrawal is $500, except where the Withdrawal is a minimum distribution as required by certain Qualified contract rules or where the Withdrawal is part of an automated process of paying investment advisory fees to the Owner's investment advisor. At least $3,500 in Cash Surrender Value must remain after any Withdrawal. However, for Contracts issued prior to November 1, 2003 only (or a later date if your state approved this change after November 1, 2003), at least $3,500 in Contract Value must remain after any Withdrawal. Generally, Withdrawals in the first Contract Year and Withdrawals in excess of 15% (10% in New Jersey and Washington) of Contract Value as of the most recent Contract Anniversary in any Contract Year are subject to the CDSC. See "Contingent Deferred Sales Charge", above. However, in the first Contract Year, a CDSC-free Withdrawal is currently available in an amount not exceeding 1/12th of 15% (10% in New Jersey and Washington) of each premium payment for each completed month since each Premium Payment. For purposes of determining CDSC-free amounts in the first Contract Year only, all Premium Payments received prior to the first Monthly Contract Date will be considered to have been paid at the Date of Issue. One way to access these CDSC-free amounts in the first Contract Year is by setting up a monthly systematic Withdrawal program (see "Available Automated Fund Management Features-Systematic Withdrawals" below). Another limited way to make a Withdrawal in the first year without paying a CDSC is to make a Withdrawal which is part of a series of substantially equal periodic payments made for the life of the Owner or the joint lives of the Owner and his or her spouse, under section 72(t)(2)(a)(iv) of the Code. Regardless of the method of Withdrawal, systematic or otherwise, at no point in the first Contract Year will total CDSC-free Withdrawals be available in an amount that exceeds 1/12th of 15% of each premium payment times the number of completed months since each premium payment. Withdrawals will be deemed to be taken from Net Premium Payments in chronological order, with the oldest Net Premium Payment being withdrawn first. This method will tend to minimize the amount of the CDSC. -41- Withdrawals will be taken based on your instructions at the time of the Withdrawal. If you do not provide specific allocation instructions, or to the extent that Contract Value in the sources you specify are insufficient, the Withdrawal will be deducted pro rata from the Subaccounts and from the unloaned portion of the Fixed Account. The Withdrawal will not be taken from the Guaranteed Accounts unless there is not sufficient Contract Value in the Subaccounts of the Variable Account and the unloaned portion of the Fixed Account. If it is necessary to take the Withdrawal from the Guaranteed Accounts, it will be taken pro rata from all Guaranteed Accounts in which there is Contract Value, and within each Guaranteed Account duration, on a first-in-first-out basis. To the extent a Withdrawal is taken from a Guaranteed Account, a market value adjustment will be applied (see "The Guaranteed Accounts - - Market Value Adjustment", below). Any CDSC associated with a Withdrawal will be deducted from the Subaccounts, the Fixed Account and/or the Guaranteed Accounts based on the allocation percentages of the Withdrawal. Any amount of CDSC that we deduct from a Subaccount which is in excess of the available value in that Subaccount will be deducted pro rata among the remaining Subaccounts and the unloaned portion of the Fixed Account (as above, it will not be taken from the Guaranteed Accounts unless there is not sufficient Contract Value in such remaining Subaccounts and the unloaned portion of the Fixed Account). If the Withdrawal cannot be processed in accordance with your instructions, then we will notify you through your agent, by telephone or by mail that we cannot process the Withdrawal, and we will not process it until we receive further instructions. If your Contract is participating in the Illuminations program described under "Optional `Illuminations' Investment Advisory Service," below, and you allocate the Withdrawal pro rata among the Subaccounts in the Policy, the proportionate allocations recommended by FundQuest for your Contract will not be disturbed. If, on the other hand, you allocate the Withdrawal to specific funds, the Contract will depart from the recommended allocations. However, if the Contract remains in the Illuminations program, at the next semi-annual rebalancing date the remaining Contract Value will be rebalanced back to the recommended model. A Surrender or a Withdrawal may have tax consequences. See "Federal Income Tax Considerations," below. Payments - -------- We will pay any funds surrendered or withdrawn from the Variable Account within 7 days of receipt of such request at our Home Office. However, we reserve the right to suspend or postpone the date of any payment or transfer of any benefit or values for any Valuation Period: o when the New York Stock Exchange ("Exchange") is closed, o when trading on the Exchange is restricted, o when an emergency exists as a result of which disposal of securities held in the Variable Account is not reasonably practicable or it is not reasonably practicable to determine the value of the Variable Account's net assets, or o during any other period when the Securities and Exchange Commission, by order, so permits for the protection of security holders. The rules and regulations of the Securities and Exchange Commission shall govern as to whether the conditions prescribed in (2) and (3) exist. In cases where you surrender your Contract within 15 days of making a premium payment by check, and we are unable to confirm that such payment has cleared, we may withhold an amount equal to such payment from your surrender proceeds until we are able to confirm that the payment item has cleared, but for no more than 15 days from our receipt of the payment item. You may avoid the possibility of this holdback by making premium payments by unconditional means, such as by certified check or wire transfer of immediately available funds. We reserve the right to delay payment of any amounts allocated to the Fixed Account or to a Guaranteed Account which are payable as a result of a Surrender, Withdrawal or loan for up to six months after we receive a written request in a form satisfactory to us. -42- If mandated under applicable law, we may be required to reject a premium payment. We may also be required to provide additional information about your account to government regulators. In addition, we may be required to block an Owner's account and thereby refuse to honor any request for transfers, withdrawals, surrenders, loans or death benefits, until instructions are received from the appropriate regulator. Surrenders and Withdrawals Under a Tax-Sheltered Annuity Contract - ----------------------------------------------------------------- Where the Contract has been issued as a Tax-Sheltered Annuity, the Owner may surrender or make a Withdrawal of part or all of the Contract Value at any time this Contract is in force prior to the earlier of the Annuitization Date or the death of the Designated Annuitant except as provided below: The surrender or Withdrawal of Contract Value attributable to contributions made pursuant to a salary reduction agreement (within the meaning of Code Section 402(g)(3)(A) or (C)), or transfers from a Custodial Account described in Section 403(b)(7) of the Code, may be executed only: o when the Owner attains age 59 1/2, severs employment, dies, or becomes disabled (within the meaning of Code Section 72(m)(7)); or o in the case of hardship (as defined for purposes of Code Section 401 (k)), provided that any surrender of Contract Value in the case of hardship may not include any income attributable to salary reduction contributions. The surrender and Withdrawal limitations described in (a) above for Tax-Sheltered Annuities apply to: o salary reduction contributions to Tax-Sheltered Annuities made for plan years beginning after December 31, 1988; o earnings credited to such contracts after the last plan year beginning before January 1, 1989, on amounts attributable to salary reduction contributions; and o all amounts transferred from 403(b)(7) Custodial Accounts (except that amounts held as of the close of the last plan year beginning before January 1, 1989 and salary reduction contributions (but not earnings) after such date may be withdrawn in the case of hardship). Any Distribution other than the above, including exercise of a contractual ten-day free look provision (when available) may result in the immediate application of taxes and penalties and/or retroactive disqualification of a Qualified Contract or Tax-Sheltered Annuity. A premature Distribution may not be eligible for rollover treatment. To assist in preventing disqualification in the event of a ten-day free look, National Life will agree to transfer the proceeds to another contract which meets the requirements of Section 403(b) of the Code, upon proper direction by the Owner. The foregoing is National Life's understanding of the withdrawal restrictions which are currently applicable under Section 403(b)(11) and Revenue Ruling 90-24. Such restrictions are subject to legislative change and/or reinterpretation from time to time. Distributions pursuant to Qualified Domestic Relations Orders will not be considered to be a violation of the restrictions stated in this provision. The Contract surrender and Withdrawal provisions may also be modified pursuant to the plan terms and Code tax provisions for Qualified Contracts. -43- Telephone Transaction Privilege - ------------------------------- If you elect the telephone transaction privilege, you may make changes in Net Premium Payment allocations, transfers, or initiate or make changes in dollar cost averaging or portfolio rebalancing, terminate or make changes in your Illuminations investment advisory program, if your Contract is participating, in the case of section 403(b) Tax Sheltered Annuities, take loans up to $10,000, and modify systematic withdrawals by providing instructions to us at our Home Office over the telephone. You can make the election either on the application for the Contract or by providing a proper written authorization to us. We reserve the right to suspend telephone transaction privileges at any time and for any reason. You may, on the application or by a written authorization, authorize your National Life agent to provide telephone instructions on your behalf. We employ reasonable procedures to confirm that instructions communicated by telephone are genuine. If we follow these procedures we will not be liable for any losses due to unauthorized or fraudulent instructions. We may be liable for any such losses if those reasonable procedures are not followed. The procedures followed for telephone transfers will include one or more of the following: o requiring some form of personal identification prior to acting on instructions received by telephone, o providing written confirmation of the transaction, and o making a tape recording of the instructions given by telephone. Telephone transfers may not always be available. Telephone systems, whether yours, ours, or your agent's, can experience outages or slowdowns for a variety of reasons. These outages or slowdowns may prevent or delay our receipt of your request. If you are experiencing problems, you should make your transfer request in writing. If, on a Contract that is participating in the Illuminations program, you effect a change in premium allocation, initiate Dollar Cost Averaging or change Portfolio Rebalancing from the Portfolio Rebalancing program included within Illuminations, your Contract's participation in the Illuminations program will terminate. Optional "Illuminations" Investment Advisory Service - ---------------------------------------------------- National Life makes available to all Sentinel Advantage Variable Annuity Contract Owners, subject to the minimums and the exception for ERISA contracts described below, at no cost to the Owner, an optional investment advisory service which National Life calls "Illuminations". Illuminations is not available on Contracts purchased under 403(b) plans subject to ERISA or any employer-sponsored ERISA qualified plan under Code Section 401(a), except for single life 401(k) plans covering only Highly Compensated Employees and employer-sponsored plans where the Contract is used as a "trust owned annuity" issued on a single life but for the benefit of all plan participants. Illuminations is available on non-ERISA Qualified Contracts, including IRA's and non-ERISA 403(b) plans, subject to the minimums described below. Under this program, National Life has arranged for FundQuest, Incorporated, a registered investment adviser firm which is independent of National Life, to provide an investment advisory service under which it determines and maintains an allocation of the Contract Value of your Contract among the available options which is suited to your investment objective, financial situation and risk tolerance. Illuminations is available at the issue of a new Contract if the initial Premium Payment is at least $50,000, or it is expected that at least $50,000 will be paid from all sources, including the initial Premium Payment and funds deposited from the section 1035 exchange of another contract. After issue of a Contract, Illuminations is available if the total Premium Payments under the Contract have been at least $50,000 or if the current Contract Value is at least $50,000. Section 403(b) Tax-Sheltered Annuity Contracts will not be eligible to add Illuminations to the Contract if a loan is outstanding on the Contract, and once in the Illuminations program, will not be able to take a loan on the Contract unless they first terminate participation in Illuminations. If you elect to participate in Illuminations, you will be asked to fill out a detailed questionnaire, which addresses your investment objective, financial situation and risk tolerance. FundQuest will then evaluate the completed questionnaire to determine the allocation best suited to you. FundQuest will maintain a number of different allocation models for clients with different investment objectives, financial situations and risk tolerances, and you will be assigned to one of these models. However, you will have the ability to impose reasonable restrictions on the management of your Contract, including the ability to designate particular funds or types of funds that should not receive allocations of Contract Value from your Contract. Please contact National Life's Home Office at (800) 732-8939 if you wish to impose restrictions on the management of your Contract which contains the Illuminations management -44- feature. If you place restrictions on a particular fund or type of fund, you must either suggest an alternative fund or fund type or specify that the assets that would have been allocated to the restricted fund or fund type be allocated pro rata among the other funds in your model. At the implementation of your Illuminations program, you will receive a Strategy Report prepared by FundQuest which discusses the strategy to be followed in allocating your Contract Value among the Funds. FundQuest will make changes to its fund allocation models from time to time as it deems appropriate based on changes in the financial markets, fund performance, and other factors. FundQuest will communicate these changes to National Life, which will then automatically implement the changes in each affected Contract, pursuant to a Limited Power of Attorney executed by Illuminations participants. This Limited Power of Attorney will authorize FundQuest to direct National Life to implement changes to your model determined by FundQuest, without obtaining your specific prior approval of the changes. In addition, FundQuest also currently intends to rebalance each Illuminations account back to its then-current model allocation semi-annually. This semi-annual rebalancing will also be implemented pursuant to the Limited Power of Attorney, and will be done automatically without your specific prior approval. Further information regarding FundQuest is included in Part II of FundQuest's Form ADV, which will be provided to Contract Owners when they elect to participate in Illuminations. Once in the Illuminations program, you will receive a quarterly report prepared by FundQuest discussing the performance of your Contract's Subaccount allocation, all the transactions made within your Contract, and its value at the beginning and end of the period. In this report, you will be reminded that you should contact National Life if there have been changes in your financial situation or investment objectives, and that you may impose reasonable restrictions on the funds in which your account may invest or modify existing restrictions. In addition, at least annually you will be contacted by your National Life agent to determine whether there have been any changes in your financial situation or investment objectives, and whether you wish to impose reasonable restrictions on the funds in which your account may invest or modify existing restrictions. Once you have elected to participate in the Illuminations program, you may terminate your participation in the program at any time, by providing written or telephone instructions to National Life. If you terminate the Illuminations program, we will no longer automatically apply any portfolio rebalancing to your Contract, unless you specifically elect to begin a Portfolio Rebalancing feature described under section below entitled "Available Automated Fund Management Features". If, while your Contract is participating in the Illuminations program, you should need or want to make a Withdrawal from your Contract, and you allocate the Withdrawal pro rata among the Subaccounts in the Contract, the proportionate allocations recommended by FundQuest for your Contract will not be disturbed. If, on the other hand, you allocate the Withdrawal to specific funds, the Contract will depart from the recommended allocations. However, if the Contract remains in the Illuminations program, at the next semi-annual rebalancing date the remaining Accumulated Value will be rebalanced back to the recommended model. While your Contract is in the Illuminations program, you will be allowed to implement fund transfers, but if you do so, your allocations will depart from the FundQuest recommendations, and, if you keep the Contract in the Illuminations program, your transfers will end up being reversed by the next semi-annual rebalancing within the program. While your Contract is in the Illuminations program, the Dollar Cost Averaging feature described in the next section below will not be available, and Portfolio Rebalancing will only be available as part of the Illuminations program. If you do elect to begin Dollar Cost Averaging, or change your Portfolio Rebalancing from the Illuminations program, such election will automatically terminate your Contract's participation in the Illuminations program. Similarly, if you instruct National Life to make a change in the allocation of new Premiums on your Policy, this will be treated as a termination of your Contract's participation in the Illuminations program. -45- Available Automated Fund Management Features - -------------------------------------------- We currently offer the following free automated fund management features. However, we are not legally obligated to continue to offer these features and we may cease offering one or more of such features at any time, after providing 60 days prior written notice to all Owners who are currently utilizing the features being discontinued. Only one of Dollar Cost Averaging and Portfolio Rebalancing is available under any single Contract at one time, but either may be used with Systematic Withdrawals. Dollar Cost Averaging. This feature permits you to automatically transfer funds from the Money Market Subaccount to any other Subaccounts on a monthly basis. You may elect it at issue by marking the appropriate box on the initial application and completing the appropriate instruction or after issue by filling out similar information on a change request form and sending it to us. If you elect this feature, each month on the Monthly Contract Date we will take the amount to be transferred from the Money Market Subaccount and transfer it to the Subaccount or Subaccounts designated to receive the funds. This procedure starts with the Monthly Contract Date next succeeding the Date of Issue or next succeeding the date of an election subsequent to purchase and stops when the amount in the Money Market Subaccount is depleted. The minimum monthly transfer by Dollar Cost Averaging is $100, except for the transfer which reduces the amount in the Money Market Subaccount to zero. You may discontinue Dollar Cost Averaging at any time by sending an appropriate change request form to us. This feature allows you to move funds into the various investment classes on a more gradual and systematic basis than the frequency on which Premium Payments ordinarily are made. The dollar cost averaging method of investment is designed to reduce the risk of making purchases only when the price of units is high. The periodic investment of the same amount will result in higher numbers of units being purchased when unit prices are lower and lower numbers of units being purchased when unit prices are higher. This technique will not assure a profit or protect against a loss in declining markets. For the dollar cost averaging technique to be effective, amounts should be available for allocation from the Money Market Subaccount through periods of low price levels as well as higher price levels. While your Contract is in the Illuminations program described in the section immediately above, Dollar Cost Averaging will not be available. If you do elect to begin Dollar Cost Averaging, such election will automatically terminate your Contract's participation in the Illuminations program. Portfolio Rebalancing. This feature permits you to automatically rebalance the value in the Subaccounts on a quarterly, semi-annual or annual basis, based on the premium allocation percentages in effect at the time of the rebalancing. You may elect it at issue by marking the appropriate box on the initial application or after issue by completing a change request form and sending it to us. In Contracts utilizing Portfolio Rebalancing from the Date of Issue, an automatic transfer takes place which causes the percentages of the current values in each Subaccount to match the current premium allocation percentages. This procedure starts with the Monthly Contract Date three, six or twelve months after the Date of Issue and continues on each Monthly Contract Date three, six or twelve months thereafter. Contracts electing Portfolio Rebalancing after issue will have the first automated transfer occur as of the Monthly Contract Date on or next following the date that the election is received. Subsequent rebalancing transfers occur every three, six or twelve months thereafter. You may discontinue Portfolio Rebalancing at any time by submitting an appropriate change request form. If you change the Contract's premium allocation percentages, Portfolio Rebalancing will automatically be discontinued unless you specifically direct otherwise. Portfolio Rebalancing results in periodic transfers out of Subaccounts that have had relatively favorable investment performance and into Subaccounts which have had relatively unfavorable investment performance. Portfolio rebalancing does not guarantee a profit or protect against a loss. While your Contract is in the Illuminations program described in the section immediately above, Portfolio Rebalancing will be available only as part of the program, which will rebalance semi-annually back to your allocations as determined by FundQuest. If you do elect to change Portfolio Rebalancing from this Illuminations program, such election will automatically terminate your Contract's participation in the Illuminations program. -46- Systematic Withdrawals. At any time after one year from the Date of Issue, if the Contract Value at the time of initiation of the program is at least $15,000, you may elect in writing to take systematic Withdrawals of a specified dollar amount (of at least $100) on a monthly, quarterly, semi-annual or annual basis. You may provide specific instructions as to how the systematic Withdrawals are to be taken, but the Withdrawals must be taken first from the Subaccounts and may only be taken from the unloaned portion of the Fixed Account to the extent that the Contract Value in the Variable Account is insufficient to accomplish the Withdrawal. Moreover, Withdrawals may only be taken from the Guaranteed Accounts to the extent that the Contract Value in the Variable Account and the Fixed Account is insufficient to accomplish the Withdrawal. If you have not provided specific instructions or if specific instructions cannot be carried out, we process the Withdrawals by taking Accumulation Units from all of the Subaccounts in which you have an interest and the unloaned portion of the Fixed Account on a pro rata basis; Contract Value will not be taken from the Guaranteed Accounts unless there is not sufficient Contract Value in the Variable Account and the Fixed Account to accomplish the Withdrawal. Each systematic Withdrawal is subject to federal income taxes. In addition, a 10% federal penalty tax may be assessed on systematic Withdrawals if you are under age 59 1/2. If you direct, we will withhold federal income taxes from each systematic Withdrawal. You may elect to have your systematic withdrawal payment electronically transferred to your checking or savings account by submitting the appropriate paperwork deemed by us to be in good order. A systematic Withdrawal program terminates automatically when a systematic Withdrawal would cause the remaining Cash Surrender Value to be $3,500 or less (or, in the case of Contracts issued prior to November 1, 2003, if a systematic Withdrawal would cause the Contract Value to be $3500 or less). If this happens, then the systematic Withdrawal transaction causing the Cash Surrender Value to fall below $3500 will not be processed. You may discontinue systematic Withdrawals at any time by notifying us in writing. A CDSC may apply to systematic Withdrawals in accordance with the considerations set forth in "Contingent Deferred Sales Charge", above. If you withdraw amounts pursuant to a systematic Withdrawal program, then, in most states, you may withdraw in each Contract Year after the first Contract Year without a CDSC an amount up to 15% of the Contract Value as of the most recent Contract Anniversary (a 10% CDSC-free Withdrawal provision applies in New Jersey and Washington - see "Contingent Deferred Sales Charge," above). Both Withdrawals you request and Withdrawals pursuant to a systematic Withdrawal program will count toward the limit of the amount that may be withdrawn in any Contract Year free of the CDSC. In addition, any amount withdrawn in order to meet minimum Distribution requirements under the Code shall be free of CDSC. Limited systematic Withdrawals are also available in the first Contract Year (but after 30 days from issue). These systematic Withdrawals are limited to monthly systematic Withdrawal programs only. The maximum aggregate amount for the remaining months of the first Contract Year is the annual amount that may be withdrawn in Contract Years after the first Contract Year free of a CDSC (i.e., either 15% or 10% of the Contract Value, depending on the state). These systematic Withdrawals will not be subject to a CDSC. The other rules for systematic Withdrawals made after the first Contract Year, including the $15,000 minimum Contract Value, minimum $100 payment, and allocation rules, will apply to these systematic Withdrawals. Regardless of the method of Withdrawal, systematic or otherwise, at no point in the first Contract Year will total CDSC-free Withdrawals be available in an amount that exceeds 1/12th of 15% of each premium payment times the number of completed months since each premium payment. Systematic withdrawals may not be elected if there is a policy loan. Contract Rights Under Certain Plans - ----------------------------------- Contracts may be purchased in connection with a plan sponsored by an employer. In such cases, all rights under the Contract rest with the Owner, which may be the employer or other obligor under the plan, and benefits available to participants under the plan are governed solely by the provisions of the plan. Accordingly, some of the options and elections under the Contract may not be available to participants under the provisions of the plan. In such cases, participants should contact their employers for information regarding the specifics of the plan. -47- THE FIXED ACCOUNT Net Premium Payments under the Fixed Account portion of the Contract and transfers to the Fixed Account portion are part of our general account, which supports insurance and annuity obligations. Because of exemptive and exclusionary provisions, interests in the general account, including the Guaranteed Accounts discussed below, are not registered under the Securities Act of 1933 ("Securities Act"), nor is the general account registered as an investment company under the Investment Company Act. Accordingly, neither the general account nor any interest therein are generally subject to the provisions of the Securities Act or Investment Company Act, and we have been advised that the staff of the Securities and Exchange Commission has not reviewed the disclosures in this prospectus which relate to the guaranteed interest portion. Disclosures regarding the Fixed Account, the Guaranteed Accounts, and the general account, however, may be subject to certain generally applicable provisions of the federal securities laws relating to the accuracy and completeness of statements made in prospectuses. Our general account is made up of all our general assets, other than those in the Variable Account and any other segregated asset account. Fixed Account Net Premium Payments will be allocated to the Fixed Account by election of the Owner at the time of purchase or by a later change in allocation of Net Premium Payments. We will invest the assets of the Fixed Account and the Guaranteed Accounts in those assets we choose and allowed by applicable law. Minimum Guaranteed and Current Interest Rates - --------------------------------------------- The Contract Value held in the Fixed Account which is not held in a Collateral Fixed Account is guaranteed to accumulate at a minimum effective annual interest rate which may vary from time to time, but which will be fixed at the issue of a Contract and will not vary over the life of the Contract, and will be at least the minimum effective interest rate required by your state's law. For Contracts issued before November 1, 2003, the minimum guaranteed effective annual interest rate is 3.0%. We may credit the Contract Value in the unloaned portion of the Fixed Account with current rates in excess of the minimum guarantee but we are not obligated to do so. We have no specific formula for determining current interest rates. Since we, in our sole discretion, anticipate changing the current interest rate from time to time, allocations to the Fixed Account made at different times are likely to be credited with different current interest rates. We declare an interest rate each month to apply to amounts allocated or transferred to the Fixed Account in that month. The rate declared on such amounts remains in effect for twelve months. In general, National Life expects to set the interest rates applicable to Contract Value held in the Fixed Account at rates which permit National Life to earn a profit on the investment of the funds. At the end of the 12-month period, we reserve the right to declare a new current interest rate on such amounts and accrued interest thereon (which may be a different current interest rate than the current interest rate on new allocations to the Fixed Account on that date). We determine any interest credited on the amounts in the Fixed Account in excess of the minimum guaranteed rate in our discretion. You assume the risk that interest credited may not exceed the guaranteed minimum rate. Amounts allocated to the Fixed Account do not share in the investment performance of our general account or any portion thereof. Amounts deducted from the unloaned portion of the Fixed Account for the charge for the optional Enhanced Death Benefit Rider, the Annual Contract Fee or transfers to the Variable Account are, for the purpose of crediting interest, accounted for on a last in, first out basis. Amounts deducted from the unloaned portion of the Fixed Account for Withdrawals are accounted for on a first in, first out basis for such purpose. National Life reserves the right to change the method of crediting interest from time to time, provided that such changes do not have the effect of reducing the guaranteed rate of interest below the applicable minimum rate or shorten the period for which the interest rate applies to less than 12 months. For Contracts purchased in the State of Washington, no Premium Payments or Contract Value may be allocated to the Fixed Account. Enhanced Fixed Account - ---------------------- During special promotional periods (the "offer period"), we may make available to the Contracts a special Fixed Account Option, called the "Enhanced Fixed Account". The Enhanced Fixed Account, when available, allows you to move value into the Variable Account on a gradual and systematic basis, while earning interest at a higher fixed rate that that otherwise offered on the Fixed Account on your value while it awaits transfer into the Variable Account. You should keep in mind that the interest rate applicable to the Enhanced Fixed Account applies only for a specified period of time and to a principal balance in the Enhanced Fixed Account which declines over time as funds are moved into the Variable Account. -48- During an offer period (which will be from time to time at our discretion), the Enhanced Fixed Account will be available to new and existing Contract Owners who make a one-time new Premium Payment of at least a minimum dollar amount we specify at the time of the offer. Contract Value in the Enhanced Fixed Account will accumulate at an effective annual interest rate in excess of the current rates then being credited to Contract Value in the Fixed Account. We will declare the interest rate for the Enhanced Fixed Account at the time of the offer in our discretion, and this interest rate will apply for the entire offer period. When we set an offer period, we will announce all the terms of the Enhanced Fixed Account, and post this information on our web site at www.nationallife.com. We may make more than one offer with respect to an Enhanced Fixed Account at the same time. If we do, we will reserve the right to allow you to participate in only one such offer at a time. In that case, once you have transferred all Contract Value out of the Enhanced Fixed Account under the terms of a given offer, you may participate in subsequent offers subject to the preceding condition and subject to any qualifying rules of any subsequent offers. Any Contract Value in the Enhanced Fixed Account accepted under one offer may not be transferred to any subsequent or concurrent offer. Offer availability and interest rates are determined solely by the date of receipt of the eligible new Premium Payment in our Home Office. We will require that the Contract Value in the Enhanced Fixed Account be systematically transferred on a monthly basis from the Enhanced Fixed Account to the Subaccounts. The required monthly transfer amount will be a percentage of the Premium Payment allocated to the Enhanced Fixed Account. We will declare this percentage at the time of the offer, in our discretion. Each month on the Monthly Contract Date, the monthly transfer amount will be transferred from the Enhanced Fixed Account to the Subaccounts and in the percentage amounts selected by the Owner (other than the Money Market Subaccount), until the Contract Value in the Enhanced Fixed Account is exhausted. The Enhanced Fixed Account will be part of the Fixed Account described above. Transfers into the Enhanced Fixed Account will not be allowed. The Owner may transfer Contract Value out of the Enhanced Fixed Account at any time, by making a transfer request. If the entire Contract Value in the Enhanced Fixed Account is transferred out, the program ends. If less than the entire Contract Value in the Enhanced Fixed Account is transferred out, the scheduled monthly transfers will continue until the Enhanced Fixed Account is exhausted. The Owner may terminate participation in the Enhanced Fixed Account at any time by notifying National Life at its Home Office. This will result in all value in the Enhanced Fixed Account being transferred in accordance with the Owner's then-current premium allocation. Withdrawals from the Enhanced Fixed Account will be allowed, in the same manner as for other Withdrawals, but will be subject to any applicable CDSC. Guaranteed Accounts, as described below, are not available for the systematic transfers out of the Enhanced Fixed Account. This program is not available simultaneously with Dollar Cost Averaging or Portfolio Rebalancing, but is available with Systematic Withdrawals. Also, if you elect to receive benefits under an Accelerated Benefits Rider while you have Contract Value in the Enhanced Fixed Account, your Contract Value in the Enhanced Fixed Account will immediately be transferred to the Money Market Subaccount. During the offer period we may permit, in our discretion, additional Premium Payments on the same Contract to be allocated to the Enhanced Fixed Account. If we do so, we will add a declared percentage of the new Premium Payment to the original monthly transfer amount, the same instructions for allocating to the Subaccounts will apply, and the program will continue to operate until the Contract Value in the Enhanced Fixed Account is exhausted. -49- We may need to refund Premium Payments intended for the Enhanced Fixed Account if they are less than the minimum required, if they are received after the end of the offer period, or if, for any other reason, the written instructions of the Owner cannot be carried out. We may hold these Premium Payments for up to 20 days before refunding them. Any amounts refunded will be credited with interest at 5%. The Enhanced Fixed Account will not be available in the State of Washington. THE GUARANTEED ACCOUNTS Contract Owners may also allocate Net Premium Payments and/or Contract Value to one or more Guaranteed Accounts. These Guaranteed Accounts guarantee a specified interest rate for the entire period of an investment, if the Contract Value remains in the Guaranteed Account for the specified period of time. Guaranteed Accounts are currently available for 3, 5, 7 and 10 year periods. Like the Fixed Account described above, Net Premium Payments under any Guaranteed Account and transfers to any Guaranteed Account are part of National Life's general account, which supports its insurance and annuity obligations. Investments in the Guaranteed Accounts - -------------------------------------- You may invest in a Guaranteed Account by allocating Net Premium Payments to the Guaranteed Account of the desired 3, 5, 7 or 10 year period, either on the application or by a later change in Net Premium Payment allocation. You may also transfer Contract Value from the Variable Account to a Guaranteed Account with the desired 3, 5, 7 or 10 year period by making a written transfer request, or by telephone if the telephone transaction privilege applies. Transfers from the Fixed Account to a Guaranteed Account are permitted only to the same extent described under "Transfers" above for transfers from the Fixed Account to the Variable Account. All deposits into a Guaranteed Account are subject to a $500 minimum. If such an allocation would result in a deposit to a Guaranteed Account of less than $500, such Net Premium Payments will be allocated instead to the Money Market Subaccount. You may not invest in a Guaranteed Account where the end of the guarantee period for such Guaranteed Account is later than your Contract's Maturity Date. Interest at a specified rate will be guaranteed to be credited to all Contract Value in a particular Guaranteed Account for the entire specified period, if the Contract Value remains in that Guaranteed Account for the entire specified period. We expect to change the specified rates for new investments in Guaranteed Accounts from time to time based on returns then available to us for the specified periods, but such changes will not affect the rates guaranteed on previously invested Contract Value. We expect to set the rates for the Guaranteed Accounts such that we will earn a profit on the investment of the funds. If you surrender your Contract or withdraw or transfer Contract Value out of the Guaranteed Account prior to the end of the specified period, a variable adjustment referred to in this Prospectus as a "market value adjustment" will be applied to such Contract Value before the surrender, Withdrawal or transfer. This market value adjustment is described in detail below. Currently there is no charge, apart from any market value adjustment as referred to above, for transfers into or out of a Guaranteed Account. However, although we have no present intention to impose a transfer charge in the foreseeable future, we reserve the right to impose in the future a transfer charge of $25 on each transfer in excess of twelve transfers in any Contract Year. We may do this if the expense of administering transfers becomes burdensome. Transfers into and out of a Guaranteed Account, other than at the termination of a Guaranteed Account, would count toward such limits. We may at any time change the number and/or duration of Guaranteed Accounts we offer. Any such changes will not affect existing allocations to Guaranteed Accounts at the time of the change. -50- Termination of a Guaranteed Account - ----------------------------------- The termination date for a particular Guaranteed Account will be the anniversary of the date Contract Value is credited to the Guaranteed Account. For example, if Contract Value is transferred to a 7 year Guaranteed Account on May 2, 2005, the termination date for this Guaranteed Account is May 2, 2012, or the next following Valuation Day if May 2, 2012 is not a Valuation Day. We will notify you in writing of the termination of your Guaranteed Account. Such notification will normally be mailed approximately 45 days prior to the termination date for the Guaranteed Account. During the 30 day period prior to the termination date (the "30 day window"), you may provide instructions to reinvest the Contract Value in the Guaranteed Account, either as of the date we receive your instructions, or the termination date (or the next Valuation Day, if the date we receive your instructions or the termination date is not a Valuation Day), in any of the Subaccounts of the Variable Account, in the Fixed Account, or in any Guaranteed Account that we may be offering at that time. No market value adjustment will apply to any such reinvestment made as the result of instructions received during the 30 day window. In the event that you do not provide instructions during the 30 day window as to how to reinvest the Contract Value in a Guaranteed Account, we will, on the termination date, or the next following Valuation Day if the termination date is not a Valuation Day, transfer the Contract Value in the Guaranteed Account to the Money Market Subaccount of the Variable Account. No market value adjustment will be applied to this transfer. You will then be able to transfer the Contract Value from the Money Market Subaccount to any other available investment option whenever you like. Market Value Adjustment - ----------------------- Contract Value allocated to a Guaranteed Account is not restricted from being surrendered, withdrawn, transferred or annuitized prior to the termination date of the Guaranteed Account. However, a market value adjustment will be applied to a surrender of your Contract or any such Contract Value withdrawn or transferred (we refer to a surrender, Withdrawal or transfer before the 30 day window as an "MVA Withdrawal") from the Guaranteed Account prior to the 30 day window before its termination date. We will apply the market value adjustment before we deduct any applicable CDSC or taxes. A market value adjustment will apply to Withdrawals from a Guaranteed Account prior to the 30 day window before its termination date even if a waiver of the CDSC applies to such a Withdrawal. A market value adjustment reflects the change in current interest rates since we established a Guaranteed Account. The market value adjustment may be positive or negative. Adjustments may be limited in amount, as described in more detail below. Generally, if at the time of your MVA Withdrawal the applicable index interest rate for maturities equal to the time remaining before the termination date of your Guaranteed Account are higher than the applicable index interest rate for maturities equal to the period of your Guaranteed Account at the time of your investment in the Guaranteed Account, then the market value adjustment will result in a reduction of your Contract Value. If the opposite is true at the time of your MVA Withdrawal, then the market value adjustment will result in an increase in your Contract Value. However, the market value adjustment is limited so that the amount available for MVA Withdrawal, before any CDSC, will never be less than the amount of the initial deposit, less any Withdrawals, plus interest at the Contract's minimum guaranteed interest rate. For Contracts issued on or after November 1, 2003, this minimum guaranteed interest rate may vary based on your state law and on prevailing interest rates, but will be set at the time of issue of the Contract and, once set, will not vary over the life of the Contract. For Contracts issued prior to November 1, 2003, however, the market value adjustment is limited so that the amount available for MVA Withdrawal, before any CDSC, will never be less than the amount of the initial deposit, less any Withdrawals, plus interest at 3.0% per annum. We compute the amount of a market value adjustment as the lesser of (1) and (2) below. The market value adjustment will be positive if (1) below is positive. It will be negative if (1) below is negative. (1) the absolute value of the Contract Value subject to the market value adjustment times: ((1+i)/(1+j+c))n/12 - 1 where -51- i = the interest rate from the U.S. Treasury Constant Maturities as found in the Federal Reserve Statistical Release H.15 available at the time of the initial deposit for the Guaranteed Account duration. n = the number of whole months until the termination date of the Guaranteed Account j = the current interest rate from the U.S. Treasury Constant Maturities as found in the Federal Reserve Statistical Release H.15 available for a period of length n/12, rounded down to the next whole year. If there is no interest rate for the maturity needed to calculate i or j, we will use straight line interpolation between the interest rate for the next highest and next lowest maturities to determine that interest rate. If the maturity is less than one year, we will use the index rate for a one-year maturity. c = a constant, .0025 in most jurisdictions. or (2) the amount initially deposited into the Guaranteed Account times: ((1+k)d/365 - (1 + g)d/365) - the sum of all [TransferT ((1+k)e/365 -(1 + g)e/365)] where k = the interest rate guaranteed for the guaranteed period. d = (365 times the number of complete years since the initial deposit into the Guaranteed Account) plus the number of days since the last anniversary of such initial deposit (or the initial deposit date if less than one year has elapsed since the initial deposit) to the current date. TransferT = a transfer from the Guaranteed Account on day T. e = (365 times the number of complete years since T to the current transfer date) plus the number of days from the last anniversary of T (or the days since T if less than one year has elapsed). g= your Contract's guaranteed minimum interest rate. If you have made more than one deposit into a Guaranteed Account, and you do not instruct us otherwise, we will treat Withdrawals and transfers as coming from such Guaranteed Accounts on a pro rata basis, and within Guaranteed Accounts with the same initial guarantee period, on a first-in-first-out basis; that is, Contract Value with the earliest date of deposit into a Guaranteed Account will be withdrawn or transferred prior to Contract Value with later dates of deposit into such Guaranteed Account. A market value adjustment will be applied to Funds transferred from a Guaranteed Account to collateralize a loan, whether for the initial loan or for loan interest. We will not apply a market value adjustment to: - any MVA Withdrawal during the 30 day window - Death Benefit proceeds - your Contract on its Maturity Date; or - any deduction from a Guaranteed Account made to cover the Annual Contract Fee or Rider Charges. Examples Example #1: Original Deposit: $10,000 Original Deposit Date: May 1, 2004 The $10,000 is placed in the seven-year Guaranteed Account. The guaranteed interest rate is 3.5%. On May 1, 2006, the Owner wishes to transfer the full amount from the seven-year Guaranteed Account. The i rate as of May 1, 2004 for seven year periods was 3.15%. The j rate available for five year periods on May 1, 2006 is 2.75%. The contract's minimum guaranteed interest rate is 1.5%. There are 60 months remaining in the original guaranteed period. The Contract Value in this Guaranteed Account on May 1, 2006 is $10,712.25. (10,000 x 1.035(2)). -52- The first part of the market value adjustment formula gives: $10,712.25 x(((1+0.0315)/(1+0.0275+.0025))60/12 - 1) = $78.23. The second part of the market value adjustment formula gives: $10,000 x ((1 + 0.035)730/365 - (1 + 0.015)730/365) = $410.00 The amount of the market value adjustment is the lesser of the absolute value of the first part, $78.23, and of the second part, $410.00. Since the result of the first part is positive, the market value adjustment is an increase in Contract Value. The amount of the transfer will be $10,712.25 + 78.23 = $10,790.48. Example #2 Original Deposit: $10,000 Original Deposit Date: May 1, 2004 The $10,000 is placed in the seven-year Guaranteed Account. The guaranteed interest rate is 3.5%. On May 1, 2006, the Owner wishes to transfer the full amount from the seven-year guaranteed account. The i rate as of May 1, 2004 for seven year periods was 3.15%. The j rate available for five year periods on May 1, 2006 is 3.75%. The contract's minimum guaranteed interest rate is 1.5%. There are 60 months remaining in the original guaranteed period. The Contract Value in this Guaranteed Account on May 1, 2006 is $10,712.25. (10,000 x 1.035(2)). The first part of the market value adjustment formula gives: $10,712.25 x (((1+0.0315)/(1+0.0375+.0025))60/12 - 1) = -$430.66. The second part of the market value adjustment formula gives: $10,000 x (( 1 + 0.035 )730/365 - ( 1 + 0.015 )730/365 ) = $410.00 The amount of the market value adjustment is the lesser of the absolute value of the first part, $430.66, and of the second part, $410.00. Since the result of the first part is negative, the market value adjustment is a reduction in Contract Value. The amount of the transfer will be $10.712.25 - $410.00 = $10,302.25. Note that the amount $10,302.25 is $10,000 accumulated for two years at 1.5%. In this example, the market value adjustment was restricted to the amount of interest earned by the Guaranteed Account in excess of 1.5%. Had the market value adjustment been positive in this example, it still would have been restricted to $410.00. Other Matters Relevant to the Guaranteed Accounts - ------------------------------------------------- If you have Contract Value allocated to a Guaranteed Account when you or a Joint Owner dies, no market value adjustment will be applied to such Contract Value before the Death Benefit is paid. If you own a section 403(b) Tax-Sheltered Annuity Contract on which loans are available, and you need to borrow Contract Value, you must transfer all Contract Value allocated to a Guaranteed Account to a Subaccount of the Variable Account or to the Fixed Account prior to the processing of the loan. A market value adjustment will apply to such transfer. We will allocate loan repayments to the Subaccounts of the Variable Account and to the unloaned portion of the Fixed Account according to your premium allocation percentages in effect at the time of the repayment. While a loan is outstanding, premiums may not be allocated to, and transfers may not be made to, the Guaranteed Accounts. -53- The Guaranteed Accounts are not available in the states of Washington and Oregon. In Texas, only Contracts issued after April 8, 2002 are eligible to invest in the Guaranteed Accounts. Preserver Plus Program - ---------------------- Under this program, you may place a portion of a Net Premium Payment into a 7 year or 10 year Guaranteed Account that will grow with guaranteed interest to 100% of that Net Premium Payment. We will calculate the portion of the Net Premium Payment needed to accumulate over the chosen guarantee period to 100% of the Net Premium Payment. The balance of the Net Premium Payment may be allocated to the Subaccounts of the Variable Account, the Fixed Account, or other Guaranteed Accounts in any manner you desire, subject to our normal allocation rules. Amounts allocated to a Guaranteed Account under this program will not equal the original Net Premium Payment if any transfer or Withdrawal is made from the Guaranteed Account prior to the end of the guarantee period. Keep in mind that if you have a Qualified Contract, you will be required to take minimum required distributions. OPTIONAL ENHANCED DEATH BENEFIT RIDER You may choose to include the Enhanced Death Benefit Rider in your Contract. The Rider is subject to the restrictions and limitations set forth in it. Election of this optional benefit involves an additional cost. This Rider is not available in Texas. If you elected the Enhanced Death Benefit Rider, then the following enhanced death benefit will be payable to the Beneficiary if you (or the Annuitant if the Owner is not a natural person) die prior to the Contract Anniversary on which you are age 81on an age on nearest birthday basis ( or in the case of Joint Owners, if the first of the Joint Owners to die dies prior to the Contract Anniversary on which the oldest of the Joint Owners is age 81 on an age nearest birthday basis), and prior to annuitization. The Enhanced Death Benefit will equal the highest of: (a) the basic Death Benefit as described above; and (b) the largest Contract Value as of any prior Contract Anniversary after the Enhanced Death Benefit Rider was applicable to the Contract, plus Net Premium Payments, minus any Withdrawals (including any CDSC deducted in connection with such Withdrawals), and minus any loan taken and accrued interest thereon, in each case since such Contract Anniversary. We calculate this as of the date we receive due proof of death. Any applicable premium tax charge payable on your death will be applied to reduce the value of the determined enhanced death benefit (see "Premium Taxes, above). If you (or the Annuitant if the Owner is not a natural person) die on or after the Contract Anniversary on which you are age 81 on an age on nearest birthday basis (or in the case of Joint Owners, if the first of the Joint Owners to die dies on or after the Contract Anniversary on which the oldest of the Joint Owners is age 81 on an age nearest birthday basis), or after annuitization, the death benefit will not be enhanced and will be an amount equal to Contract Value, less any applicable premium tax charge. The Enhanced Death Benefit Rider is available at issue if the Owner (or the Annuitant if the Owner is not a natural person, or the oldest of Joint Owners) is age 75 or younger, on an age on nearest birthday basis on the Date of Issue of the Contract. It is available after issue if the Owner (or the Annuitant if the Owner is not a natural person, or the oldest of Joint Owners) is age 75 or younger, on an age on nearest birthday basis on the Contract Anniversary on which the Rider is being added, and only on a Contract Anniversary and only if at the time of the Rider is requested the Contract Value is greater than the total of all Net Premium Payments less all Withdrawals, and any outstanding loan on the Contract and accrued interest on such loan. -54- The annual charge for this Rider is 0.20% of Contract Value. After the Contract Anniversary on which you (or the Annuitant, if the Owner is not a natural person) are age 80 on an age on nearest birthday basis (or in the case of Joint Owners, after the Contract Anniversary in which the oldest Joint owner is age 80 on an age on nearest birthday basis), we discontinue the charge. See "Charge for Optional Enhanced Death Benefit Rider", above. It is possible that the Internal Revenue Service may take a position that rider charges are deemed to be taxable distributions to you. Although we do not believe that a rider charge under the Contract should be treated as taxable withdrawal, you should consult your tax advisor prior to selecting any rider or endorsement under the Contract. We distribute the Enhanced Death Benefit in the same manner as the normal Death Benefit. See "Death of Owner," above. OPTIONAL ACCELERATED BENEFIT RIDERS If the Contract has been in force for at least five years, the Accelerated Benefit Riders provide accelerated Death Benefits prior to the death of the covered person in certain circumstances where a terminal illness or chronic illness creates a need for access to the Death Benefit. The terminal illness or chronic illness must have begun while the Contract was in force. Benefits accelerated under these Riders are discounted for interest and mortality. Once benefits have been accelerated, the Contract terminates. There is no cost for these Riders. They can be included in the Contract at issue, or they can be added after issue, for a covered person at the time of Contract issue whose age, on an age on nearest birthday basis, is 0-75. The covered person is the Owner, unless the Owner is not a person, in which case the covered person is the Annuitant. If there are Joint Owners, then each are considered covered persons. If the covered person changes, then the Contract is not eligible for acceleration until the Contract has been in force five years from the date of the change. These Riders may not be available in all states and its terms may vary by state. These Riders will not be available in New York, Texas, Virginia and Washington. As of the date of this Prospectus, California, Oregon and Pennsylvania have not yet approved these Riders. Connecticut, Kansas, Louisiana, Minnesota, New Jersey, South Carolina and Utah only allow the terminal illness portion of the Riders. Any amount received under an Accelerated Benefits Rider should be taxed in the same manner as a surrender of the Contract. See "Federal Income Tax Considerations", below. FEDERAL INCOME TAX CONSIDERATIONS The following discussion is general in nature and is not intended as tax advice. Each person concerned should consult a competent tax advisor. No attempt is made to consider any applicable state tax or other tax laws. If you invest in a variable annuity as part of a pension plan or employer-sponsored retirement program, your contract is called a Qualified Contract. If your annuity is independent of any formal retirement or pension plan, it is termed a Non-Qualified Contract. The tax rules applicable to Qualified Contracts vary according to the type of retirement plan and the terms and conditions of the plan. Because the tax benefits of annuity contracts may not be needed in the context of Qualified Contracts, you generally should not buy a Qualified Contract for the purpose of obtaining tax deferral. Taxation of Non-Qualified Contracts - ----------------------------------- Non-Natural Person. If a non-natural person (e.g., a corporation or a trust) owns a Non-Qualified Contract, the taxpayer generally must include in income any increase in the excess of the account value over the investment in the Contract (generally, the premiums or other consideration paid for the contract) during the taxable year. There are some exceptions to this rule and a prospective owner that is not a natural person should discuss these with a tax adviser. The following discussion generally applies to Contracts owned by natural persons. -55- Withdrawals. When a withdrawal from a Non-Qualified Contract occurs, the amount received will be treated as ordinary income subject to tax up to an amount equal to the excess (if any) of the account value immediately before the distribution over the Owner's investment in the Contract (generally, the premiums or other consideration paid for the Contract, reduced by any amount previously distributed from the Contract that was not subject to tax) at that time. There is no guidance on the proper tax treatment of market value adjustment and it is possible that a positive market value adjustment at the time of a Withdrawal from a Guaranteed Account may be treated as part of the Contract Value immediately prior to the distribution. A tax advisor should be consulted on this issue. In the case of a surrender under a Non-Qualified Contract, the amount received generally will be taxable only to the extent it exceeds the Owner's investment in the Contract. Penalty Tax on Certain Withdrawals. In the case of a distribution from a Non-Qualified Contract, there may be imposed a federal tax penalty equal to ten percent of the amount treated as income. In general, however, there is no penalty on distributions: o made on or after the taxpayer reaches age 59 1/2; o made on or after the death of an Owner; o attributable to the taxpayer's becoming disabled; or o made as part of a series of substantially equal periodic payments for the life (or life expectancy) of the taxpayer. Other exceptions may be applicable under certain circumstances and special rules may be applicable in connection with the exceptions enumerated above. You should consult a tax adviser with regard to exceptions from the penalty tax. Annuity Payments. Although tax consequences may vary depending on the payout option elected under an annuity contract, a portion of each annuity payment is generally not taxed and the remainder is taxed as ordinary income. The non-taxable portion of an annuity payment is generally determined in a manner that is designed to allow you to recover your investment in the contract ratably on a tax-free basis over the expected stream of annuity payments, as determined when annuity payments start. Once your investment in the contract has been fully recovered, however, the full amount of each annuity payment is subject to tax as ordinary income. Taxation of Death Benefit Proceeds. Amounts may be distributed from a Contract because of your death or the death of the Annuitant. Generally, such amounts are includible in the income of the recipient as follows: (i) if distributed in a lump sum, they are taxed in the same manner as a surrender of the Contract, or (ii) if distributed under a payout option, they are taxed in the same way as annuity payments. Transfers, Assignments or Exchanges of a Contract. A transfer or assignment of ownership of a Contract, the designation of an annuitant or payee who is not an Owner, the selection of certain maturity dates, or the exchange of a Contract may result in certain tax consequences to you that are not discussed herein. An owner contemplating any such transfer, assignment, designation or exchange, should consult a tax advisor as to the tax consequences. Withholding. Annuity distributions are generally subject to withholding for the recipient's federal income tax liability. Recipients can generally elect, however, not to have tax withheld from distributions. Multiple Contracts. All non-qualified deferred annuity contracts that are issued by us (or our affiliates) to the same owner during any calendar year are treated as one annuity contract for purposes of determining the amount includible in such owner's income when a taxable distribution occurs. -56- Taxation of Qualified Contracts - ------------------------------- The tax rules applicable to Qualified Contracts vary according to the type of retirement plan and the terms and conditions of the plan. Your rights under a Qualified Contract may be subject to the terms of the retirement plan itself, regardless of the terms of the Qualified Contract. Adverse tax consequences may result if you do not ensure that contributions, distributions and other transactions with respect to the Contract comply with the law. Individual Retirement Accounts (IRAs), as defined in Section 408 of the Internal Revenue Code (Code), permit individuals to make annual contributions up to a maximum amount specified in the Code. The contributions may be deductible in whole or in part, depending on the individual's income. Distributions from certain pension plans may be "rolled over" into an IRA on a tax-deferred basis without regard to these limits. Amounts in the IRA (other than nondeductible contributions) are taxed when distributed from the IRA. A 10% penalty tax generally applies to distributions made before age 59 1/2, unless certain exceptions apply. The Internal Revenue Service has not reviewed the Contract for qualification as an IRA, and has not addressed in a ruling of general applicability whether a death benefit provision such as the optional Enhanced Death Benefit provision in the Contract comports with IRA qualification requirements. SIMPLE IRAs permit certain small employers to establish SIMPLE plans as provided by Section 408(p) of the Code, under which employees may elect to defer to a SIMPLE IRA a percentage of compensation up to a maximum amount specified in the Code. The sponsoring employer is required to make matching or non-elective contributions on behalf of employees. Distributions from SIMPLE IRAs are subject to the same restrictions that apply to IRA distributions and are taxed as ordinary income. Subject to certain exceptions, premature distributions prior to age 59 1/2 are subject to a 10 percent penalty tax, which is increased to 25 percent if the distribution occurs within the first two years after the commencement of the employee's participation in the plan. Roth IRAs, as described in Code section 408A, permit certain eligible individuals to contribute to make non-deductible contributions to a Roth IRA in cash or as a rollover or transfer from another Roth IRA or other IRA. A rollover from or conversion of an IRA to a Roth IRA is generally subject to tax and other special rules apply. The Owner may wish to consult a tax adviser before combining any converted amounts with any other Roth IRA contributions, including any other conversion amounts from other tax years. Distributions from a Roth IRA generally are not taxed, except that, once aggregate distributions exceed contributions to the Roth IRA, income tax and a 10% penalty tax may apply to distributions made (1) before age 59 1/2 (subject to certain exceptions) or (2) during the five taxable years starting with the year in which the first contribution is made to any Roth IRA. A 10% penalty tax may apply to amounts attributable to a conversion from an IRA if they are distributed during the five taxable years beginning with the year in which the conversion was made. Corporate pension and profit-sharing plans under Section 401(a) of the Code allow corporate employers to establish various types of retirement plans for employees, and self-employed individuals to establish qualified plans for themselves and their employees. Adverse tax consequences to the retirement plan, the participant or both may result if the Contract is transferred to any individual as a means to provide benefit payments, unless the plan complies with all the requirements applicable to such benefits prior to transferring the Contract. The Contract includes an Enhanced Death Benefit that in some cases may exceed the greater of the premium payments or the account value. The Death Benefit could be characterized as an incidental benefit, the amount of which is limited in any pension or profit-sharing plan. Because the Death Benefit may exceed this limitation, employers using the Contract in connection with such plans should consult their tax adviser. Tax Sheltered Annuities under section 403(b) of the Code allow employees of certain Section 501(c)(3) organizations and public schools to exclude from their gross income the premium payments made, within certain limits, on a contract that will provide an annuity for the employee's retirement. These premium payments may be subject to FICA (social security) tax. Distributions of (1) salary reduction contributions made in years beginning after December 31, 1988; (2) earnings on those contributions; and (3) earnings on amounts held as of the last year beginning before January 1, 1989, are not allowed prior to age 59 1/2, severance from employment, death or disability. Salary reduction contributions may also be distributed upon hardship, but would generally be subject to penalties. The Contract includes an Enhanced Death Benefit that in some cases may exceed the greater of the premium payments or the account value. The Death Benefit could be characterized as an incidental benefit, the amount of which is limited in any tax-sheltered annuity. Because the Death Benefit may exceed this limitation, employers using the Contract in connection with such plans should consult their tax adviser. -57- Section 457 Plans, while not actually providing for a qualified plan as that term is normally used, provides for certain deferred compensation plans with respect to service for state governments, local governments, political subdivisions, agencies, instrumentalities and certain affiliates of such entities, and tax exempt organizations. The Contract can be used with such plans. Under such plans a participant may specify the form of investment for his or her deferred compensation account. For non-governmental Section 457 plans, all such investments are owned by and are subject to, the claims of the general creditors of the sponsoring employer. In general, all amounts received under a section 457 plan are taxable and are subject to federal income tax withholding as wages. Other Tax Issues. Qualified Contracts have minimum distribution rules that govern the timing and amount of distributions. You should refer to your retirement plan or adoption agreement, or consult a tax advisor for more information about these distribution rules. Distributions from Qualified Contracts generally are subject to withholding for the Owner's federal income tax liability. The withholding rate varies according to the type of distribution and the Owner's tax status. The Owner will be provided the opportunity to elect not have tax withheld from distributions. "Eligible rollover distributions" from section 401(a) plans, Section 403(a) annuities, and Section 403(b) plans, and governmental 457 plans are subject to a mandatory federal income tax withholding of 20%. An eligible rollover distribution is any distribution to an employee (or employee's spouse or former spouse as beneficiary or alternate payee) from such a plan, except certain distributions such as distributions required by the Code, distributions in a specified annuity form or hardship distributions. The 20% withholding does not apply, however, to non-taxable distributions if the Owner chooses a "direct rollover" from the plan to another tax-qualified plan, Section 403(b) plan, IRA or to a governmental section 457 plan that agrees to separately account for rollover contributions. Federal Estate Taxes - -------------------- While no attempt is being made to discuss the Federal estate tax implications of the Contract, a purchaser should keep in mind that the value of an annuity contract owned by a decedent and payable to a beneficiary by virtue of surviving the decedent is included in the decedent's gross estate. Depending on the terms of the annuity contract, the value of the annuity included in the gross estate may be the value of the lump sum payment payable to the designated beneficiary or the actuarial value of the payments to be received by the beneficiary. Consult an estate planning advisor for more information. Generation-skipping transfer tax. Under certain circumstances, the Code may impose a "generation skipping transfer tax" when all or part of an annuity contract is transferred to, or a death benefit is paid to, an individual two or more generations younger than the Owner. Regulations issued under the Code may require us to deduct the tax from your Contract, or from any applicable payment, and pay it directly to the IRS. Annuity purchases by nonresident aliens and foreign corporations. The discussion above provides general information regarding U.S. federal income tax consequences to annuity purchasers that are U.S. citizens or residents. Purchasers that are not U.S. citizens or residents will generally be subject to U.S. federal withholding tax on taxable distributions from annuity contracts at a 30% rate, unless a lower treaty rate applies. In addition, purchasers may be subject to state and/or municipal taxes and taxes that may be imposed by the purchaser's country of citizenship or residence. Prospective purchasers are advised to consult with a qualified tax adviser regarding U.S. state, and foreign taxation with respect to an annuity contract purchase. Foreign Tax Credits. We may benefit from any foreign tax credits attributable to taxes paid by certain portfolios to foreign jurisdictions to the extent permitted under federal tax law. -58- Possible Tax Law Changes - ------------------------ Although the likelihood of legislative changes is uncertain, there is always the possibility that the tax treatment of the Contract could change by legislation or otherwise. Consult a tax adviser with respect to legislative developments and their effect on the Contract. We have the right to modify the contract in response to legislative changes that could otherwise diminish the favorable tax treatment that annuity contract owners currently receive. We make no guarantee regarding the tax status of any contact and do not intend the above discussion as tax advice. For additional information relating to the tax status of the Contract, see the Statement of Additional Information. GENDER NEUTRALITY In 1983, the United States Supreme Court held that optional annuity benefits provided under an employee's deferred compensation plan could not, under Title VII of the Civil Rights Act of 1964 vary between men and women on the basis of sex. The Court applied its decision to benefits derived from contributions made on or after August 1, 1983. Lower federal courts have since held that the Title VII prohibition of sex-distinct benefits may apply at an earlier date. In addition, some states prohibit using sex-distinct mortality tables. The Contract uses sex-distinct actuarial tables, unless state law requires the use of sex-neutral actuarial tables. As a result, the Contract generally provides different benefits to men and women of the same age. Employers and employee organizations which may consider buying Contracts in connection with any employment-related insurance or benefits program should consult their legal advisors to determine whether the Contract is appropriate for this purpose. VOTING RIGHTS Voting rights under the Contracts apply only with respect to Net Premium Payments or accumulated amounts allocated to the Variable Account. In accordance with our view of present applicable law, we vote the shares of the Funds held in the Variable Account at regular and special meetings of the shareholders of the Funds. These shares are voted in accordance with instructions received from you if you have an interest in the Variable Account. If the Investment Company Act or any regulation thereunder should be amended or if the present interpretation thereof should change, and as a result we determine that we are permitted to vote the shares of the Funds in our own right, we may elect to do so. The person having the voting interest under a Contract is the Owner. The number of Fund shares attributable to each Owner is determined by dividing the Owner's interest in each Subaccount by the net asset value of the Fund corresponding to the Subaccount. We determine the number of full and fractional shares which a person has the right to vote on a date we choose not more than 90 days prior to the meeting of the Fund. We solicit voting instructions by written communication at least 21 days prior to such meeting. We vote Fund shares held in the Variable Account as to which no timely instructions are received in the same proportions as the voting instructions we receive with respect to all contracts participating in the Variable Account. Each person having a voting interest will receive periodic reports relating to the Funds, proxy material and a form with which to give such voting instructions. -59- CHANGES TO VARIABLE ACCOUNT We reserve the right to create one or more new separate accounts, combine or substitute separate accounts, or to add new investment Funds for use in the Contracts at any time. In addition, if the shares of the Funds described in this Prospectus should no longer be available for investment by the Variable Account or, if in our judgment further investment in such Fund shares should become inappropriate, we may eliminate Subaccounts, combine two or more Subaccounts or substitute one or more Funds for other Fund shares already purchased or to be purchased in the future under the Contract. The other Funds may have higher fees and charges than the ones they replaced, and not all Funds may be available to all classes of Contracts. No substitution of securities in the Variable Account may take place without prior approval of the Securities and Exchange Commission and under such requirements as it may impose. We may also operate the Variable Account as a management investment company under the Investment Company Act, deregister the Variable Account under the Investment Company Act (if such registration is no longer required), transfer all or part of the assets of the Variable Account to another separate account or to the Fixed Account (subject to obtaining all necessary regulatory approvals), and make any other changes reasonably necessary under the Investment Company Act or applicable state law. DISTRIBUTION OF THE CONTRACTS We have entered into a distribution agreement with ESI for the distribution and sale of the Contracts. ESI is an SEC-registered broker-dealer firm and is a member of the National Association of Securities Dealers, Inc. More information about ESI and its registered persons is available at http://www.nasdr.com or by calling 1-800-289-9999. You can also obtain an investor brochure from NASD Regulation describing its Public Disclosure Program. ESI is a wholly-owned subsidiary of National Life. It distributes a full line of securities products, including mutual funds, unit investment trusts, and variable insurance contracts, and provides individual securities brokerage services. You may purchase a Contract through a registered representative of ESI, and you may also purchase a Contract from another broker-dealer which has a selling agreement with ESI. The maximum payment to a dealer for selling the Contracts will generally be 6.5%; however, during certain promotional periods the dealer concession, or commission, may vary. These promotional periods will be determined by National Life and the maximum dealer concession paid during these periods will not exceed 7.0%. We will pay the dealer concession, at the election of the registered representative, either as a percentage of the Premium Payment at the time it is paid, as a percentage of Contract Value over time, or a combination of both. Registered representatives of ESI may also be eligible for bonuses, fringe benefits, financing arrangements, conferences, trips, prizes and awards. From time to time we may also offer specific sales incentives to selling dealers and registered representatives. These incentives may take the form of cash bonuses for reaching certain sales levels or for attaining a high ranking among registered representatives based on sales levels. These incentive programs may also include sales of National Life's or their affiliates' other products. To the extent, if any, that such bonuses are attributable to the sale of variable products, including the Contracts, such bonuses will be paid through the agent's broker-dealer. A portion of the payments made to selling broker-dealers will be passed on to their sales representatives in accordance with their internal compensation programs. Those programs may also include other types of cash and non-cash compensation and other benefits. You may ask your sales representative for further information about what your sales representative and the selling broker-dealer for which he or she works may receive in connection with your purchase of a Contract. National Life may provide loans to unaffiliated distribution firms to finance business development, and may then provide further loans or may forgive outstanding loans based on specified business criteria, including sales of variable and fixed life insurance and annuity products, and measures of business quality. Any further loans or forgiveness of outstanding loans based on sales of variable insurance or annuity products are provided through the distribution firm's registered broker-dealer. Commissions and other incentives or payments described above are not charged directly to Contract owners or the Variable Account. We intend to recoup commission and other sales expenses through fees and charges deducted under the Contract. The Franklin Templeton, Scudder and T. Rowe Price Funds offered in the Contracts, and the Fasciano Portfolio of Neuberger Berman Advisers Management, Trust make payments to ESI under their distribution plans in consideration of services provided and expenses incurred by ESI in distributing shares of these Funds. In each case these payments amount to 0.25% of Variable Account assets invested in the particular Fund. -60- FINANCIAL STATEMENTS National Life's financial statements as of and for the years ended December 31, 2005 and 2004, which are included in the Statement of Additional Information, should be considered only as bearing on National Life's ability to meet its obligations under the Contracts. They should not be considered as bearing on the investment performance of the assets held in the Variable Account. STATEMENTS AND REPORTS National Life will mail to Owners, at their last known address of record, any statements and reports required by applicable laws or regulations. Owners should therefore give National Life prompt notice of any address change. National Life will send a confirmation statement to Owners each time a transaction is made affecting the Owner's Variable Account Contract Value, such as making additional Premium Payments, transfers, exchanges or Withdrawals. Quarterly statements are also mailed detailing the Contract activity during the calendar quarter. Instead of receiving an immediate confirmation of transactions made pursuant to some types of periodic payment plans (such as a dollar cost averaging program) or salary reduction arrangement, the Owner may receive confirmation of such transactions in their quarterly statements. The Owner should review the information in these statements carefully. All errors or corrections must be reported to National Life immediately to assure proper crediting to the Owner's Contract. National Life will assume all transactions are accurately reported on quarterly statements or confirmation statements unless the Owner notifies National Life otherwise within 30 days after receipt of the statement. OWNER INQUIRIES Owner inquiries may be directed to National Life by writing to us at National Life Drive, Montpelier, Vermont 05604, or calling 1-800-732-8939. LEGAL PROCEEDINGS The Company, like other life insurance companies, is involved in lawsuits, including class action lawsuits. In some class action and other lawsuits involving insurance companies, substantial damages have been sought and/or material settlement payments have been made. Although the Company cannot predict the outcome of any litigation with certainty, the Company believes that at the present time, there are no pending or threatened lawsuits that are reasonably likely to have a material adverse impact on it or the Variable Account. ESI is not engaged in any litigation of any material nature. -61- GLOSSARY ACCUMULATION UNIT - An accounting unit of measure used to calculate the Variable Account Contract Value prior to the Annuitization Date. ANNUITANT - A person named in the Contract who is expected to become, at Annuitization, the person upon whose continuation of life any annuity payments involving life contingencies depends. Unless the Owner is a different individual who is age 85 or younger, this person must be age 85 or younger at the time of Contract issuance unless National Life has approved a request for an Annuitant of greater age. The Owner may change the Annuitant prior to the Annuitization Date, as set forth in the Contract. ANNUITIZATION - The period during which annuity payments are received. ANNUITIZATION DATE - The date on which annuity payments commence. ANNUITY PAYMENT OPTION - The chosen form of annuity payments. Several options are available under the Contract. ANNUITY UNIT - An accounting unit of measure used to calculate the value of Variable Annuity payments. BENEFICIARY - The Beneficiary is the person designated to receive certain benefits under the Contract upon the death of the Owner or Annuitant prior to the Annuitization Date. The Beneficiary can be changed by the Owner as set forth in the Contract. CASH SURRENDER VALUE - An amount equal to Contract Value, minus any applicable Contingent Deferred Sales Charge, minus any applicable premium tax charge. CHOSEN HUMAN BEING - An individual named at the time of Annuitization upon whose continuance of life any annuity payments involving life contingencies depends. CODE - The Internal Revenue Code of 1986, as amended. COLLATERAL FIXED ACCOUNT - The portion of the Fixed Account which holds value that secures a loan on the Contract. CONTRACT ANNIVERSARY - An anniversary of the Date of Issue of the Contract. CONTRACT VALUE - The sum of the value of all Variable Account Accumulation Units attributable to the Contract, plus any amount held under the Contract in the Fixed Account, plus any amounts held in the Guaranteed Accounts, and minus any outstanding loan and accrued interest on such loans. CONTRACT YEAR - Each year the Contract remains in force commencing with the Date of Issue. DATE OF ISSUE - The date shown as the Date of Issue on the Data Page of the Contract. DEATH BENEFIT - The benefit payable to the Beneficiary upon the death of the Owner or the Annuitant. DISTRIBUTION - Any payment of part or all of the Contract Value. FIXED ACCOUNT - The Fixed Account is part of National Life's general account and Guaranteed Accounts. made up of all assets of National Life other than those in the Variable Account or any other segregated asset account of National Life. FIXED ANNUITY - An annuity providing for payments which are guaranteed by National Life as to dollar amount during Annuitization. FUND - A registered management investment company in which the assets of a Subaccount of the Variable Account will be invested. -62- GUARANTEED ACCOUNT - A Guaranteed Account is part of National Life's general account. We guarantee a specified interest rate for the entire time an investment remains in the Guaranteed Account. INDIVIDUAL RETIREMENT ANNUITY (IRA) - An annuity which qualifies for favorable tax treatment under Section 408 of the Code. INVESTMENT COMPANY ACT - The Investment Company Act of 1940, as amended from time to time. JOINT OWNERS - Two or more persons who own the Contract as tenants in common or as joint tenants. If joint owners are named, references to "Owner" in this prospectus will apply to both of the Joint Owners. MATURITY DATE - The date on which annuity payments are scheduled to commence. The Maturity Date is shown on the Data Page of the Contract, and is subject to change by the Owner, within any applicable legal limits, subject to National Life's approval. MONTHLY CONTRACT DATE - The day in each calendar month which is the same day of the month as the Date of Issue, or the last day of any month having no such date, except that whenever the Monthly Contract Date would otherwise fall on a date other than a Valuation Day, the Monthly Contract Date will be deemed to be the next Valuation Day. NON-QUALIFIED CONTRACT - A Contract which does not qualify for favorable tax treatment under the provisions of Sections 401 or 403(a) (Qualified Plans), 408 (IRA's), 408A (Roth IRA's), 403(b) (Tax-Sheltered Annuities), or 457 of the Code. OWNER ("YOU") - The Owner is the person who possesses all rights under the Contract, including the right to designate and change any designations of the Owner, Annuitant, Beneficiary, Annuity Payment Option, and the Maturity Date. PAYEE - The person who is designated at the time of Annuitization to receive the proceeds of the Contract upon Annuitization. PREMIUM PAYMENT - A deposit of new value into the Contract. The term "Premium Payment" does not include transfers among the Variable Account, Fixed Account, and Guaranteed Accounts, or among the Subaccounts. NET PREMIUM PAYMENTS - The total of all Premium Payments made under the Contract, less any premium tax deducted from premiums. QUALIFIED CONTRACT - A Contract which qualifies for favorable tax treatment under the provisions of Sections 401 or 403(a) (Qualified Plans), 408 (IRA's), 408A (Roth IRA's), 403(b) (Tax-Sheltered Annuities) or 457 of the Code. QUALIFIED PLANS - Retirement plans which receive favorable tax treatment under section 401 or 403(a) of the Code. SUBACCOUNTS - Separate and distinct divisions of the Variable Account that purchase shares of underlying Funds. Separate Accumulation Units and Annuity Units are maintained for each Subaccount. TAX-SHELTERED ANNUITY - An annuity which qualifies for favorable tax treatment under section 403(b) of the Code. VALUATION DAY - Each day the New York Stock Exchange is open for business other than any day on which trading is restricted. Unless otherwise indicated, when an event occurs or a transaction is to be effected on a day that is not a Valuation Day, it will be effected on the next Valuation Day. A Valuation Day ends at the close of regular trading of the New York Stock Exchange. VALUATION PERIOD - The time between two successive Valuation Days. VARIABLE ACCOUNT -The National Variable Annuity Account II, a separate investment account of National Life into which Net Premium Payments under the Contracts are allocated. The Variable Account is divided into Subaccounts, each of which invests in the shares of a separate underlying Fund. VARIABLE ANNUITY - An annuity the accumulated value of which varies with the investment experience of a separate account. WITHDRAWAL - A payment made at the request of the Owner pursuant to the right to withdraw a portion of the Contract Value of the Contract. -63- STATEMENT OF ADDITIONAL INFORMATION TABLE OF CONTENTS Page Additional Contract Provisions............................................1 The Contract.....................................................1 Misstatement of Age or Sex.......................................1 Dividends........................................................1 Assignment.......................................................1 Contractual Arrangements Between National Life and the Funds' Investment Advisors or Distributors.....................................1 Tax Status of the Contracts...............................................2 Distribution of the Contracts.............................................3 Safekeeping of Account Assets.............................................3 State Regulation..........................................................3 Records and Reports.......................................................3 Legal Matters.............................................................4 Experts .................................................................4 Other Information.........................................................4 Financial Statements......................................................4 Financial Statements......................................................F-1 The Statement of Additional Information contains more detailed information about the Contracts than is contained in this Prospectus. The Statement of Additional information is incorporated by reference into this Prospectus and is legally a part of this Prospectus. -64- NATIONAL LIFE INSURANCE COMPANY NATIONAL VARIABLE ANNUITY ACCOUNT II SENTINEL ADVANTAGE VARIABLE ANNUITY CONTRACT STATEMENT OF ADDITIONAL INFORMATION OFFERED BY NATIONAL LIFE INSURANCE COMPANY One National Life Drive Montpelier, Vermont 05604 This Statement of Additional Information expands upon subjects discussed in the current Prospectus for the Sentinel Advantage Variable Annuity Contract ("Contract") offered by National Life Insurance Company. You may obtain a copy of the Prospectus dated May 1, 2006 by calling 1-800-732-8939, by writing to National Life Insurance Company, One National Life Drive, Montpelier, Vermont 05604 or by accessing the SEC's website at http://www.sec.gov. Definitions of terms used in the current Prospectus for the Contract are incorporated in this Statement of Additional Information. This statement of additional information is not a prospectus and should be read only in conjunction with the prospectus for the contract. Dated May 1, 2006 TABLE OF CONTENTS Page Additional Contract Provisions..............................................1 The Contract.......................................................1 Misstatement of Age or Sex.........................................1 Dividends..........................................................1 Assignment.........................................................1 Contractual Arrangements Between National Life and the Funds' Investment Advisors or Distributors.......................................1 Tax Status of the Contracts.................................................2 Distribution of the Contracts...............................................3 Safekeeping of Account Assets...............................................3 State Regulation............................................................3 Records and Reports.........................................................3 Legal Matters...............................................................4 Experts ...................................................................4 Other Information...........................................................4 Financial Statements........................................................4 Financial Statements........................................................F-1 ADDITIONAL CONTRACT PROVISIONS The Contract - ------------ The entire contract is made up of the Contract and the application. The statements made in the application are deemed representations and not warranties. National Life Insurance Company ("National Life" or "we") cannot use any statement in defense of a claim or to void the Contract unless it is contained in the application and a copy of the application is attached to the Contract at issue. Misstatement of Age or Sex - -------------------------- If the age or sex of the Chosen Human Being has been misstated, the amount which will be paid is that which is appropriate to the correct age and sex. Dividends - --------- The Contract is participating; however, no dividends are expected to be paid on the Contract. If dividends are ever declared, they will be paid in cash. Assignment - ---------- Where permitted, the Owner may assign some or all of the rights under the Contract at any time during the lifetime of the Annuitant prior to the Annuitization Date. Such assignment will take effect upon receipt and recording by National Life at its Home Office of a written notice executed by the Owner. National Life assumes no responsibility for the validity or tax consequences of any assignment. National Life shall not be liable as to any payment or other settlement made by National Life before recording of the assignment. Where necessary for the proper administration of the terms of the Contract, an assignment will not be recorded until National Life has received sufficient direction from the Owner and assignee as to the proper allocation of Contract rights under the assignment. Any portion of Contract Value which is pledged or assigned shall be treated as a Distribution and shall be included in gross income to the extent that the cash value exceeds the investment in the Contract for the taxable year in which assigned or pledged. In addition, any Contract Values assigned may, under certain conditions, be subject to a tax penalty equal to 10% of the amount which is included in gross income. Assignment of the entire Contract Value may cause the portion of the Contract Value which exceeds the total investment in the Contract and previously taxed amounts to be included in gross income for federal income tax purposes each year that the assignment is in effect. Qualified Contracts are not eligible for assignment. CONTRACTUAL ARRANGEMENTS BETWEEN NATIONAL LIFE AND THE FUNDS' INVESTMENT ADVISORS OR DISTRIBUTORS We have entered into or may enter into agreements with Funds pursuant to which the advisor or distributor pays us a fee based upon an annual percentage of the average net asset amount we invest on behalf of the Variable Account and our other separate accounts. These percentages may differ, and we may be paid a greater percentage by some investment advisors or distributors than other advisors or distributors. These agreements reflect administrative services provided by us. National Life and/or ESI receives compensation from the adviser or distributor of the Funds in connection with administration, distribution, or other services provided with respect to the Fund and its availability through the Contracts. The amount of this compensation with respect to the Contracts during 2005, which is based upon the indicated percentages of assets of each Fund attributable to the Contracts, is shown below: -1-
- ----------------------------------------------------- ----------------- ----------------------------- Portfolios of the % of Assets Revenues Received By National Life During 2005 - ----------------------------------------------------- ----------------- ----------------------------- AIM Variable Insurance Funds Series 0.25% $17,327 - ----------------------------------------------------- ----------------- ----------------------------- Alger American Fund 0.10% $14,768 - ----------------------------------------------------- ----------------- ----------------------------- American Century Variable Portfolios, Inc. 0.25%(1) $72,686 - ----------------------------------------------------- ----------------- ----------------------------- Dreyfus Variable Investment Fund and 0.20% $10,491 Dreyfus Socially Responsible Growth Fund, Inc. - ----------------------------------------------------- ----------------- ----------------------------- Fidelity(R) Variable Insurance Products 0.10%(2) $87,311 - ----------------------------------------------------- ----------------- ----------------------------- Franklin Templeton Variable Insurance Products Trust 0.35%(3) $22,081 - ----------------------------------------------------- ----------------- ----------------------------- J.P. Morgan Series Trust II 0.20% $9,263 - ----------------------------------------------------- ----------------- ----------------------------- Neuberger Berman Advisers Management Trust 0.15%(4) $21,600 - ----------------------------------------------------- ----------------- ----------------------------- Scudder Variable Series II 0.40%(3) $4,304 - ----------------------------------------------------- ----------------- ----------------------------- T. Rowe Price Equity Series, Inc. 0.25%(5) $15,571 - ----------------------------------------------------- ----------------- ----------------------------- Wells Fargo Variable Trust 0.25(3)% $40,060 - ----------------------------------------------------- ----------------- -----------------------------
(1) 0.10% on the VP Inflation Protection Portfolio. (2) 0.05% with respect to the Index 500 Portfolio. (3) Includes 0.25% payable under the Fund's 12b-1 Plan. (4) The Fasciano Portfolio offers only an S-Series class, which has a 0.25% 12b-1 fee which is also paid to ESI. (5) The 0.25% payment shown in the table is payable under the Fund's 12b-1 plan. In addition, the Fund's adviser will pay to National Life for administrative services an amount equal to 0.15% of the amount, if any, by which the shares held by National Life separate accounts exceed $25 million. These arrangements may change from time to time, and may include more Funds in the future. TAX STATUS OF THE CONTRACTS Tax law imposes several requirements that variable annuities must satisfy in order to receive the tax treatment normally accorded to annuity contracts. Diversification Requirements. The Internal Revenue Code (Code) requires that the investments of each investment division of the separate account underlying the Contracts be "adequately diversified" in order for the Contracts to be treated as annuity contracts for Federal income tax purposes. It is intended that each investment division, through the fund in which it invests, will satisfy these diversification requirements. Owner Control. In some circumstances, owners of variable annuity contracts who retain excessive control over the investment of the underlying separate account assets may be treated as the owners of those assets and may be subject to tax on income produced by those assets. Although published guidance in this area does not address certain aspects of our Contracts, we believe that the Owner of a Contract should not be treated as the owner of the assets of the separate account. We reserve the right to modify the Contracts to bring them into conformity with applicable standards should such modification be necessary to prevent Contract Owners from being treated as the owner of the underlying assets of the separate account asset. Required Distributions. In order to be treated as an annuity contract for Federal income tax purposes, Section 72(s) of the Code requires any Non-Qualified Contract to contain certain provisions specifying how your interest in the Contract will be distributed in the event of the death of an owner of the Contract. Specifically, section 72(s) requires that (a) if any owner dies on or after the annuity starting date, but prior to the time the entire interest in the contract has been distributed, the entire interest in the contract will be distributed at least as rapidly as under the method of distribution being used as of the date of such owner's death; and (b) if any owner dies prior to the annuity starting date, the entire interest in the contract will be distributed within five years after the date of such owner's death. These requirements will be considered satisfied as to any portion of a owner's interest which is payable to or for the benefit of a designated beneficiary and which is distributed over the life of such designated beneficiary or over a period not extending beyond the life expectancy of that beneficiary, provided that such distributions begin within one year of the owner's death. The designated beneficiary refers to a natural person designated by the owner as a beneficiary and to whom ownership of the contract passes by reason of death. However, if the designated beneficiary is the surviving spouse of the deceased owner, the contract may be continued with the surviving spouse as the new owner. -2- The Non-Qualified Contracts contain provisions that are intended to comply with these Code requirements, although no regulations interpreting these requirements have yet been issued. We intend to review such provisions and modify them if necessary to assure that they comply with the applicable requirements when such requirements are clarified by regulation or otherwise. Other rules may apply to Qualified Contracts. DISTRIBUTION OF THE CONTRACTS Equity Services, Inc. ("ESI") is responsible for distributing the Contracts pursuant to a distribution agreement with us. ESI serves as principal underwriter for the Contracts. ESI, a Vermont corporation and an affiliate of National Life, is located at One National Life Drive, Montpelier, Vermont 05604. We offer the Contracts to the public on a continuous basis through ESI. We anticipate continuing to offer the Contracts, but reserve the right to discontinue the offering. ESI offers the Contracts through its sales representatives. ESI has also entered into selling agreements with other broker-dealers for sales of the Contracts through their sales representatives. Sales representatives must be licensed as insurance agents and appointed by us. We pay commissions to ESI for sales of the Contracts. Commissions paid on the Contracts, as well as other incentives or payments, are not charged directly to the Contract Owners or the Variable Account. We intend to recoup commissions and other sales expenses through fees and charges imposed under the Contract. ESI received sales compensation in connection with the Contracts in the following amounts during the periods indicated: - ------------- ----------------------------- ------------------------------------ Fiscal Year Aggregate Amount of Aggregate Amount of Commissions Commissions Paid to ESI* Retained by ESI After Payments to its Registered Persons and Other Broker-Dealers - ------------- ----------------------------- ------------------------------------ 2003 $3,032,880 $71,531 - ------------- ----------------------------- ------------------------------------ 2004 $5,496,577 $441,162 - ------------- ----------------------------- ------------------------------------ 2005 $3,997,084 $389,450 - ------------- ----------------------------- ------------------------------------ * Includes sales compensation paid to registered persons of ESI. From time to time National Life, in conjunction with ESI, may conduct special sales programs. SAFEKEEPING OF ACCOUNT ASSETS National Life holds the title to the assets of the Variable Account. The assets are kept physically segregated and held separate and apart from the Company's General Account assets and from the assets in any other separate account. Records are maintained of all purchases and redemptions of Fund shares held by each of the Subaccounts. -3- STATE REGULATION National Life is subject to regulation and supervision by the Insurance Department of the State of Vermont which periodically examines its affairs. It is also subject to the insurance laws and regulations of all jurisdictions where it is authorized to do business. A copy of the Contract form has been filed with, and where required approved by, insurance officials in each jurisdiction where the Contracts are sold. National Life is required to submit annual statements of its operations, including financial statements, to the insurance departments of the various jurisdictions in which it does business for the purposes of determining solvency and compliance with local insurance laws and regulations. RECORDS AND REPORTS National Life will maintain all records and accounts relating to the Variable Account. As presently required by the Investment Company Act of 1940 and regulations promulgated thereunder, reports containing such information as may be required under the Act or by any other applicable law or regulation will be sent to Contract Owners semi-annually at the last address known to the Company. LEGAL MATTERS All matters relating to Vermont law pertaining to the Contracts, including the validity of the Contracts and National Life's authority to issue the Contracts, have been passed upon by Kerry A. Jung, Senior Counsel of National Life. Sutherland Asbill & Brennan LLP of Washington, D.C. has provided advice on certain matters relating to the Federal securities laws. EXPERTS The financial statements of National Life as of and for the years ended December 31, 2005 and 2004, and the financial statements of the Variable Account as of and for the years ended December 31, 2005 and 2004, which are included in this Statement of Additional Information and in the registration statement, have been audited by PricewaterhouseCoopers LLP, independent registered public accounting firm, of 125 High Street, Boston, Massachusetts 02110 , as set forth in its report included herein, and are included herein in reliance upon such report and upon the authority of such firm as experts in accounting and auditing. OTHER INFORMATION A registration statement has been filed with the SEC under the Securities Act of 1933 as amended, with respect to the Contracts discussed in this Statement of Additional Information. Not all the information set forth in the registration statement, amendments and exhibits thereto has been included in this Statement of Additional Information. Statements contained in this Statement of Additional Information concerning the content of the Contracts and other legal instruments are intended to be summaries. For a complete statement of the terms of these documents, reference should be made to the instruments filed with the SEC at 100 F. Street, N.E., Washington, D.C. 20549. FINANCIAL STATEMENTS The financial statements of National Life and of the relevant Subaccounts of the Separate Account appear on the following pages. The 2004 and 2003 financial statements of National Life filed with the SEC on May 2, 2005 (Post Effective Amendment No. 18, 1940 and 1933 SEC File numbers 811-08015 and 333-19583) are incorporated herein by reference. The financial statements of National Life should be distinguished from the financial statements of the Separate Account and should be considered only as bearing upon National Life's ability to meet its obligations under the Policies. -4- NATIONAL LIFE INSURANCE COMPANY * * * * * FINANCIAL STATEMENTS AND SUPPLEMENTAL SCHEDULES (STATUTORY BASIS) * * * * * DECEMBER 31, 2005 AND 2004 F-1 NATIONAL LIFE INSURANCE COMPANY FINANCIAL STATEMENTS - STATUTORY BASIS FOR THE YEAR ENDED DECEMBER 31, 2005 Pages Report of Independent Registered Public Accounting Firm F-3 Statement of Admitted Assets, Liabilties and Capital and Surplus - Statutory Basis F-4 Statement of Operations - Statutory Basis F-5 Statement of Cash Flows - Statutory Basis F-6 Notes to Statutory Basis Financial Statements F-7 F-2 [LETTERHEAD, PRICEWATERHOUSECOOPERS] REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholder of National Life Insurance Company: We have audited the accompanying statutory statements of admitted assets, liabilities, and capital and surplus of National Life Insurance Company (the "Company") as of December 31, 2005 and 2004, and the related statutory statements of income, capital and surplus, and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. As described in Note 2 to the financial statements, the Company prepared these financial statements using accounting practices prescribed or permitted by the Vermont Department of Banking, Insurance, Securities and Health Care Administration, which practices differ from accounting principles generally accepted in the United States of America. The effects on the financial statements of the variances between such practices and accounting principles generally accepted in the United States of America are material and are disclosed in Note 12. In our opinion, because of the effects of the matter discussed in the preceding paragraph, the financial statements referred to above do not present fairly, in conformity with accounting principles generally accepted in the United States of America, the financial position of the Company as of December 31, 2005 and 2004, or the results of its operations or its cash flows for the years then ended. In our opinion, the financial statements referred to above present fairly, in all material respects, the admitted assets, liabilities, capital stock and surplus of the Company as of December 31, 2005 and 2004, and the results of its operations and its cash flows for the years then ended, on the basis of accounting described in Note 2. /s/ PricewaterhouseCoopers LLP April 7, 2006 F-3 NATIONAL LIFE INSURANCE COMPANY STATEMENTS OF ADMITTED ASSETS, LIABILITIES, CAPITAL AND SURPLUS DECEMBER 31,
(IN THOUSANDS) 2005 2004 ---------- ---------- ADMITTED ASSETS: Cash and short-term investments $ 33,457 $ 40,665 Bonds 4,657,465 4,426,164 Preferred stocks 70,644 71,146 Common stocks 261,315 251,437 Mortgage loans 910,544 948,947 Policy loans 570,647 584,053 Real estate investments 5,808 9,279 Home office properties 40,956 40,910 Other invested assets 140,005 99,213 ---------- ---------- Total cash and invested assets 6,690,841 6,471,814 Due and deferred premiums 73,806 74,258 Due and accrued investment income 79,349 79,051 Deferred income taxes 76,982 51,156 Federal income taxes recoverable 722 9,108 Other assets 137,194 125,729 Separate account assets 843,072 782,360 ---------- ---------- Total admitted assets $7,901,966 $7,593,476 ========== ========== LIABILITIES: Policy and other contract reserves $5,760,888 $5,679,400 Policyholders' deposits 167,159 176,840 Claims in process of settlement 28,241 29,889 Policyholders' dividends 124,068 133,698 Interest maintenance reserve 61,021 64,743 Asset valuation reserve 67,053 77,253 Broker deposits on loaned securities -- 14,340 Minimum pension benefit obligation 60,410 27,641 Other liabilities 169,536 67,644 Separate account liabilities 840,125 779,591 ---------- ---------- Total liabilities 7,278,501 7,051,039 ---------- ---------- CAPITAL AND SURPLUS: Common stock (authorized 2.5 million shares at $1 par value, 2.5 million shares issued and outstanding) 2,500 2,500 Additional paid-in capital 107,123 107,123 Unassigned surplus 513,842 432,814 ---------- ---------- Total capital and surplus 623,465 542,437 ---------- ---------- Total liabilities, capital and surplus $7,901,966 $7,593,476 ========== ==========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS. F-4 NATIONAL LIFE INSURANCE COMPANY STATEMENTS OF INCOME AND CAPITAL AND SURPLUS FOR THE YEARS ENDED DECEMBER 31,
(IN THOUSANDS) 2005 2004 ---------- ---------- INCOME: Premiums and annuity considerations for life and accident health contracts $ 559,536 $ 641,063 Considerations for supplementary contracts with life contingencies 2,387 2,533 Net investment income and interest maintenance reserve amortization 495,760 420,535 Other (expense) income, net (4,339) (11,729) ---------- ---------- Total income 1,053,344 1,052,402 ---------- ---------- EXPENSES: Benefits 516,824 545,182 Increase in reserves 104,288 136,136 Commissions and operating expenses 173,896 174,751 ---------- ---------- Total expenses 795,008 856,069 ---------- ---------- Net gain from operations before dividends and federal income taxes 258,336 196,333 Dividends to policyholders 119,561 129,846 ---------- ---------- Net gain from operations before federal income taxes 138,775 66,487 Federal income tax expense 12,437 4,686 ---------- ---------- Net gain from operations 126,338 61,801 Net realized (losses) gains (33,965) 3,366 ---------- ---------- NET INCOME 92,373 65,167 ADJUSTMENTS TO SURPLUS: Unrealized (losses) gains, net of deferred tax effects (7,945) 24,902 Change in asset valuation reserve 10,200 (14,202) Change in minimum pension benefit obligation, net of deferred tax effects (21,300) 449 Change in non-admitted assets 62,593 2,556 Decrease in surplus notes, net -- (62,739) Change in deferred tax asset, net (54,580) (12,469) Additional paid-in capital -- 72,724 Dividends to stockholder (9,312) -- Other adjustments to surplus, net 8,999 13,659 ---------- ---------- Increase in capital and surplus 81,028 90,047 CAPITAL AND SURPLUS: Beginning of year 542,437 452,390 ---------- ---------- End of year $ 623,465 $ 542,437 ========== ==========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS. F-5 NATIONAL LIFE INSURANCE COMPANY STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, (IN THOUSANDS) 2005 2004 ------------ ------------ OPERATING ACTIVITIES: Premiums, policy proceeds, and other considerations received, net of reinsurance paid $ 563,748 $ 643,465 Net investment income received 498,578 436,948 Benefits paid (518,232) (541,105) Net transfers to Separate Accounts (23,741) (58,671) Insurance expenses paid (143,646) (209,651) Dividends paid to policyholders (129,191) (130,569) Federal income taxes (paid) recovered (4,473) 888 Other income received, net of other expenses paid (4,340) (14,296) ------------ ------------ Net cash provided by operations 238,703 127,009 ------------ ------------ INVESTMENT ACTIVITIES: Proceeds from sales, maturities, or repayments of investments: Bonds 1,731,219 2,308,095 Stocks 12,703 15,872 Mortgage loans 143,392 163,687 Real estate 2,231 618 Other invested assets 99,811 39,209 Miscellaneous proceeds 207 -- ------------ ------------ Total proceeds from sales, maturities, or repayments of investments 1,989,563 2,527,481 Cost of investments acquired: Bonds (1,974,676) (2,515,981) Stocks (30,348) (32,027) Mortgage loans (104,989) (150,776) Real estate (1,789) (1,623) Other invested assets (148,115) (19,957) Miscellaneous applications (9,345) -- ------------ ------------ Total cost of investments acquired (2,269,262) (2,720,364) Net change in contract loans 13,405 34,138 ------------ ------------ Net cash used in investing activities (266,294) (158,745) ------------ ------------ FINANCING AND MISCELLANEOUS ACTIVITIES: Other cash provided (applied): Retirement of surplus notes -- (62,739) Capital and paid in surplus -- 72,724 Deposits on deposit-type contract funds and other liabilities without life contingencies (16,387) (4,648) Other cash provided (applied) 36,770 (30,058) ------------ ------------ Net cash provided by (used in) financing and miscellaneous 20,383 (24,721) ------------ ------------ Net decrease in cash and short-term investments (7,208) (56,457) Cash and short-term investments: Beginning of year 40,665 97,122 ------------ ------------ End of year $ 33,457 $ 40,665 ============ ============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PAR OF THESE FINANCIAL STATEMENTS F-6 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS NOTE 1 - NATURE OF OPERATIONS National Life Insurance Company (the "Company") is primarily engaged in the development and distribution of traditional and universal individual life insurance and annuity products. Through affiliates, it also provides distribution and investment advisory services to the Sentinel Group Funds, Inc., a family of mutual funds. The Company's insurance and annuity products are primarily marketed through a general agency system. On January 1, 1999, pursuant to a mutual holding company reorganization, the Company converted from a mutual to a stock life insurance company. This reorganization was approved by policyowners of National Life and was completed with the approval of the Vermont Commissioner of Insurance (the "Commissioner"). Concurrent with the conversion to a stock life insurance company, National Life established and began operating the Closed Block. The Closed Block was established on January 1, 1999 pursuant to regulatory requirements as part of the reorganization into a mutual holding company corporate structure. The Closed Block was established for the benefit of policyholders of participating policies inforce at December 31, 1998. Included in the block are traditional dividend paying life insurance policies, certain participating term insurance policies, dividend paying flexible premium annuities, and other related liabilities. The Closed Block was established to protect the policy dividend expectations related to these policies. The Closed Block is expected to remain in effect until all policies within the Closed Block are no longer inforce. Assets assigned to the Closed Block at January 1, 1999, together with projected future premiums and investment returns, are reasonably expected to be sufficient to pay out all future Closed Block policy benefits. Such benefits include policyholder dividends paid out under the current dividend scale, adjusted to reflect future changes in the underlying experience. See Note 14 for additional information on the Closed Block. All of the Company's outstanding shares are currently held by its parent, NLV Financial Corp ("NLVF"), which is the wholly-owned subsidiary of National Life Holding Company ("NLHC"). NLHC and its subsidiaries (including the Company) are collectively known as the National Life Group. The Company is licensed in all 50 states and the District of Columbia. Approximately 25% of total collected premiums and deposits are from residents of the states of New York and California. NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The accompanying financial statements of the Company have been prepared in conformity with statutory accounting practices prescribed or permitted by the State of Vermont Department of Banking, Insurance, Securities and Health Care Administration (the "Department"), which is a comprehensive basis of accounting other than accounting principles generally accepted in the United States of America ("GAAP"). The Department recognizes only statutory accounting practices prescribed or permitted by the State of Vermont for determining solvency under Vermont Insurance Law. The National Association of Insurance Commissioners' ("NAIC") Accounting Practices and Procedures Manual - version effective January 1, 2001 (and as amended) ("NAIC SAP"), has been adopted as a component of prescribed or permitted practices by the Department. NAIC SAP consists of Statements of Statutory Accounting Principles ("SSAPs") and other authoritative guidance. Although no such practices were in effect at the Company as of December 31, 2005, the Commissioner has the right to permit specific practices that deviate from NAIC SAP. F-7 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) There are significant differences between statutory accounting practices and GAAP. Under statutory accounting practices: o The costs related to acquiring business, principally commissions and certain policy issue expenses, are charged to income in the year incurred; o Statutory concepts such as non-admitted assets, asset valuation reserve, and interest maintenance reserve are required; o Bonds and preferred stocks are carried at amortized cost and cost, respectively; o Reserves for participating life policies are calculated using various methods allowed under statutory accounting; Statutory reserve assumptions are generally more conservative than GAAP reserve assumptions; o Subsidiaries and affiliates, life and non-life, are recorded at their GAAP basis net worth, with downstream insurance subsidiaries adjusted to reflect equity on a statutory basis, plus admissible goodwill; o For individual participating life policies, premiums are recognized at the policies' anniversary dates. For universal life, interest sensitive life, variable universal life policies and deferred annuity contracts, premiums or deposits are recognized as revenue and withdrawals are recognized as surrender benefits; o Liabilities for policyholders' dividends primarily represent amounts estimated to be paid or credited in the subsequent year; o The costs of employee pension and postretirement health benefits are recognized as the employee vests in these benefits during an employee's service period; o Assets and liabilities are reported net of reinsurance business; See Note 12 for a reconciliation of the Company's statutory basis capital and surplus to the Company's consolidated GAAP basis equity, and statutory net income to GAAP net income. Certain reclassifications have been made to conform the prior year presentation to the current year. INVESTMENTS Bonds and preferred stocks are generally carried at amortized cost and cost, respectively. Bonds in or near default are carried at the lower of amortized cost or fair value. Non-affiliated common stocks are carried at fair value. Affiliated common stocks are carried at GAAP basis net worth, with down-stream insurance subsidiaries adjusted to reflect equity on a statutory basis, plus admissible goodwill. Mortgage loans in good standing are valued at their unpaid principal balance. Mortgage loans that are delinquent or in process of foreclosure are valued at the lower of their principal balance or the estimated fair value of the underlying collateral. The maximum ratio of loan to collateral value at the time a loan is made is generally 75%. Loan-backed securities are stated at either amortized cost or the lower of amortized cost or fair market value. Policy loans are reported at their unpaid balances and are fully collateralized by policy cash values. Real estate investments are generally depreciated over 39.5 years using the straight line method, and are reflected at the lower of depreciated cost or fair value, net of encumbrances. All derivatives are stated at fair value. The Company has minor ownership interests in several joint ventures. The Company generally carries these interests based on the underlying audited GAAP equity of the investee. F-8 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Realized gains and losses are determined using the specific identification method and are reported net of related income taxes and deferrals into the Interest Maintenance Reserve ("IMR"). Debt and equity securities that experience declines in value that are other than temporary are written down with a corresponding charge to net realized losses. Amortization of premium or discount on debt securities is computed using the interest method. Unrealized losses primarily represent changes in fair value of non-affiliated common stock investments, underlying equity of affiliated companies, and fair value of debt securities in or near default, all net of deferred tax effects. SHORT-TERM INVESTMENTS Short-term investments are generally carried at amortized cost, which approximates fair value. Short-term investments in or near default are carried at the lower of amortized cost or fair value. For purposes of the statement of cash flows, the Company considers all highly liquid investments purchased with a remaining maturity of one year or less to be short-term investments. ASSET VALUATION RESERVE AND INTEREST MAINTENANCE RESERVE The Asset Valuation Reserve ("AVR") is designed to stabilize unassigned surplus from default losses on bonds, preferred stocks, mortgages, real estate and other invested assets and from fluctuations in the value of common stocks. The AVR is calculated as prescribed by the NAIC. The IMR defers interest rate related after-tax capital gains and losses on fixed income investments and amortizes them into income over the remaining lives of the securities sold. IMR amortization is included in net investment income. The Company uses the seriatim method for the amortization of IMR. NON-ADMITTED ASSETS In accordance with regulatory requirements, certain assets, including certain deferred tax assets, amounts due from agents, furniture and equipment, and internally developed software, are excluded from the balance sheet. The net change in these assets is included in other adjustments to surplus. F-9 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) GOODWILL Goodwill is amortized over 10 years using the straight-line method and is periodically evaluated for recoverability. PROPERTY AND EQUIPMENT Property and equipment is reported at depreciated cost. Real property owned by the Company is primarily depreciated over 39.5 years using the straight-line method. Furniture and equipment is depreciated using accelerated depreciation methods over five years and three years, respectively. EDP equipment and software is depreciated for a period not exceeding three years. CORPORATE OWNED LIFE INSURANCE The Company holds life insurance contracts on certain members of management and other key individuals. The total cash surrender value of these Corporate Owned Life Insurance ("COLI") contracts was $96.2 million and $92.8 million at December 31, 2005 and 2004, respectively, and is included in other assets. COLI income includes the net change in cash surrender value and any benefits received. COLI income was $7.0 million and $4.0 million in 2005 and 2004, respectively, and is included in other income. POLICY AND OTHER CONTRACT RESERVES Policy reserves for life, annuity and disability income contracts are developed using accepted actuarial methods. Actuarial factors used in determining life insurance reserves are based primarily upon the 1941, 1958, and 1980 Commissioners' Standard Ordinary ("CSO") mortality tables. Methods used to calculate life reserves consist primarily of net level premium, Commissioners' Reserve Valuation Method, and modified preliminary term, with valuation interest rates ranging from 2.0% to 6.0%. The Company waives deduction of deferred fractional premiums upon death of the insured and returns any portion of the final premium beyond the date of death. Surrender values are not promised in excess of the legally computed reserves. Extra premiums are charged for substandard lives in addition to the gross premium for a true age. Reserves are determined by computing mean reserves using standard mortality, then calculating a substandard extra reserve. Where the extra premium is a flat extra, the extra reserve is equal to one-half the flat extra premium charge for the year. For policies with a percentage extra rating, the extra reserve is defined as the difference between mean reserves calculated using standard valuation mortality and mean reserves calculated using valuation mortality adjusted by the percentage rating. No substandard extra reserves are held after 20 years. Reserves for individual annuities are determined principally using the Commissioners' Annuity Reserve Valuation Method, based on A-1949, 1983, and 2000 annuity tables with valuation interest rates from 2.0% to 9.0%. Liabilities for losses and loss/claim adjustment expenses for accident and health contracts are estimated by using statistical claim development models. Active life disability income reserves are determined primarily using the Commissioners' Disability 1964 table with the 1958 CSO mortality table and Commissioners' Individual Disability Table A morbidity tables with the 1980 CSO mortality tables. Valuation interest rates for active life reserves range from 3.0% to 6.0%. Disability income reserves are based on expected experience at 4.5% interest and exceed statutory minimum reserves. The Company anticipates investment income as a factor in the premium deficiency calculation. Tabular components of reserves are calculated in accordance with NAIC instructions and, as appropriate, have been compared to related contract rates for reasonableness. F-10 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) REINSURANCE The Company reinsures certain risks assumed in the normal course of business to other companies. The Company assumes a small amount of reinsurance from other companies. These reinsurance arrangements provide for greater diversification of business, allow management to control exposure to potential losses arising from large risks, and provide additional capacity for growth. Amounts recoverable from and payable to reinsurers are estimated in a manner consistent with the related liabilities associated with the reinsured policies. Reinsurance premiums and benefits paid or provided are accounted for on bases consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. RECOGNITION OF INSURANCE INCOME AND RELATED EXPENSES Annual premiums and related reserve increases on traditional life insurance policies are recorded at each policy anniversary. Premiums and related reserve increases on annuity contracts and universal life policies are recorded when premiums are collected. Premiums from disability income policies are recognized as revenue over the period to which the premiums relate. Commissions and other policy and contract costs are expensed as incurred. First-year policy and contract costs and required additions to policy and contract reserves generally exceed first-year premiums. DIVIDENDS TO POLICYHOLDERS The Company issued all of its traditional life insurance and certain annuity policies on a participating basis. The Company's universal life policies, most annuities, and disability income policies are issued on a non-participating basis. Term life insurance, while on a participating basis, currently receives no dividend. Liabilities for policyholders' dividends primarily represent amounts estimated to be paid or credited in the subsequent year. The amount of policyholder dividends to be distributed is based upon a scale which seeks to reflect the relative contribution of each group of policies to the Company's overall operating results. The dividend scale is approved annually by the Company's Board of Directors. See additional information below on policyholder dividends on contracts within the Closed Block. SEPARATE ACCOUNTS Separate account assets represent segregated funds held for the benefit of certain variable annuity, variable life, pension policyholders, and the Company's pension plans. Separate account liabilities represent the policyholders' share of separate account assets. The Company also participates in certain separate accounts. Policy values funded by separate accounts reflect the actual investment performance of the respective accounts and are generally not guaranteed. Investments held in the separate accounts are primarily common stocks, bonds, mortgage loans, and real estate and are carried at fair value. F-11 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) The Company has approximately $1.1 million of reserves for minimum death benefit guarantees on variable annuities at both December 31, 2005 and 2004. These benefits include a provision that allows withdrawals by policyholders to adjust the death benefit guarantee on a "dollar for dollar" basis, which increases the risk profile of this benefit. Partial withdrawals from policies issued after November 1, 2003 will use the pro-rata method subject to state approval. Policyholder partial withdrawals to date have not been significant. The Company assumes no partial withdrawals in its calculation of minimum death benefit guarantee reserves, but does include partial withdrawals in asset adequacy testing. FEDERAL INCOME TAXES The Company files its federal income tax returns as a member of a consolidated federal income tax return of its upstream parent NLHC and other affiliated subsidiaries. Under a written tax sharing agreement approved by the Board of Directors, taxes are allocated among members of the group based upon separate return calculations with current credit for net losses. Deferred income tax assets and liabilities are recognized based upon temporary differences between financial statement carrying amounts and income tax bases of assets and liabilities using enacted income tax rates and laws. Deferred income tax assets are subject to admissibility criterion based upon the expected reversal of temporary timing differences, the Company's level of capital and surplus, and any deferred income tax liabilities. Unrealized gains and losses are presented net of related changes in deferred taxes. The net change in other deferred taxes is recorded in adjustments to unassigned surplus. USE OF ESTIMATES The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of admitted assets, liabilities, income, and expenses, and related disclosures in the notes to financial statements. Actual results could differ from estimates. NOTE 3 - BUSINESS COMBINATIONS AND GOODWILL STATUTORY PURCHASE METHOD On July 2, 1999, National Financial Services ("NFS"), a wholly-owned subsidiary of the Company, acquired the outstanding one-third interest in LSW National Holdings, Inc. ("LSWNH"), the parent of Dallas, Texas based Life Insurance Company of the Southwest ("LSW"). NFS had previously purchased a two-thirds interest in LSWNH in February 1996. LSW is licensed in 49 states and specializes in the sale of individual annuities and universal life insurance. The transactions were accounted for as statutory purchases. Initial statutory basis goodwill was $73.1 million. In late 2005, the Company dissolved NFS and now holds 100% of the outstanding stock of LSWNH. Prior to dissolution, NFS had $80.0 million of debt. NFS had cumulative operating losses, primarily due to the servicing of the debt. As a result of these losses, the company had recorded an unrealized loss of $31.5 million with respect to its investment in NFS prior to the date of dissolution. In connection with the dissolution of NFS, the Company recognized realized losses of $31.5 million with a corresponding reduction in unrealized losses. F-12 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 3 - BUSINESS COMBINATIONS AND GOODWILL (CONTINUED) Goodwill amortization relating to LSWNH was $7.4 million for 2005 and 2004. Total admitted goodwill was $8.0 million and $15.4 million at December 31, 2005 and 2004, respectively. Total nonadmitted goodwill at December 31 was $0 for both 2005 and 2004. NOTE 4 - INVESTMENTS BONDS The amortized cost and estimated fair value of the Company's bond investments at December 31, 2005 and 2004 were as follows (in thousands):
ESTIMATED GROSS UNREALIZED AMORTIZED FAIR ----------------------- 2005 COST VALUE GAINS LOSSES - ------------------------------------------------------------------------------------ U.S. government obligations $ 50,212 $ 50,279 $ 247 $ 180 All other government obligations 10,000 10,000 -- -- Special revenue and assessments 1,872,953 1,860,846 20,617 32,724 Public utilities 570,296 608,036 40,976 3,236 Industrial & miscellaneous 2,117,224 2,230,812 130,880 17,292 Credit tenant loans 36,780 42,649 5,869 -- ---------- ---------- ---------- ---------- Total $4,657,465 $4,802,622 $ 198,589 $ 53,432 ========== ========== ========== ========== ESTIMATED GROSS UNREALIZED AMORTIZED FAIR ----------------------- 2004 COST VALUE GAINS LOSSES - ------------------------------------------------------------------------------------ U.S. government obligations $ 6,805 $ 7,244 $ 439 $ -- All other government obligations 10,250 10,250 -- -- Special revenue and assessments 1,807,005 1,838,466 38,059 6,598 Public utilities 545,894 600,925 55,709 678 Industrial & miscellaneous 2,016,920 2,193,660 181,122 4,382 Credit tenant loans 39,290 46,414 7,124 -- ---------- ---------- ---------- ---------- Total $4,426,164 $4,696,959 $ 282,453 $ 11,658 ========== ========== ========== ==========
F-13 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 4 - INVESTMENTS (CONTINUED) The amortized cost and estimated fair value of the Company's bond investments at December 31, 2005, by contractual maturity, are shown below (in thousands). Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. ESTIMATED AMORTIZED FAIR COST VALUE -------------------------------------------------------------- Due - in one year or less $ 87,841 $ 89,143 Due - one year through five years 609,912 632,666 Due - five years through ten years 1,191,868 1,228,275 Due - after ten years 992,058 1,094,433 Mortgage-backed securities 1,775,786 1,758,105 ---------- ---------- Total $4,657,465 $4,802,622 ========== ========== Proceeds from bond sales during 2005 and 2004 were $1,484.6 million and $ 2,000.8 million, respectively. Gross gains of $7.2 million and $21.8 million, and gross losses of $7.9 million and $18.3 million were realized on these sales in 2005 and 2004, respectively. The carrying value of preferred stocks at December 31, 2005 and 2004 was $70.6 million and $71.1 million, and the related fair value of preferred stocks was $74.9 million and $78.6 million, respectively. Proceeds from sales of preferred stocks during 2005 and 2004 were $1.6 million and $4.0 million, respectively. Gross gains of $0.8 million and $36,000 were realized on these sales in 2005 and 2004, respectively. There were no gross losses realized on these sales in 2005 or 2004. The cost of common stocks at December 31, 2005 and 2004 was $241.2 million and $220.3 million, respectively. The carrying value of common stocks at December 31, 2005 and 2004 was $261.3 million and $251.4 million, respectively. Proceeds from sales of common stocks during 2005 and 2004 were $18.6 million and $1.8 million, respectively. Gross gains of $1.6 million and $0.6 million, and gross losses of $0 million, were realized on these sales in 2005 and 2004, respectively. Substantially all of the Company's common stock holdings were in subsidiary or affiliated companies. F-14 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 4 - INVESTMENTS (CONTINUED) Investments' gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31 were as follows (in thousands):
2005 LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL - ---------------------------------------------------------------------------------------------------------------- UNREALIZED UNREALIZED UNREALIZED DESCRIPTION OF SECURITIES FAIR VALUE LOSSES FAIR VALUE LOSSES FAIR VALUE LOSSES - ---------------------------------------------------------------------------------------------------------------- Corporate debt: Communications $ 62,931 $ (1,366) $ 4,910 $ (81) $ 67,841 $ (1,447) Consumer & retail 124,700 (2,886) 29,622 (4,730) 154,322 (7,616) Financial institutions 196,454 (3,305) 51,931 (1,837) 248,385 (5,142) Industrial and chemicals 67,545 (2,069) 5,202 (310) 72,747 (2,379) Transportation 11,629 (256) -- -- 11,629 (256) Utilities 144,625 (3,016) 19,309 (671) 163,934 (3,687) ---------- ---------- ---------- ---------- ---------- ---------- Total corporate debt 607,884 (12,898) 110,974 (7,629) 718,858 (20,527) Mortgage-backed securities 1,206,008 (32,857) 2,735 (48) 1,208,743 (32,905) ---------- ---------- ---------- ---------- ---------- ---------- Total debt securities 1,813,892 (45,755) 113,709 (7,677) 1,927,601 (53,432) Preferred stock 5,222 (34) 4,210 (146) 9,432 (180) Common stock -- -- -- -- -- -- ---------- ---------- ---------- ---------- ---------- ---------- Total securities $1,819,114 $ (45,789) $ 117,919 $ (7,823) $1,937,033 $ (53,612) ========== ========== ========== ========== ========== ========== 2004 LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL - ---------------------------------------------------------------------------------------------------------------- UNREALIZED UNREALIZED UNREALIZED DESCRIPTION OF SECURITIES FAIR VALUE LOSSES FAIR VALUE LOSSES FAIR VALUE LOSSES - ---------------------------------------------------------------------------------------------------------------- Corporate debt: Communications $ 10,719 $ (125) $ -- $- $ 10,719 $ (125) Consumer & retail 54,758 (980) -- -- 54,758 (980) Financial institutions 96,278 (1,160) 35,985 (1,460) 132,263 (2,620) Industrial and chemicals 6,291 (213) 6,162 (200) 12,453 (413) Transportation -- -- -- -- -- -- Utilities 54,411 (360) 12,304 (443) 66,715 (803) ---------- ---------- ---------- ---------- ---------- ---------- Total corporate debt 222,457 (2,838) 54,451 (2,103) 276,908 (4,941) Mortgage-backed securities 685,370 (6,139) 33,659 (578) 719,029 (6,717) ---------- ---------- ---------- ---------- ---------- ---------- Total debt securities 907,827 (8,977) 88,110 (2,681) 995,937 (11,658) Preferred stock 3,896 (104) 377 -- 4,273 (104) Common stock -- -- 14 (41) 14 (41) ---------- ---------- ---------- ---------- ---------- ---------- Total securities $ 911,723 $ (9,081) $ 88,501 $ (2,722) $1,000,224 $ (11,803) ========== ========== ========== ========== ========== ==========
F-15 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 4 - INVESTMENTS (CONTINUED) Of the $45.8 million total unrealized losses on debt securities in the 2005 less than 12 months category, $32.9 million was in the mortgage backed securities portfolio. All of these securities were rated AAA at acquisition and maintained that rating as of December 31, 2005. These unrealized losses are due to the higher level of market interest rates at December 31, 2005, compared to those at the time of purchase. All of these securities are trading at equivalent or tighter spreads than when purchased. The $32.9 million of unrealized losses on mortgage backed securities represents 2.7% of the aggregate fair value of the approximately $1.2 billion in mortgage backed securities with unrealized losses at December 31, 2005. Many of the positions in this category have fair values only marginally below their respective carrying values. The $12.9 million unrealized losses in the corporate bond portfolio in the less than 12 months category is primarily interest rate related, not credit related. All of the corporate bonds purchased in 2005 were investment grade at the time of purchase, and none have been subsequently downgraded to non-investment grade since purchase. Of the $7.8 million total unrealized losses in the 12 months or more category, $7.6 million was in the corporate bond portfolio. Virtually all of these securities trade at tighter spreads than when they were purchased, but have unrealized losses due to an increase in interest rates since purchase. Based on the facts and circumstances surrounding the individual securities, the Company believes that the unrealized losses on these bonds at December 31, 2005 are temporary. MORTGAGE LOANS AND REAL ESTATE The distributions of mortgage loans and real estate at December 31 were as follows: 2005 2004 ----------------------------------------------------------------- GEOGRAPHIC REGION New England 2.5% 3.1% Middle Atlantic 5.0 5.6 East North Central 12.0 10.3 West North Central 10.1 9.1 South Atlantic 27.0 29.5 East South Central 2.6 2.6 West South Central 10.8 9.3 Mountain 13.4 15.7 Pacific 16.6 14.8 ----- ----- Total 100.0% 100.0% ===== ===== F-16 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 4 - INVESTMENTS (CONTINUED) 2005 2004 ----------------------------------------------------------------- PROPERTY TYPE Apartment 23.9% 28.7% Retail 10.1 8.4 Office Building 37.3 38.2 Industrial 24.9 21.5 Hotel/Motel 1.0 1.0 Other Commercial 2.8 2.2 ----- ----- Total 100.0% 100.0% ===== ===== The distribution of the book value of mortgages, classified by scheduled year of contractual maturity as of December 31, 2005 and 2004, is shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties. 2005 2004 ----------------------------------------------------------------- 1 year or less 4.0% 5.8% Over 1 through 3 years 9.6 8.9 Over 3 through 5 years 19.9 17.7 Over 5 through 10 years 46.0 43.1 Over 10 through 15 years 14.4 18.2 Over 15 through 20 years 4.8 4.4 Over 20 years 1.3 1.9 ----- ----- Total 100.0% 100.0% ===== ===== The estimated fair value of mortgages at December 31, 2005 and 2004 was $939.1 million and $1,010.1 million, respectively. The fair value of mortgages was estimated as the average of the present value of future cash flows under different scenarios of future mortgage interest rates (including appropriate provisions for default losses) and related changes in borrower prepayments. The maximum and minimum lending rates for mortgage loans during 2005 were 7.85% and 5.33%, and 7.81% and 4.84% during 2004. During 2005, the Company reduced the interest rate on one outstanding mortgage loan with an unpaid balance of $2.3 million by 1.34%. During 2004, the Company reduced the interest rate on one outstanding mortgage loan with an unpaid balance of $4.4 million by 0.625%. The reduced interest rates on loans restructured during 2005 and 2004 were above or equal to market rates of interest on equivalent loans at the refinancing date. F-17 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 4 - INVESTMENTS (CONTINUED) Mortgage loans and related valuation allowances at December 31 were as follows (in thousands): 2005 2004 ---------------------------------------------------------------------- Unimpaired loans $ 905,744 $ 944,147 Impaired loans without valuation allowances -- -- --------- --------- Subtotal 905,744 944,147 Impaired loans with valuation allowances 5,660 5,660 Related valuation allowances (860) (860) --------- --------- Subtotal 4,800 4,800 --------- --------- Total $ 910,544 $ 948,947 ========= ========= 2005 2004 ---------------------------------------------------------------------- Impaired loans: Average recorded investment $ 5,660 $ 6,405 Interest income recognized 340 283 Interest received 368 283 The Company had investments in loans restructured with below market rates of interest at the refinancing date of $5.6 million at December 31, 2005 and 2004. The Company accrues interest income on impaired loans to the extent it is deemed collectible (delinquent less than 90 days) and the loan continues to perform under its original or restructured contractual terms. Interest income on non-performing loans is generally recognized on a cash basis. Allowance for credit losses on mortgage loans (in thousands): 2005 2004 --------------------------------------------------------------------- Balance at beginning of period $ 860 $1,350 Additions charged to operations -- -- Direct write-downs charged against the allowances -- 490 Recoveries of amounts previously charged off -- -- ------ ------ Balance at the end of period $ 860 $ 860 ====== ====== F-18 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 4 - INVESTMENTS (CONTINUED) LOANED SECURITIES The Company periodically lends certain U.S. government or corporate bonds to approved counterparties to enhance the yield of its bond portfolio. In 2005, the Company substantially modified its securities lending program as a result of entering into a new agreement with its securities lending agent. The Company receives cash collateral for at least 102% of the market value of securities loaned. Collateral adequacy is evaluated daily and periodically adjusted for changes in the market value of securities loaned. The carrying values of securities loaned are unaffected by the transaction. As a result of the modification in 2005, the collateral held and the corresponding liability for collateral held of approximately $166.9 million at December 31, 2005, are presented net in the Company's financial statements. Prior to the modification, at December 31, 2004, collateral held (included in cash and short-term investments) and the corresponding liability for collateral held (included in broker deposits on loaned securities) was $14.3 million. The fair value of the collateral held approximates its carrying value at December 31, 2005 and 2004. The fair value of the loaned securities was $163.7 million and $13.6 million at December 31, 2005 and 2004, respectively. LOAN-BACKED SECURITIES Prepayment assumptions used in the calculation of the effective yield and valuation of loan-backed bonds and structured securities are based on available industry sources and information provided by lenders. The retrospective adjustment methodology is used for the valuation of securities held by the Company. The Company has elected to use book value as of January 1, 1994 as the cost for securities purchased prior to January 1, 1994 in lieu of historical cash flows. JOINT VENTURES, PARTNERSHIPS AND LIMITED LIABILITY COMPANIES The Company has no investments in joint ventures, partnerships or limited liability companies that exceed 10% of its admitted assets. The Company recorded $4.4 million and $1.8 million of impairments on non-public joint ventures in 2005 and 2004, respectively. These joint ventures have underlying characteristics of common stock. Fair values utilized in determining impairments were determined by the Company based on the joint venture's operating results and comparisons with similar publicly traded investments. REPURCHASE AGREEMENTS The Company also periodically enters into repurchase agreements on U.S. Treasury securities to enhance the yield of its bond portfolio. These transactions are accounted for as financings as the securities received at the end of the repurchase period are identical to the securities transferred. Any repurchase liability is included in other liabilities. There were no open transactions at December 31, 2005 or 2004. F-19 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 4 - INVESTMENTS (CONTINUED) NET INVESTMENT INCOME The components of net investment income and interest maintenance reserve amortization for the years ended December 31 were as follows (in thousands): 2005 2004 ----------------------------------------------------------------------- Debt securities interest $ 290,546 $ 281,699 Equity securities dividends - unaffiliated 6,726 6,288 Equity securities dividends - affiliated 40,619 -- Mortgage loan interest 71,841 83,844 Real estate income 8,454 8,143 Contract loans 33,843 36,387 Other invested assets 51,717 12,205 Other 1,902 1,608 ---------- ---------- Gross investment income 505,648 430,174 Amortization of IMR 3,992 5,475 Gain on separate accounts 76 259 Less: investment expenses (13,956) (15,373) ---------- ---------- Net investment income $ 495,760 $ 420,535 ========== ========== Due and accrued income is excluded from investment income when collection of interest is uncertain. Rental income is excluded from investment income when more than three months in arrears. Total due and accrued investment income excluded at December 31, 2005 and 2004 was $0 and $2,168, respectively. NOTE 5 - INVESTMENT PRODUCTS The Company issues several different investment products, including flexible premium annuities, single premium deferred annuities and supplementary contracts not involving life contingencies. The book value of liabilities for these investment products was $761.7 million and $776.8 million at December 31, 2005 and 2004, respectively. The fair value of liabilities for these investment products was $783.5 million and $821.6 million at December 31, 2005 and 2004, respectively. The fair value of these liabilities was estimated as the average of the present value of future cash flows under different scenarios of future interest rates of A-rated corporate bonds and related changes in premium persistency and surrenders. NOTE 6 - REINSURANCE AND VALUATION RESERVES For individual life products sold beginning in August 2004, the company increased the amount it retains to $2.0 million of risk on any person. Prior to that and beginning January 1, 2002, the Company generally retained no more than $1.0 million of risk on any person (excluding accidental death benefits and dividend additions). Reinsurance for life products is ceded under yearly renewable term, coinsurance, and modified coinsurance agreements with various reinsurers. Total individual life premiums ceded were $41.8 million and $38.5 million for the years ended December 31, 2005 and 2004, respectively, and are included as a reduction of insurance income. Total individual life insurance ceded was $19.5 billion and $18.0 billion of the $42.5 billion and $41.9 billion in force at December 31, 2005 and 2004, respectively. The Company has assumed a small amount of yearly renewable term reinsurance from non-affiliated insurers, and has assumed reinsurance under coinsurance and modified coinsurance agreements from affiliated insurers. (See below for changes in these agreements effective April 1, 2004.) Premiums assumed from affiliated insurers were $0.0 million and $10.5 million for 2005 and 2004, respectively, and are included in insurance income. F-20 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 6 - REINSURANCE AND VALUATION RESERVES (CONTINUED) At December 31, 2005 and 2004, the Company did not have ownership or control over any non-affiliated reinsurers, and there were no policies reinsured outside the United States with companies owned or controlled by an affiliated entity. There were no unilaterally cancelable reinsurance agreements (for reasons other than for nonpayment of premium or other similar credits) in effect at December 31, 2005 and 2004. No reinsurance agreements were in force at December 31, 2005 and 2004 which could reasonably result in a payment to the reinsurer in excess of the total direct premiums collected. No new reinsurance agreements were enacted during the year which included life insurance policies inforce at the end of the previous year. Effective April 1, 2004, Life Insurance Company of the Southwest ("LSW"), an indirectly wholly-owned insurance subsidiary, recaptured universal life ("UL") and equity indexed universal life ("EIUL") insurance in-force previously ceded to the Company through two separate amendments to the existing UL and EIUL reinsurance agreements. Prior to April 1, 2004, the UL products were reinsured to the Company under an 80% coinsurance agreement, and the EIUL product was 100% reinsured to the Company under a modified coinsurance agreement. The reinsurance assumption transaction was accounted for at book value, and included a transfer of reserves and other liabilities, prepaid commissions, policy loans, and cash totaling $26.1 million from the Company to LSW. Pursuant to NAIC SAP, no material gain or loss was recognized by the Company or LSW as a result of the transfer. Disability income products are significantly reinsured under coinsurance and modified coinsurance agreements primarily with Unum Provident Corporation ("UNUM"). In February 2003, the Company executed amendments to disability income reinsurance agreements with UNUM. Under the terms of the amendments, virtually all of the existing disability income coinsurance was converted to modified coinsurance. This change resulted in $286 million in cash and reinsurance liabilities being transferred to the Company from UNUM. The Company has agreed to pay UNUM an interest rate of 7% on the reserves held by the Company. All other rights and responsibilities outlined in the reinsurance agreements between the Company and UNUM remain in force. The original agreements and amendments meet risk transfer criteria to qualify for reinsurance accounting treatment as prescribed by the Department. Total disability income premiums ceded in 2005 and 2004 were $35.1 million and $36.5 million, respectively. Reserve transfers and related interest expense on reinsured disability income reserves, exclusive of the reinsurance amendment outlined below, produced income of $2.6 million and $19.4 million in 2005 and 2004, respectively, and are included in other income. The Company would be liable with respect to any ceded insurance should any reinsurer be unable to meet its assumed obligations. F-21 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 6 - REINSURANCE AND VALUATION RESERVES (CONTINUED) As of December 31, 2005 and 2004, the Company had $4.3 billion and $4.9 billion, respectively, of insurance in force for which the gross premiums are less than the net premiums according to the standard valuation set by the State of Vermont. At December 31, 2005 and 2004, reserves to cover the above insurance totaled $62.6 million and $65.1 million, respectively, and are included in policy reserves. At December 31, 2005 and 2004, there would be no significant change in the Company's financial position if all reinsurance agreements were terminated. NOTE 7 - FEDERAL INCOME TAXES The components of the net deferred tax asset at December 31 are as follows (in thousands): 2005 2004 ------------------------------------------------------------ Total gross deferred tax assets $ 252,873 $ 225,478 Total deferred tax liabilities (80,507) (9,327) ---------- ---------- Net deferred tax asset 172,366 216,151 Deferred tax asset nonadmitted (95,384) (164,995) ---------- ---------- Net admitted deferred tax asset $ 76,982 $ 51,156 ========== ========== Current income taxes incurred consist of the following major components (in thousands): 2005 2004 ----------------------------------------------------------------- Current income tax expense (benefit) on: Operations $ 12,437 $ 4,686 Capital gains/losses (1,694) (6,294) Surplus (60) 44 -------- -------- Total income tax expense (benefit) $ 10,683 $ (1,564) ======== ======== F-22 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 7 - FEDERAL INCOME TAXES (CONTINUED) The main components of the deferred tax assets and liabilities at December 31 are as follows (in thousands): 2005 2004 --------------------------------------------------------------------- Deferred tax assets: Reserves $ 94,197 $ 66,364 Policy DAC 60,902 62,642 Policyholder dividends 22,054 23,662 Stocks 1,248 1,754 Bonds (1,782) 712 Low income housing credits 2,367 10,514 Deferred compensation 58,614 46,451 Other 15,273 13,379 ---------- ---------- Total deferred tax assets 252,873 225,478 Nonadmitted deferred tax assets (95,384) (164,995) ---------- ---------- Admitted deferred tax assets 157,489 60,483 Deferred tax liabilities: Deferred intercompany gain 38,280 -- Premiums receivable 25,786 -- Other invested assets 10,943 2,720 Depreciable assets 3,714 3,816 Other 1,784 2,791 ---------- ---------- Total deferred tax liabilities 80,507 9,327 ---------- ---------- Net deferred tax asset $ 76,982 $ 51,156 ========== ========== The net change in nonadmitted deferred tax assets was as follows (in thousands): 2005 2004 --------------------------------------------------------------------- Net (decrease) increase in nonadmitted deferred tax assets $ (69,611) $ 13,606 ========== ========== The change in net deferred income taxes is comprised of the following (in thousands): 2005 2004 CHANGE ------------------------------------------------------------------------- Total deferred tax assets $252,873 $225,478 $ 27,395 Total deferred tax liabilities (80,507) (9,327) (71,180) -------- -------- -------- Net deferred tax asset $172,366 $216,151 (43,785) -------- -------- Less: tax effect of unrealized gains 674 Less: tax effect of increase in minimum pension obligation (11,469) -------- Adjusted change in gross deferred taxes $(54,580) ========================================================================= F-23 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 7 - FEDERAL INCOME TAXES (CONTINUED) The provision for federal income taxes incurred in 2005 is different from that which would be obtained by applying the statutory federal income tax rate of 35% to income before income taxes. The tax at the statutory rate and significant items causing this difference are as follows (in thousands): Operations and gains provision computed at statutory rate $36,088 Dividends received deduction and tax exempt interest (16,320) Interest maintenance reserve (1,397) COLI (2,660) Change in nonadmitted assets 274 Deferred compensation 1,215 Intercompany note interest (2,053) Deferred intercompany gain 38,279 Loss on liquidation of subsidiary 11,009 Other 828 ------- Total $65,263 ======= Current federal income tax provision $10,683 Adjusted change in gross deferred taxes 54,580 ------- Statutory federal income taxes $65,263 ======= The Company has affordable housing tax credit carryforwards of $2.4 million that begin to expire in 2025. NLHC files a consolidated tax return which includes all of its downstream subsidiaries including the Company. The method of allocation for federal income tax expense between the companies is pursuant to a written agreement approved by the Board of Directors. Allocation is based upon separate return calculations with current credit for net losses. Intercompany tax balances are settled annually. Income taxes incurred that will be available for recoupment in the event of future net losses are as follows (in thousands): 2005 $8,039 2004 1,850 2003 8,097 In 2005, pursuant to SSAP No. I0 Q&A2.5, the Company modified its groupings of assets and liabilities. To incorporate a more detailed methodology, the Company separated premiums receivable from the underlying policy reserves. Deferred taxes are calculated separately for premium receivable and for policy reserves. The Company requested that the Department approve its change in methodology and such approval was granted on February 17, 2006. The effect of the change in methodology was to increase net deferred tax assets and surplus by $24.5 million at December 31, 2005. F-24 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 8 - INFORMATION CONCERNING PARENT, SUBSIDIARIES AND AFFILIATES On January 1, 2005, the Company entered into agreements with NRPA whereby the Company assumed the primary obligation for the servicing of all the Company's non-qualified pension obligations. This included all the defined contribution deferred compensation plans, General Agents Pension Plan, and other benefit obligations previously transferred to NRPA. Invested assets and plan liabilities of approximately $125 million were transferred from NRPA to the Company. During 2005, the Company dividended its interests of approximately $9.3 million in National Life Capital Management, Inc. ("NLCAP") and Administrative Services, Inc. ("ASI"), wholly owned subsidiaries of the Company, to NLVF. Prior to the Company's dividend of its interest in NLCAP to NLVF, NLCAP dividended assets of approximately $38.9 million to the Company. In late 2005, the Company dissolved NFS and now holds 100% of the outstanding stock of LSWNH. Prior to dissolution, NFS had $80.0 million of debt. NFS had cumulative operating losses, primarily due to the servicing of the debt. As a result of these losses, the company had recorded an unrealized loss of $31.5 million with respect to its investment in NFS prior to the date of dissolution. In connection with the dissolution of NFS, the Company recognized realized losses of $31.5 million with a corresponding reduction in unrealized losses. During 2005 LSWNH dividended assets of approximately $1.8 million to the Company. During 1998, the Company entered into agreements with a downstream affiliate, National Retirement Plan Advisors ("NRPA"), a wholly owned subsidiary of NLCAP, whereby NRPA assumed the primary obligation for the servicing of certain deferred compensation, accrued vested General Agent pension plan, and other benefit obligations from the Company in exchange for a lump-sum payment. The Company remained contingently liable for these plans in the event that NRPA was unable to fulfill its contractual obligations. The Company also transferred its pension administration and servicing operations to NRPA in 1998. Between 1998 and 2004, the Company transferred additional non-qualified pension obligations to NRPA. All intercompany transactions are settled on a current basis. Amounts payable or receivable at December 31 generally represent year end cost allocations, reinsurance transactions, and income taxes and are included in the accompanying Statements of Admitted Assets, Liabilities and Surplus. No guarantees or undertakings on behalf of an affiliate resulting in a material contingent exposure of the Company's surplus existed at December 31, 2005 and 2004. See Note 13 for information regarding other contingencies. The Company and several of its subsidiaries and affiliates share common facilities and employees. Expenses are periodically allocated according to specified reimbursement agreements. The Company had no agreements in place at December 31, 2005 to potentially move non-admitted assets into subsidiaries or affiliates. During 2004, the Company contributed $15.3 million in affordable housing credits to its downstream subsidiary, LSW. F-25 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 9 - BENEFIT PLANS The Company sponsors a qualified defined benefit pension plan covering substantially all National Life Group employees. The plan is administered by the Company and is non-contributory, with benefits for Company employees hired prior to July 1, 2001 based on an employee's retirement age, years of service, and compensation near retirement. Benefits for Company employees hired after June 30, 2001 and non-Company employees are based on the amount credited to the employee's account each year, which is a factor of the employee's age, service and compensation, increased at a specified rate of interest. Plan assets are primarily bonds and common stocks held in a Company separate account and funds invested in a general account group annuity contract issued by the Company. The Company also sponsors other non-qualified pension plans, including a non-contributory defined benefit plan for general agents that provides benefits based on years of service and sales levels, a non-contributory defined supplemental benefit plan for certain executives and a non-contributory defined benefit plan for retired directors. These non-qualified defined benefit pension plans are not separately funded. Participation costs for non-Company employees are allocated to subsidiaries and affiliates as appropriate. The Company sponsors four defined benefit postretirement plans that provide medical, dental, and life insurance benefits to employees and agents. Substantially all employees and agents who began service prior to July 1, 2001 may be eligible for retiree benefits if they reach normal retirement age and meet certain minimum service requirements while working for the Company. Most of the plans are contributory, with retiree contributions adjusted annually, and contain cost sharing features such as deductibles and copayments. The plans are not funded and the Company pays for the plan benefits on a current basis. The plan costs are recognized as benefits are earned. These defined benefit plans are included in the other benefits category in the tables that follow. At December 31, 1998, the Company entered into agreements with a downstream affiliate, NRPA, a wholly-owned subsidiary of NLCAP, whereby NRPA assumed the primary obligation for the servicing of certain deferred compensation, accrued vested General Agent pension plan, and other benefit obligations from the Company in exchange for a lump-sum payment. The Company remained contingently liable for these plans in the event that NRPA was unable to fulfill its contractual obligations. The Company also transferred its pension administration and servicing operations to NRPA at December 31, 1998. The Company transferred additional non-qualified pension obligations to NRPA between 1998 and 2004. On January 1, 2005, the Company entered into agreements with NRPA whereby the Company assumed the primary obligation for the servicing of all the Company's non-qualified pension obligations. This included all the defined contribution deferred compensation plans, General Agents Pension Plan, and other benefit obligations previously transferred to NRPA. Invested assets and plan liabilities of approximately $125 million were transferred from NRPA to the Company. F-26 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 9 - BENEFIT PLANS (CONTINUED) The following tables show the plans' combined funded status at December 31 (in thousands):
PENSION BENEFITS OTHER BENEFITS 2005 2004 2005 2004 ---------- ---------- ---------- ---------- (1) Change in benefit obligation Benefit obligation at beginning of year $ 150,205 $ 137,900 $ 27,429 $ 28,427 Transfer-in from affiliate - PBO 91,240 -- -- -- Service cost 5,502 5,817 1,435 1,520 Interest cost 13,539 8,597 1,669 1,820 Actuarial loss 18,297 10,081 4,598 1,442 Transfer-in from affiliate - actuarial loss (14,289) -- Benefits paid (14,055) (8,580) (2,091) (1,898) Plan amendments -- -- -- (4,000) Curtailments (639) (3,610) -- 118 ---------- ---------- ---------- ---------- Benefit obligation at end of year $ 249,800 $ 150,205 $ 33,040 $ 27,429 ========== ========== ========== ========== PENSION BENEFITS OTHER BENEFITS 2005 2004 2005 2004 ---------- ---------- ---------- ---------- (2) Change in plan assets Fair value of plan assets at beginning of year $ 99,147 $ 87,784 $ -- $ -- Actual return on plan assets 8,739 12,115 -- -- Employer contribution 7,081 6,728 -- -- Benefits paid (6,285) (7,480) -- -- ---------- ---------- ---------- ---------- Fair value of plan assets at end of year $ 108,682 $ 99,147 $ -- $ -- ========== ========== ========== ========== PENSION BENEFITS OTHER BENEFITS 2005 2004 2005 2004 ---------- ---------- ---------- ---------- (3) Funded status Unamortized prior service cost $ (508) $ (574) $ (841) $ (1,682) Unrecognized net loss 76,898 49,815 5,047 282 Additional funding for minimum pension liability 60,410 27,641 -- -- Remaining net obligation or net asset at initial date of application -- -- 5,168 5,906 Prepaid assets or (accrued liabilities) (62,679) 623 (23,666) (22,923) ========== ========== ========== ========== PENSION BENEFITS OTHER BENEFITS 2005 2004 2005 2004 ---------- ---------- ---------- ---------- (4) Benefit obligation for non-vested employees $ 16,620 $ 15,925 $ 7,879 $ 7,094 ========== ========== ========== ==========
F-27 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 9 - BENEFIT PLANS (CONTINUED) The components of net periodic benefit cost are as follows:
PENSION BENEFITS OTHER BENEFITS 2005 2004 2005 2004 ---------- ---------- ---------- ---------- Components of net periodic benefit cost Service cost $ 5,502 $ 5,817 $ 1,435 $ 1,520 Interest cost 13,539 8,597 1,669 1,820 Expected (return) on plan assets (7,949) (7,472) -- -- Amortization of unrecognized transition obligation or transition asset -- -- 738 785 Amount of unrecognized gains and losses 4,074 3,047 (167) 483 Amount of prior service cost recognized (66) (67) (841) (556) Amount of gain or loss recognized due to a settlement or curtailment -- -- -- 305 ---------- ---------- ---------- ---------- Total net periodic benefit cost $ 15,100 $ 9,922 $ 2,834 $ 4,357 ========== ========== ========== ==========
The total accumulated benefit obligation was $233.8 million and $132.9 million at December 31, 2005 and 2004, respectively. In 2005 and 2004, an increase (decrease) of $32.8 million and $(0.7) million in the minimum pension liability were recorded as an adjustment to surplus. The minimum funding obligation liability at December 31, 2005 and 2004 was $60.4 million and $27.6 million, respectively. There were no admitted intangible pension assets at December 31, 2005 or 2004.
PENSION BENEFITS OTHER BENEFITS 2005 2004 2005 2004 ---------- ---------- ---------- ---------- Weighted-average assumptions as of Dec. 31 a. Discount rate 5.50% 6.00% 5.50% 6.00% b. Rate of compensation increase VARIES - Varies - N/A N/A BASED ON based on AGE age c. Expected long-term rate of return on plan assets 8.00% 8.00% N/A N/A
The projected health care cost trend rate ("HCCTR") for 2005 and 2004 was 8% and 9%, respectively. This projected rate declines linearly to 5% in 2008 and remains level thereafter. Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. Increasing the assumed HCCTR by one percentage point in each year would increase the accumulated postretirement benefit obligation ("APBO") by about $3.2 million and increase the 2005 service and interest cost components of net periodic postretirement benefit cost by about $0.2 million. Decreasing the assumed HCCTR by one percentage point in each year would reduce the APBO by about $2.6 million and the 2005 service and interest cost components of net periodic postretirement benefit cost by about $0.2 million. The Company uses the straight-line method of amortization for prior service cost and unrecognized gains and losses. F-28 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 9 - BENEFIT PLANS (CONTINUED) The percentage distribution of the fair value of total plan assets held as of the measurement date is as follows: PLAN ASSET CATEGORY OCTOBER 1, 2005 OCTOBER 1, 2004 ------------------------------------------------------------------- Bonds 36% 33% Common stocks 60 63 Group annuity contract 4 4 ------------------------------------------------------------------- Total 100% 100% =================================================================== Investments are selected pursuant to investment objectives, policy, and guidelines as approved by the Chief Investment Officer of the Company and by the Committee on Finance of the Company's Board of Directors. The primary objective is to maximize long-term total return within the investment policy and guidelines. The Company's investment policy for the plan assets is to achieve a target allocation of approximately 50%-75% stocks and 25%-50% bonds and other fixed income instruments when measured at fair value. Investments in the obligations of any one issuer, other than the United States of America government or its agencies, shall not exceed 5% of the total investment portfolio. Further, no more than 50% of the total investment portfolio shall be invested in any major industry group (for example, public utilities, industrial, mortgage-backed or asset-backed securities, etc.), and no more than 30% shall be invested in any sub-industry (for example, oil, gas, or steel). The Company's expected long-term rate of return of 8% is based upon an expected return on stock investments of 10%-11%, and a weighted expected return of 5%-6% on fixed income investments. These projections were based on the Company's historical and projected experience and on long term projections by investment research organizations. Projected benefit payments for defined benefit obligations and for projected Medicare Part D reimbursements for each of the five years following December 31, 2005, and in aggregate for the five years thereafter is as follows (in thousands): PROJECTED PROJECTED MEDICARE PENSION BENEFIT PROJECTED OTHER PART D YEAR PAYMENTS BENEFIT PAYMENTS REIMBURSEMENTS ----------------------------------------------------------------------- 2006 $15,376 $ 2,350 $ 190 2007 15,397 2,500 211 2008 15,462 2,628 231 2009 15,649 2,750 249 2010 15,748 2,850 268 2011-2014 85,184 14,931 1,580 ======================================================================= The Company's expected 2006 contribution into its separately funded defined benefit pension plan is $16.8 million. The Company may elect to make smaller or larger contributions in 2006, subject to regulatory requirements and maximum contribution limitations. F-29 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 9 - BENEFIT PLANS (CONTINUED) The Company provides 401-K plans for its employees. For employees hired prior to July 1, 2001, up to 3% of an employee's salary may be invested by the employee in a plan and matched by funds contributed by the Company subject to applicable maximum contribution guidelines. Employees hired prior to July 1, 2001 and below specified levels of compensation also receive a foundation contribution of 1.5% of compensation. Employees beginning service after June 30, 2001 will receive a 50% match on up to 6% of an employee's salary, subject to applicable maximum contribution guidelines. Additional employee voluntary contributions may be made to the plans subject to contribution guidelines. Accumulated funds may be invested by the employee in a group annuity contract with the Company or in mutual funds (several of which are sponsored by an affiliate of the Company). Vesting and withdrawal privilege schedules are attached to the Company's matching contributions. Plan assets invested in the mutual funds are outside the Company and as such are excluded from the Company's assets and liabilities. The Company also provides a 401-K plan for it's regular full-time agents whereby accumulated funds may be invested by the agent in a group annuity contract with the Company or in mutual funds (several of which are sponsored by an affiliate of the Company). Total annual contributions can not exceed certain limits which vary based on total agent compensation. No Company contributions are made to the plan. Plan assets invested in the mutual funds are outside the Company and as such are excluded from the Company's assets and liabilities. The Company also has a defined contribution pension plan covering substantially all full-time agents. Contributions of 6.1% of each agent's compensation up to the Social Security taxable wage base and 7.5% of the agent's compensation in excess of the wage base, subject to the maximum legal limitations for qualified plans, are made each year. Accumulated funds may be invested by the agent in a group annuity contract with the Company or in mutual funds (several of which are sponsored by an affiliate of the Company). Plan assets invested in the mutual funds are outside the Company and as such are excluded from the Company's assets and liabilities. Total company contributions made to defined contribution plans were $2.4 million and $2.6 million in 2005 and 2004, respectively. During the fourth quarter of 2005, the Company announced plans to restructure a significant number of general agencies. These restructurings included the termination or redeployment of several general agent participants in a non-contributory defined benefit plan. The effect of this curtailment was to reduce the projected benefit obligation at December 31, 2005 by $0.6 million with a corresponding reduction in unrecognized losses. There was no effect on 2005 net income. Projected 2006 service costs decreased by $0.4 million as a result of the curtailment. During December 2003, the Company substantially finalized agreements with Keane, Inc., an independent technology company with worldwide operations, to assume the responsibility for the Company's software maintenance and development, and other technology related activities. The ten year agreement was signed in early 2004 and announced on January 14, 2004. Under the terms of the agreements, the 158 employees affected were offered positions with Keane effective February 1, 2004, and substantially all accepted. There were no termination or other special benefits provided to the affected employees by the Company, primarily due to the employee transition agreement established with Keane. F-30 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 9 - BENEFIT PLANS (CONTINUED) As the outsourcing decision occurred after the 2003 measurement date for both the Company's pension and other post-employment benefit obligations, remeasurement of the plans obligations and the recording of curtailment effects were reflected in 2004's results from operations. The pension benefit obligation was reduced in 2004 by $3.6 million, with a corresponding reduction in unrecognized losses. Projected pension service costs for 2004 were reduced due to curtailment by $0.1 million. Other post-employment benefit obligations were reduced by $0.1 million which was recognized immediately. Projected service costs for 2004 were reduced due to curtailment by $0.1 million. The curtailment reduced post-employment plan amendment benefits and transition obligations, resulting in a 2004 pre-tax charge of $0.2 million. In December 2003, the Medicare Prescription Drug Improvement and Modernization Act of 2003 was enacted which provides certain prescription drug related benefits for retirees and subsidies for employers providing actuarial equivalent subsidies to their retirees beginning in 2006. On the aggregate basis, it is estimated that the Company's postretirement health plans will pass the actuarial equivalence test, and qualify for the Medicare Part D Subsidy. The effect of this legislation is reflected in the obligations of December 31, 2005 and 2004. The reduction in the accumulated benefit obligation for the subsidy related to benefits attributed to past service is $5.1 million and $4.0 million in 2005 and 2004, respectively. The effect of the subsidy on the measurement of the net postretirement benefit cost of fiscal year 2005 is approximately $0.5 million which includes a reduction of interest cost on the accumulated benefit obligation of $0.3 million. NOTE 10 - LEASES The Company leases data processing equipment under various noncancelable operating lease agreements that expire through December 2006. Annual rental expense was $3.9 million in 2005 and $5.1 million in 2004. The Company leases rights to the use of certain data processing hardware and software from American International Technology Enterprises, Inc ("AITE"), a subsidiary of AIG, located in Livingston, New Jersey. AITE assumed the responsibility for mainframe processing in October 2001. The lease with AITE was renegotiated in September 2004 for an additional 5 years. The lease contains clauses and penalties for termination prior to the end of the lease term. Certain rental commitments have renewal options extending through the year 2007. Some of these renewals are subject to adjustments in future periods. The Company has no sale-leaseback transactions. F-31 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 10 - LEASES (CONTINUED) At December 31, 2005, the minimum aggregate annual rental commitments are as follows (in thousands): OPERATING YEAR LEASES -------------------------------------------------------------- 2006 $ 4,781 2007 4,697 2008 4,625 2009 3,081 -------- Total minimum lease payments $ 17,184 ======== The Company has a multi year contract for information systems application and infrastructure services from Keane, Inc. of Boston, Massachusetts. The contract became effective on February 1, 2004. The Company's remaining obligation under the contract as of December 31, 2005 (in thousands): CONTRACT YEAR OBLIGATION --------------------------------------------------------------- 2006 $ 13,006 2007 12,977 2008 12,977 2009 13,345 2010 1,115 -------- Total contract obligation $ 53,420 ======== NOTE 11 - CAPITAL AND SURPLUS, SHAREHOLDER DIVIDEND RESTRICTIONS AND QUASI-REORGANIZATIONS At December 31, 2005 and 2004, the Company had 2.5 million shares authorized and outstanding. All shares are Class A shares. No preferred stock has been issued. On January 1, 1999, the Company converted from a mutual to a stock insurance company as part of a reorganization into a mutual holding company corporate structure. Under the provisions of the reorganization, the Company issued 2.5 million common stock $1 par shares to its parent and recorded $5.0 million of additional paid-in-capital as transfers from unappropriated surplus. Prior to the conversion, policyowners held policy contractual and membership rights from National Life. The contractual rights, as defined in the various insurance and annuity policies, remained with National Life after the conversion. Membership interests held by policyowners of National Life at December 31, 1998 were converted to membership interests in NLHC, a mutual insurance holding company created for this purpose. NLHC currently owns all the outstanding shares of NLVF, a stock holding company created for this purpose, which in turn currently owns all the outstanding shares of National Life. NLHC currently has no other significant assets, liabilities or operations other than that related to its ownership of NLVF's outstanding stock. Similarly, NLVF currently has no significant assets or operations other than those related to investments funded by a 2002 dividend from the Company, subsidiary's dividended by the Company in 2005 as previously discussed, issuance of $220 million in debt financing in 2003, issuance of an additional $75 million in debt financing in 2005, and its ownership of National Life's outstanding stock. Under the terms of the reorganization, NLHC must always hold a majority of the voting shares of NLVF. See Note 8 for additional information on the issuance of debt. F-32 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 11 - CAPITAL AND SURPLUS, SHAREHOLDER DIVIDEND RESTRICTIONS AND QUASI-REORGANIZATIONS (CONTINUED) Policyowner surplus is restricted by required statutory surplus of $5 million, other state permanent surplus (guaranty fund) requirements of $500,000, and special surplus amounts required by the State of New York in connection with variable annuity business. There were no changes in the balances of any special surplus funds from the prior period. During 2005, the Company dividended its interest of approximately $9.3 million in NLCAP and ASI, wholly owned subsidiaries of the Company, to NLVF. No dividends were declared or paid in 2004. Dividends declared by the Company in excess of the lesser of net gain from operations or 10% of statutory surplus require pre-approval by the Commissioner. Within the limitations of the above, there are no restrictions placed on the portion of Company profits that may be paid as ordinary dividends to the shareholder. No stock is held for special purposes. During 2004, the Company retired the remaining balance of $62.7 million of surplus notes (the "Notes") issued on March 1, 1994. As part of the retirement, original issue costs and discount totaling $0.9 million were expensed. A repurchase premium of $2.5 million was also expensed. These costs are included in net realized gains and losses. Interest paid on the Notes during 2004 was $2.6 million. The Company did not receive any capital contributions from its parent, NLVF, during 2005. Capital contributions received from NLVF in 2004 totaled $72.7 million. The Company also has two lines of credit available. A $25 million line of credit with State Street Bank, based on an adjustable rate equal to LIBOR plus 50 basis points. The outstanding balance was $0 as of December 31, 2005 and 2004. The Company also has a $20 million line of credit with Banknorth Group, based on an adjustable rate equal to LIBOR plus 37.5 basis points. The outstanding balance on the Banknorth line of credit was $0 as of December 31, 2005 and 2004. Total interest on the combined lines of credit was $ 4,448 for 2005 and $1,641 for 2004. F-33 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 12 - RECONCILIATION BETWEEN STATUTORY ACCOUNTING PRACTICES AND GAAP The Company has prepared consolidated GAAP basis financial statements for general purpose public reporting of its financial position and financial results for 2005 and 2004. A reconciliation of the Company's statutory basis capital and surplus ("surplus") to the Company's consolidated GAAP basis equity at December 31 and statutory net income to GAAP net income for the years ended December 31 is as follows (in thousands):
2005 2004 ------------------------ ------------------------ SURPLUS/ SURPLUS/ EQUITY NET INCOME EQUITY NET INCOME ---------- ---------- ---------- ---------- Statutory surplus/net income $ 623,465 $ 92,373 $ 542,437 $ 65,167 Asset valuation reserve 67,053 -- 77,253 -- Interest maintenance reserve 61,021 (3,722) 64,743 (3,227) Other assets 46,364 19,898 46,263 5,262 Investments 310,515 42,708 154,846 43,169 Policy acquisition costs 466,865 (28,367) 484,039 (15,735) Income taxes 16,752 (9,345) 45,019 (13,138) Policy liabilities and dividends (161,664) 16,639 (181,997) (4,625) Sales practices litigation provision -- 2,055 -- 2,500 Benefit plans (171,242) (238) 16,202 10,296 Other comprehensive income, net 53,513 -- 69,893 -- ---------- ---------- ---------- ---------- GAAP equity/net income $1,312,642 $ 132,001 $1,318,698 $ 89,669 ========== ========== ========== ==========
NOTE 13 - CONTINGENCIES CONTINGENT COMMITMENTS National Life anticipates additional capital investments of $65.5 million into existing limited partnerships due to funding commitments. At December 31, 2005, National Life has $18.5 million in outstanding mortgage loan funding commitments. ASSESSMENTS The Company participates in the guaranty association of each state in which it conducts business. The amount of any assessment is based on various rates, established by members of the National Organization of Life and Health Insurance Guaranty Associations ("NOLHGA"). At December 31, 2005 and 2004, NLIC had accrued assessment charges of $1.2 million with expected payment over five years. The Company has also recorded a related asset of $139,000 for premium tax credits, which are expected to be realized through 2016. F-34 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 13 - CONTINGENCIES (CONTINUED) OTHER CONTINGENCIES During 1997, several class action lawsuits were filed against the Company in various states related to the sale of life insurance policies during the 1980's and 1990's. The Company specifically denied any wrongdoing. The Company agreed to a settlement of these class action lawsuits in June 1998. This agreement was subsequently approved by the court in October 1998. The settlement provided class members with various policy enhancement options and new product purchase discounts. Class members could instead pursue alternative dispute resolution according to predetermined guidelines. All of the alternative dispute resolution cases had been settled by December 31, 2000. Qualifying members also opted out of the class action to preserve their litigation rights against the Company. Management believes that while the ultimate cost of this litigation (including those who opted out of the class action) is still uncertain, it is unlikely, after considering existing provisions, to have a material adverse effect on the Company's financial position. Existing provisions for this contingency were reduced in each year beginning in 2001, and are included as other adjustments to surplus. NOTE 14 - CLOSED BLOCK The Closed Block was established on January 1, 1999 as part of the conversion to a mutual holding company corporate structure (see Note 1). The Closed Block was initially funded on January 1, 1999 with cash and securities totaling $2.2 billion. Assets, liabilities, and results of operations of the Closed Block are presented in their normal categories on the statements of admitted assets, liabilities and surplus, and on the statements of income and capital and surplus. At December 31, 2005 and 2004, Closed Block liabilities exceeded Closed Block assets, and no additional dividend obligation was required. NOTE 15 - ANALYSIS OF ANNUITY ACTUARIAL RESERVES AND DEPOSIT LIABILITIES BY WITHDRAWAL CHARACTERISTICS Withdrawal characteristics of annuity actuarial reserves and deposit liabilities at December 31, 2005 and 2004 follow (in thousands):
2005 2004 ---------- ---------- Subject to discretionary withdrawal with market value adjustment $ 51,865 $ 52,891 At book value less surrender charges of 5% or more 285,392 283,232 ---------- ---------- Subtotal 337,257 336,123 Subject to discretionary withdrawal without adjustment - at book value 1,120,937 1,115,807 Not subject to discretionary withdrawal provision 299,459 296,468 ---------- ---------- Total annuity actuarial reserves and deposit liabilities (gross) 1,757,653 1,748,398 Less reinsurance -- -- ---------- ---------- Total annuity actuarial reserves and deposit liabilities (net) $1,757,653 $1,748,398 ========== ==========
F-35 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 16 - PREMIUM AND ANNUITY CONSIDERATIONS DEFERRED AND UNCOLLECTED Deferred and uncollected life insurance premiums and annuity considerations as of December 31, 2005 and 2004 were as follows (in thousands): 2005 ---------------------------------------------------------------- TYPE GROSS NET ---------------------------------------------------------------- Ordinary new business $ 3,859 $ 1,569 Ordinary renewal 72,200 72,238 -------- -------- Total $ 76,059 $ 73,807 ======== ======== 2004 ---------------------------------------------------------------- TYPE GROSS NET ---------------------------------------------------------------- Ordinary new business $ 4,608 $ 1,767 Ordinary renewal 72,914 72,371 -------- -------- Total $ 77,522 $ 74,138 -------- -------- NOTE 17 - SEPARATE ACCOUNTS Separate and variable accounts held by the Company represent funds held in connection with certain variable annuity, variable universal life, Company sponsored benefit plans, and funds invested on behalf of group pensions. All separate account assets are carried at fair value. The Company participates in certain separate accounts. All of the Company's separate accounts are nonguaranteed.
2005 2004 -------- -------- Separate account premiums and considerations (in thousands): $107,052 $120,151 Reserves for accounts with assets at fair value (in thousands): 791,026 730,154 ======== ========
The withdrawal characteristics of separate accounts at December 31 were as follows (in thousands):
2005 2004 -------- -------- Subject to discretionary withdrawal with adjustment - At book value (which equals fair value) less surrender charge $336,030 $297,342 Of 5% or more Subject to discretionary withdrawal without adjustment - At book value (which equals fair value) 342,201 324,480 Not subject to discretionary withdrawal 112,795 108,332 -------- -------- Total reserves $791,026 $730,154 ======== ========
F-36 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 17 - SEPARATE ACCOUNTS (CONTINUED) A reconciliation of net transfers to/from separate accounts during 2005 and 2004 is as follows (in thousands): 2005 2004 -------- -------- Net transfers to/from separate accounts $ 46,921 $ 78,020 Reconciling items: Cost of insurance charges (22,990) (21,517) -------- -------- Total $ 23,931 $ 56,503 ======== ======== NOTE 18 - FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying values and estimated fair values of financial instruments at December 31 were as follows (in thousands):
2005 2004 ------------------------ ------------------------ CARRYING ESTIMATED CARRYING ESTIMATED VALUE FAIR VALUE VALUE FAIR VALUE ---------- ---------- ---------- ---------- Cash and short-term investments $ 33,457 $ 33,457 $ 40,665 $ 33,457 Bonds 4,657,465 4,802,622 4,426,164 4,696,959 Preferred stocks 70,644 74,900 71,146 78,615 Common stocks 261,315 261,315 251,437 261,315 Mortgage loans 910,544 939,094 948,947 1,011,015 Policy loans 570,647 573,113 584,053 574,927 Investment product liabilities 761,686 783,538 776,845 821,609
For cash and short-term investments carrying value approximates estimated fair value. Debt and equity securities' estimated fair values are based on quoted values where available. Where quoted values are not available, estimated fair values are based on discounted cash flows using current interest rates of similar securities. Mortgage loan fair values are estimated as the average of discounted cash flows under different scenarios of future mortgage interest rates (including appropriate provisions for default losses and borrower prepayments). For variable rate policy loans the unpaid balance approximates fair value. Fixed rate policy loan fair values are estimated based on discounted cash flows using the current variable policy loan rate (including appropriate provisions for mortality and repayments). Investment product liabilities include flexible premium annuities, single premium deferred annuities, and supplementary contracts not involving life contingencies. Investment product fair values are estimated as the average of discounted cash flows under different scenarios of future interest rates of A-rated corporate bonds and related changes in premium persistency and surrenders. F-37 NATIONAL LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS - STATUTORY BASIS (CONTINUED) NOTE 19 - RECONCILIATION TO STATUTORY ANNUAL STATEMENTS These financial statements reflect an adjustment to an inter-company commission accrual between the Company and LSW. This adjustment was recorded subsequent to the filing of the Company's 2004 annual statement with the Department. The effect of this adjustment was to increase commissions and operating expenses by $1.2 million and decrease federal income tax expense by $0.4 million, with a corresponding increase in unrealized gains of $0.8 million from that previously reported to the Department. There was no net effect on December 31, 2004 surplus.
2005 2004 ------------------------- ------------------------- NET NET (in thousands) INCOME SURPLUS INCOME SURPLUS ---------- ---------- ---------- ---------- Per annual statement, as filed $ 91,566 $ 623,465 $ 65,974 $ 542,437 Commission expense 1,241 1,241 (1,241) (1,241) Tax expense (434) (434) 434 434 Unrealized -- (807) -- 807 ---------- ---------- ---------- ---------- Per accompanying financial statements $ 92,373 $ 623,465 $ 65,167 $ 542,437 ========== ========== ========== ==========
NOTE 20 - NEW ACCOUNTING PRONOUNCEMENTS In June 2005, the NAIC issued Statements of Statutory Accounting Principles No. 90 "ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF REAL ESTATE INVESTMENTS" ("SSAP 90"). This Statement establishes statutory accounting principles for the impairment or disposal of real estate investments and the treatment of long-lived assets associated with discontinued operations. The Company plans to adopt SSAP 90 effective January 1, 2006. The effect of adopting SSAP 90 will not have a material impact on the Company's financial position or the results of its operations. In June 2005, the NAIC issued Statements of Statutory Accounting Principles No. 93 "ACCOUNTING FOR LOW INCOME HOUSING TAX CREDIT PROPERTY INVESTMENTS" (SSAP 93). This Statement prescribes the accounting treatment for investments in federal and certain state sponsored Low Income Housing Tax Credit properties. It also adopts with modifications EITF 94-1 "ACCOUNTING FOR TAX BENEFITS RESULTING FROM INVESTMENTS IN AFFORDABLE HOUSING PROJECTS". The Company plans to adopt SSAP 93 effective January 1, 2006. The effect of adopting SSAP 93 will not have a material impact on the Company's financial position or the results of its operations. F-38 NATIONAL VARIABLE ANNUITY ACCOUNT II (A Separate Account of National Life Insurance Company) FINANCIAL STATEMENTS * * * * * DECEMBER 31, 2005 F-39 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors of National Life Insurance Company and Policyholders of National Variable Annuity Account II: In our opinion, the accompanying statements of net assets and the related statements of operations and of changes in net assets present fairly, in all material respects, the financial position of each of the sub-accounts constituting the National Variable Annuity Account II (a Separate Account of National Life Insurance Company) (the Variable Account) at December 31, 2005, the results of each of their operations for the year then ended and the changes in each of their net assets for each of the two years then ended, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Variable Account's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of securities at December 31, 2005 by correspondence with the mutual funds, provide a reasonable basis for our opinion. /s/PRICEWATERHOUSECOOPERS LLP - ----------------------------- Boston, Massachusetts April 7, 2006 F-40
NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) STATEMENTS OF NET ASSETS DECEMBER 31, 2005 TOTAL ASSETS AND NET ASSETS: Investments in shares of mutual fund portfolios at market value: (contractholder accumulation units and unit value) AIM Variable Insurance Dynamics Fund (319,611.18 units at $8.09 per unit) 2,585,386 AIM Variable Insurance Global Health Care Fund (487,457.77 units at $9.68 per unit) 4,720,853 AIM Variable Insurance Technology Fund (506,007.26 units at $4.20 per unit) 2,125,695 Alger American Growth Fund (767,708.36 units at $15.18 per unit) 11,653,244 Alger American Leveraged AllCap Fund (227,328.46 units at $8.66 per unit) 1,968,511 Alger American Small Capitalization Fund (478,400.25 units at $11.97 per unit) 5,727,835 American Century Variable Income & Growth Portfolio (693,014.06 units at $11.86 per unit) 8,216,514 American Century Variable Inflation Protection Portfolio (891,208.84 units at $10.57 per unit) 9,420,417 American Century Variable International Portfolio (401,457.13 units at $12.61 per unit) 5,062,144 American Century Variable Ultra Portfolio (7,270.30 units at $10.84 per unit) 78,775 American Century Variable Value Portfolio (1,137,146.59 units at $16.88 per unit) 19,197,958 American Century Variable Vista Portfolio (607,473.06 units at $11.52 per unit) 6,997,778 Dreyfus Variable Investment Appreciation Portfolio (596,449.94 units at $10.62 per unit) 6,332,679 Dreyfus Variable Investment Developing Leaders Portfolio (9,327.96 units at $11.36 per unit) 105,999 Dreyfus Variable Investment Quality Bond Portfolio (51,108.89 units at $10.53 per unit) 538,009 Dreyfus Variable Investment Socially Responsible Growth Fund (127,070.26 units at $7.12 per unit) 904,240 Franklin Templeton Variable Insurance Products Trust Foreign Securities Fund (465,272.17 units at $12.53 per unit) 5,831,297 Franklin Templeton Variable Insurance Products Trust Mutual Shares Securities Fund (85,355.59 units at $11.96 per unit) 1,020,623 Franklin Templeton Variable Insurance Products Trust Real Estate Fund (193,126.53 units at $15.20 per unit) 2,935,107 Franklin Templeton Variable Insurance Products Trust Small Cap Fund (18,483.51 units at $11.32 per unit) 209,150 Franklin Templeton Variable Insurance Products Trust Small Cap Value Securities Fund (86,582.41 units at $12.88 per unit) 1,114,845 JP Morgan Series Trust II International Equity Portfolio (293,409.68 units at $11.59 per unit) 3,400,201 JP Morgan Series Trust II Small Company Portfolio (135,781.36 units at $14.94 per unit) 2,028,678 Neuberger Berman Advisors Management Trust Fasciano Portfolio (293,062.77 units at $11.10 per unit) 3,254,237 Neuberger Berman Advisors Management Trust Limited Maturity Portfolio (1,138,951.87 units at $9.97 per unit) 11,359,349 Neuberger Berman Advisors Management Trust Mid Cap Growth Portfolio (21,984.08 units at $12.92 per unit) 283,967 Neuberger Berman Advisors Management Trust Partners Portfolio (247,078.34 units at $13.98 per unit) 3,453,662 The accompanying notes are an integral part of these financial statements.
F-41
NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) STATEMENTS OF NET ASSETS DECEMBER 31, 2005 TOTAL ASSETS AND NET ASSETS: Investments in shares of mutual fund portfolios at market value: (contractholder accumulation units and unit value) Scudder Variable Series II Dreman High Return Equity Portfolio (43,214.20 units at $11.91 per unit) $514,666 Scudder Variable Series II Dreman Small Cap Value Portfolio (134,345.28 units at $12.91 per unit) $1,734,753 Sentinel Variable Products Trust Balanced Fund (1,223,837.69 units at $13.77 per unit) $16,848,680 Sentinel Variable Products Trust Bond Fund (1,285,058.87 units at $14.14 per unit) $18,167,016 Sentinel Variable Products Trust Common Stock Fund (2,669,872.25 units at $14.45 per unit) $38,584,070 Sentinel Variable Products Trust Growth Index Fund (306,765.84 units at $7.80 per unit) $2,391,964 Sentinel Variable Products Trust Mid Cap Growth Fund (969,791.06 units at $15.08 per unit) $14,624,167 Sentinel Variable Products Trust Money Market Fund (798,931.40 units at $11.76 per unit) $9,393,694 Sentinel Variable Products Trust Small Company Fund (1,366,986.96 units at $26.40 per unit) $36,081,655 T Rowe Price Equity Series Blue Chip Growth Portfolio (897,520.24 units at $11.24 per unit) $10,086,065 T Rowe Price Equity Series Equity Income Portfolio (86,284.46 units at $11.46 per unit) $989,208 T Rowe Price Equity Series Health Sciences Portfolio (136,594.72 units at $11.56 per unit) $1,579,203 Variable Insurance Product Funds Contrafund Portfolio (1,007,625.06 units at $20.39 per unit) $20,545,487 Variable Insurance Product Funds Equity Income Portfolio (1,221,652.87 units at $15.15 per unit) $18,512,263 Variable Insurance Product Funds Growth Portfolio (1,011,887.95 units at $13.68 per unit) $13,840,827 Variable Insurance Product Funds High Income Portfolio (988,225.88 units at $10.17 per unit) $10,046,584 Variable Insurance Product Funds Index 500 Portfolio (1,911,724.13 units at $13.89 per unit) $26,562,493 Variable Insurance Product Funds Investment Grade Bond Portfolio (1,880,488.62 units at $12.77 per unit) $24,004,755 Variable Insurance Product Funds Mid Cap Portfolio (266,876.98 units at $14.31 per unit) $3,818,693 Variable Insurance Product Funds Overseas Portfolio (1,141,752.35 units at $13.40 per unit) $15,300,839 Wells Fargo Discovery Fund (449,988.47 units at $15.89 per unit) $7,148,772 Wells Fargo Opportunity Fund (485,070.58 units at $20.07 per unit) $9,736,898 The accompanying notes are an integral part of these financial statements.
F-42
NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) STATEMENTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2005 AIM VARIABLE INSURANCE FUNDS ALGER AMERICAN FUND ------------------------------------------- --------------------------------------------- HEALTH LEVERAGED SMALL DYNAMICS SCIENCES (1) TECHNOLOGY GROWTH ALLCAP CAPITALIZATION -------- ------------ ---------- ------ ------ -------------- INVESTMENT INCOME: Dividend income $ -- $ -- $ -- $ 28,355 $ -- $ -- EXPENSES: Mortality and expense risk and administrative charges 36,032 63,875 29,015 166,855 24,518 81,840 ----------------------------------------- ----------------------------------------- NET INVESTMENT LOSS (36,032) (63,875) (29,015) (138,500) (24,518) (81,840) ----------------------------------------- ----------------------------------------- REALIZED AND UNREALIZED GAIN ON INVESTMENTS: Capital gains distributions -- -- -- -- -- -- Net realized gain from shares 340,651 219,015 78,765 1,277,783 101,180 820,280 sold Net unrealized (depreciation) appreciation on investments (71,899) 145,944 (34,464) 1,712 143,259 81,517 ----------------------------------------- ----------------------------------------- NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS 268,752 364,959 44,301 1,279,495 244,439 901,797 ----------------------------------------- ----------------------------------------- INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 232,720 $ 301,084 $ 15,286 $ 1,140,995 $ 219,921 $ 819,957 ========================================= ========================================= (1) On July 1, 2005, AIM Health Sciences Fund was renamed AIM Global Health Care Fund. The accompanying notes are an integral part of these financial statements.
F-43
NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) STATEMENTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2005 AMERICAN CENTURY VARIABLE PORTFOLIOS --------------------------------------------------------------------------------------- INCOME & INFLATION GROWTH PROTECTION INTERNATIONAL ULTRA VALUE VISTA ------ ---------- ------------- ----- ----- ----- INVESTMENT INCOME: Dividend income $ 171,973 $ 345,238 $ 31,728 $ -- $ 158,676 $ -- EXPENSES: Mortality and expense risk and administrative charges 116,980 100,066 49,631 1,001 254,079 75,395 -------------------------------------------------------------------------------------- NET INVESTMENT INCOME (LOSS) 54,993 245,172 (17,903) (1,001) (95,403) (75,395) -------------------------------------------------------------------------------------- REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS: Capital gains distributions -- 3,205 -- -- 1,835,924 -- Net realized gain from shares 231,888 18,384 110,437 1,769 782,388 132,581 sold Net unrealized (depreciation) appreciationon investments (29,913) (227,339) 417,844 (181) (1,858,526) 359,137 -------------------------------------------------------------------------------------- NET REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS 201,975 (205,750) 528,281 1,588 759,786 491,718 -------------------------------------------------------------------------------------- INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 256,968 $ 39,422 $ 510,378 $ 587 $ 664,383 $ 416,323 ====================================================================================== The accompanying notes are an integral part of these financial statements.
F-44
NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) STATEMENTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2005 FRANKLIN TEMPLETON VARIABLE DREYFUS VARIABLE INVESTMENT FUND INSURANCE PRODUCTS TRUST -------------------------------------------------- --------------------------- DEVELOPING QUALITY SOCIALLY FOREIGN MUTUAL APPRECIATION LEADERS BOND RESPONSIBLE SECURITIES SHARES ------------ ------- ---- ----------- ---------- ------ INVESTMENT INCOME: Dividend income $ 654 $ -- $ 13,910 $ -- $ 46,055 $ 6,311 EXPENSES: Mortality and expense risk and administrative charges 63,705 1,087 5,327 12,552 57,691 9,548 ------------------------------------------------ ---------------------- NET INVESTMENT (LOSS) INCOME (63,051) (1,087) 8,583 (12,552) (11,636) (3,237) ------------------------------------------------ ---------------------- REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS: Capital gains distributions -- -- -- -- -- 2,364 Net realized gain (loss) from 46,333 1,426 2,441 (4,756) 134,313 10,768 shares sold Net unrealized appreciation (depreciation) on investments 144,977 6,019 (6,020) 33,937 304,986 60,600 ------------------------------------------------ ---------------------- NET REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS 191,310 7,445 (3,579) 29,181 439,299 73,732 ------------------------------------------------ ---------------------- INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 128,259 $ 6,358 $ 5,004 $ 16,629 $ 427,663 $ 70,495 ========================================================================== The accompanying notes are an integral part of these financial statements.
F-45
NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) STATEMENTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2005 FRANKLIN TEMPLETON VARIABLE INSURANCE JP MORGAN SERIES PRODUCTS TRUST TRUST II ------------------------------------- ---------------------- REAL SMALL SMALL INTERNATIONAL SMALL ESTATE CAP CAP VALUE EQUITY COMPANY ------ --- --------- ------ ------- INVESTMENT INCOME: Dividend income $ 31,210 $ -- $ 8,027 $ 26,663 $ -- EXPENSES: Mortality and expense risk and administrative charges 31,656 2,036 12,920 43,530 27,153 ----------------------------------- ---------------------- NET INVESTMENT LOSS (446) (2,036) (4,893) (16,867) (27,153) ----------------------------------- ---------------------- REALIZED AND UNREALIZED GAIN ON INVESTMENTS: Capital gains distributions 134,243 -- 6,493 -- 242,298 Net realized gain from shares 88,018 5,521 55,510 284,669 78,661 sold Net unrealized appreciation (depreciation) on investments 71,487 7,014 20,265 19,435 (256,168) ----------------------------------- ---------------------- NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS 293,748 12,535 82,268 304,104 64,791 ----------------------------------- ---------------------- INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 293,302 $ 10,499 $ 77,375 $ 287,237 $ 37,638 =================================== ====================== The accompanying notes are an integral part of these financial statements.
F-46
NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) STATEMENTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2005 NEUBERGER BERMAN ADVISORS MANAGEMENT TRUST SCUDDER VARIABLE SERIES II ------------------------------------------------ -------------------------- DREMAN HIGH DREMAN LIMITED MID CAP RETURN SMALL FASCIANO MATURITY GROWTH PARTNERS EQUITY CAP VALUE -------- -------- ------ -------- ------ --------- INVESTMENT INCOME: Dividend income $ -- $ 287,719 $ -- $ 30,732 $ 4,245 $ 7,986 EXPENSES: Mortality and expense risk and administrative charges 33,893 120,657 2,592 39,007 5,052 25,764 ------------------------------------------------ ---------------------- NET INVESTMENT (LOSS) INCOME (33,893) 167,062 (2,592) (8,275) (807) (17,778) ------------------------------------------------ ---------------------- REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS: Capital gains distributions 13,477 -- -- 713 -- 192,365 Net realized gain (loss) from 62,853 (37,314) 11,385 343,584 9,008 68,206 shares sold Net unrealized appreciation (depreciation) on investments 57,783 (114,843) 20,929 92,917 15,867 (45,522) ------------------------------------------------ ---------------------- NET REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS 134,113 (152,157) 32,314 437,214 24,875 215,049 ------------------------------------------------ ---------------------- INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 100,220 $ 14,905 $ 29,722 $ 428,939 $ 24,068 $ 197,271 ================================================ ====================== The accompanying notes are an integral part of these financial statements.
F-47
NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) STATEMENTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2005 SENTINEL VARIABLE PRODUCTS TRUST -------------------------------------------------------------------------------------- COMMON MID CAP MONEY SMALL BALANCED BOND STOCK GROWTH MARKET COMPANY -------- ---- ----- ------ ------ ------- INVESTMENT INCOME: Dividend income $ 372,108 $ 798,831 $ 423,823 $ -- $ 289,979 $ 30,399 EXPENSES: Mortality and expense risk and administrative charges 230,800 253,449 501,500 210,687 146,220 501,320 -------------------------------------------------------------------------------------- NET INVESTMENT INCOME (LOSS) 141,308 545,382 (77,677) (210,687) 143,759 (470,921) -------------------------------------------------------------------------------------- REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS: Capital gains distributions 280,098 -- -- -- -- 3,448,887 Net realized gain from shares sold 405,778 83,003 1,119,352 748,934 -- 3,420,500 Net unrealized (depreciation) appreciation on investments (145,609) (544,635) 1,170,815 (263,743) -- (3,941,444) -------------------------------------------------------------------------------------- NET REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS 540,267 (461,632) 2,290,167 485,191 -- 2,927,943 -------------------------------------------------------------------------------------- INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 681,575 $ 83,750 $ 2,212,490 $ 274,504 $ 143,759 $ 2,457,022 ====================================================================================== The accompanying notes are an integral part of these financial statements.
F-48
NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) STATEMENTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2005 STRONG VARIABLE INSURANCE FUND T ROWE PRICE EQUITY SERIES ---------------------------------- ------------------------------------ MID CAP OPPORTUNITY BLUE CHIP EQUITY HEALTH GROWTH FUND II (2) FUND II (2) GROWTH INCOME SCIENCES ------------------ ----------- ------ ------ -------- INVESTMENT INCOME: Dividend income $ -- $ -- $ 10,311 $ 11,878 $ -- EXPENSES: Mortality and expense risk and administrative charges -- -- 83,204 11,636 20,050 ---------------------------------- ----------------------------------- NET INVESTMENT (LOSS) INCOME -- -- (72,893) 242 (20,050) REALIZED AND UNREALIZED GAIN ON INVESTMENTS: Capital gains distributions -- -- -- 44,652 -- Net realized gain (loss) from shares sold -- -- 74,187 17,337 129,158 Net unrealized appreciation (depreciation) on investments -- -- 404,443 (37,134) 88,682 ---------------------------------- ----------------------------------- NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS -- -- 478,630 24,855 217,840 ---------------------------------- ----------------------------------- INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ -- $ -- $ 405,737 $ 25,097 $ 197,790 ================================== =================================== (2) In 2005, Wells Fargo acquired assets from Strong Financial Corporation which became part of the Wells Fargo Variable Trust Funds. The accompanying notes are an integral part of these financial statements.
F-49
NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) STATEMENTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2005 VARIABLE INSURANCE PRODUCT FUNDS -------------------------------------------------------------------------------------- EQUITY HIGH INVESTMENT CONTRAFUND INCOME GROWTH INCOME INDEX 500 GRADE BOND ---------- ------ ------ ------ --------- ---------- INVESTMENT INCOME: Dividend income $ 56,544 $ 314,152 $ 75,023 $ 1,495,391 $ 486,538 $ 886,009 EXPENSES: Mortality and expense risk and administrative charges 269,054 260,602 199,621 138,321 374,129 338,970 -------------------------------------------------------------------------------------- NET INVESTMENT INCOME (LOSS) (212,510) 53,550 (124,598) 1,357,070 112,409 547,039 -------------------------------------------------------------------------------------- REALIZED AND UNREALIZED (LOSS) GAIN ON INVESTMENTS: Capital gains distributions 3,534 690,359 -- -- -- 535,297 Net realized gain (loss) 1,111,334 397,199 (339,749) 205,148 13,261 (252,327) from shares sold Net unrealized (depreciation) appreciation on investments 1,909,318 (357,709) 1,021,743 (1,430,133) 737,988 (642,146) -------------------------------------------------------------------------------------- NET REALIZED AND UNREALIZED (LOSS) GAIN ON INVESTMENTS 3,024,186 729,849 681,994 (1,224,985) 751,249 (359,176) -------------------------------------------------------------------------------------- INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 2,811,676 $ 783,399 $ 557,396 $ 132,085 $ 863,658 $ 187,863 ====================================================================================== The accompanying notes are an integral part of these financial statements.
F-50
NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) STATEMENTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2005 VARIABLE INSURANCE PRODUCT FUNDS WELLS FARGO VARIABLE TRUST FUNDS -------------------------------- -------------------------------- MID CAP OVERSEAS DISCOVERY (2) OPPORTUNITY (2) ------- -------- ------------- --------------- INVESTMENT INCOME: Dividend income $ -- $ 88,766 $ -- $ -- EXPENSES: Mortality and expense risk and administrative charges 36,291 190,725 100,247 143,640 ---------------------------- ---------------------------- NET INVESTMENT INCOME (LOSS) (36,291) (101,959) (100,247) (143,640) ---------------------------- ---------------------------- REALIZED AND UNREALIZED (LOSS) GAIN ON INVESTMENTS: Capital gains distributions 28,189 69,469 -- -- Net realized gain (loss) 141,293 805,566 912,949 2,471,171 from shares sold Net unrealized (depreciation) appreciation on investments 354,335 1,540,132 (296,787) (1,718,555) ---------------------------- ---------------------------- NET REALIZED AND UNREALIZED (LOSS) GAIN ON INVESTMENTS 523,817 2,415,167 616,162 752,616 ---------------------------- ---------------------------- INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 487,526 $ 2,313,208 $ 515,915 $ 608,976 ============================ ============================ (2) In 2005, Wells Fargo acquired assets from Strong Financial Corporation which became part of the Wells Fargo Variable Trust Funds. The accompanying notes are an integral part of these financial statements.
F-51
NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) STATEMENTS OF CHANGES IN NET ASSETS FOR THE YEAR ENDED DECEMBER 31, 2005 AIM VARIABLE INSURANCE FUNDS ALGER AMERICAN FUND -------------------------------------------- ---------------------------------------------- HEALTH LEVERAGED SMALL DYNAMICS SCIENCES (1) TECHNOLOGY GROWTH ALLCAP CAPITALIZATION -------- ------------ ---------- ------ ------ -------------- NET INVESTMENT (LOSS) INCOME $ (36,032) $ (63,875) $ (29,015) $ (138,500) $ (24,518) $ (81,840) REALIZED AND UNREALIZED GAIN ON INVESTMENTS: Capital gains distributions -- -- -- -- -- -- Net realized gain from shares 340,651 219,015 78,765 1,277,783 101,180 820,280 sold Net unrealized (depreciation) appreciation on investments (71,899) 145,944 (34,464) 1,712 143,259 81,517 -------------------------------------------- -------------------------------------------- NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS 268,752 364,959 44,301 1,279,495 244,439 901,797 -------------------------------------------- -------------------------------------------- INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 232,720 301,084 15,286 1,140,995 219,921 819,957 -------------------------------------------- -------------------------------------------- ACCUMULATION UNIT TRANSACTIONS: Participant deposits 107,834 320,825 272,441 251,234 156,730 134,178 Transfers between investment sub-accounts and general (267,570) (247,700) (83,912) (1,070,981) 40,972 (359,722) account, net Net surrenders and lapses (196,060) (377,336) (262,744) (2,069,359) (187,568) (1,129,572) Contract benefits -- (589) (8,844) (83,803) -- (47,373) Loan collateral interest received -- 139 229 61 108 52 Transfers for policy loans -- 1,704 1,953 1,997 666 (246) Contract charges (1,594) (3,552) (1,685) (10,665) (1,884) (4,860) Other (133) 279 183 3,004 622 (175) -------------------------------------------- -------------------------------------------- Total net accumulation unit (357,523) (306,230) (82,379) (2,978,512) 9,646 (1,407,718) transactions -------------------------------------------- -------------------------------------------- (Decrease) increase in net assets (124,803) (5,146) (67,093) (1,837,517) 229,567 (587,761) Net assets, beginning of period 2,710,189 4,725,999 2,192,788 13,490,761 1,738,944 6,315,596 -------------------------------------------- -------------------------------------------- NET ASSETS, END OF PERIOD $ 2,585,386 $ 4,720,853 $ 2,125,695 $ 11,653,244 $ 1,968,511 $ 5,727,835 ============================================ ============================================ UNITS ISSUED, TRANSFERRED AND REDEEMED: Beginning balance 365,843.00 520,475.69 525,974.29 981,988.91 226,660.10 608,040.56 Units issued 13,944.17 34,591.56 66,034.28 18,074.31 10,859.61 12,356.79 Units transferred (34,599.86) (26,707.18) (20,338.60) (77,048.67) 2,838.89 (33,127.71) Units redeemed (25,576.13) (40,902.30) (65,662.71) (155,306.19) (13,030.14) (108,869.39) -------------------------------------------- -------------------------------------------- Ending balance 319,611.18 487,457.77 506,007.26 767,708.36 227,328.46 478,400.25 ============================================ ============================================ (1) On July 1, 2005, AIM Health Sciences Fund was renamed AIM Global Health Care Fund. The accompanying notes are an integral part of these financial statements.
F-52
NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) STATEMENTS OF CHANGES IN NET ASSETS FOR THE YEAR ENDED DECEMBER 31, 2005 AMERICAN CENTURY VARIABLE PORTFOLIOS -------------------------------------------------------------------------------------------- INCOME & INFLATION GROWTH PROTECTION INTERNATIONAL ULTRA VALUE VISTA ------ ---------- ------------- ----- ----- ----- NET INVESTMENT INCOME (LOSS) $ 54,993 $ 245,172 $ (17,903) $ (1,001) $ (95,403) $ (75,395) REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS: Capital gains distributions -- 3,205 -- -- 1,835,924 -- Net realized gain from shares sold 231,888 18,384 110,437 1,769 782,388 132,581 Net unrealized (depreciation) appreciation on investments (29,913) (227,339) 417,844 (181) (1,858,526) 359,137 -------------------------------------------------------------------------------------------- NET REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS 201,975 (205,750) 528,281 1,588 759,786 491,718 -------------------------------------------------------------------------------------------- INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 256,968 39,422 510,378 587 664,383 416,323 -------------------------------------------------------------------------------------------- ACCUMULATION UNIT TRANSACTIONS: Participant deposits 280,585 2,888,458 1,720,958 20,339 2,002,770 2,171,711 Transfers between investment sub-accounts and general (133,673) 1,952,886 607,777 7,149 465,277 877,271 account, net Net surrenders and lapses (951,699) (318,418) (173,120) (28,319) (1,930,145) (454,866) Contract benefits (28,310) (29,577) -- -- (57,942) -- Loan collateral interest received 75 -- -- -- 63 -- Transfers for policy loans 484 -- -- -- 2,597 (617) Contract charges (5,130) (3,510) (1,852) (42) (12,706) (3,021) Other 941 1,697 1,335 5 3,816 3,049 -------------------------------------------------------------------------------------------- Total net accumulation unit (836,727) 4,491,536 2,155,098 (868) 473,730 2,593,527 transactions -------------------------------------------------------------------------------------------- (Decrease) increase in net assets (579,759) 4,530,958 2,665,476 (281) 1,138,113 3,009,850 Net assets, beginning of period 8,796,273 4,889,459 2,396,668 79,056 18,059,845 3,987,928 -------------------------------------------------------------------------------------------- NET ASSETS, END OF PERIOD $ 8,216,514 $ 9,420,417 $ 5,062,144 $ 78,775 $ 19,197,958 $ 6,997,778 ============================================================================================ UNITS ISSUED, TRANSFERRED AND REDEEMED: Beginning balance 765,569.07 464,504.55 212,294.68 7,351.49 1,108,091.56 369,192.37 Units issued 24,330.33 274,408.89 151,056.07 1,902.36 122,834.83 199,526.28 Units transferred (11,591.17) 185,527.81 53,347.27 668.66 28,536.58 80,599.41 Units redeemed (85,294.17) (33,232.41) (15,240.89) (2,652.21) (122,316.38) (41,845.00) -------------------------------------------------------------------------------------------- Ending balance 693,014.06 891,208.84 401,457.13 7,270.30 1,137,146.59 607,473.06 ============================================================================================ The accompanying notes are an integral part of these financial statements.
F-53
NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) STATEMENTS OF CHANGES IN NET ASSETS FOR THE YEAR ENDED DECEMBER 31, 2005 FRANKLIN TEMPLETON VARIABLE DREYFUS VARIABLE INVESTMENT FUND INSURANCE PRODUCTS TRUST -------------------------------------------------------- ---------------------------- DEVELOPING QUALITY SOCIALLY FOREIGN MUTUAL APPRECIATION LEADERS BOND RESPONSIBLE SECURITIES SHARES ------------ ------- ---- ----------- ---------- ------ NET INVESTMENT (LOSS) INCOME $ (63,051) $ (1,087) $ 8,583 $ (12,552) $ (11,636) $ (3,237) REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS: Capital gains distributions -- -- -- -- -- 2,364 Net realized gain (loss) from 46,333 1,426 2,441 (4,756) 134,313 10,768 shares sold Net unrealized appreciation (depreciation) on investments 144,977 6,019 (6,020) 33,937 304,986 60,600 -------------------------------------------------------- -------------------------- NET REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS 191,310 7,445 (3,579) 29,181 439,299 73,732 -------------------------------------------------------- -------------------------- INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 128,259 6,358 5,004 16,629 427,663 70,495 -------------------------------------------------------- -------------------------- ACCUMULATION UNIT TRANSACTIONS: Participant deposits 2,018,120 53,879 167,690 26,091 1,941,181 310,376 Transfers between investment sub-accounts and general account, 2,061,635 21,630 168,356 9,919 996,997 325,949 net Net surrenders and lapses (429,264) (8,452) (16,766) (132,763) (225,061) (68,478) Contract benefits -- -- (8,731) (37,561) -- -- Loan collateral interest received -- -- -- -- -- -- Transfers for policy loans -- -- -- -- -- -- Contract charges (2,675) (83) (238) (526) (2,122) (775) Other (387) 664 (6) (2) 1,488 680 -------------------------------------------------------- -------------------------- Total net accumulation unit 3,647,429 67,638 310,305 (134,842) 2,712,483 567,752 transactions -------------------------------------------------------- -------------------------- Increase (decrease) in net assets 3,775,688 73,996 315,309 (118,213) 3,140,146 638,247 Net assets, beginning of period 2,556,991 32,003 222,700 1,022,453 2,691,151 382,376 -------------------------------------------------------- -------------------------- NET ASSETS, END OF PERIOD $ 6,332,679 $ 105,999 $ 538,009 $ 904,240 $ 5,831,297 $ 1,020,623 ======================================================== ========================== UNITS ISSUED, TRANSFERRED AND REDEEMED: Beginning balance 247,910.98 2,938.60 21,381.13 146,825.11 233,297.54 34,866.29 Units issued 192,846.37 5,089.63 16,064.99 3,822.43 166,012.00 27,601.25 Units transferred 197,004.55 2,043.26 16,128.80 1,453.17 85,264.32 28,986.14 Units redeemed (41,311.96) (743.53) (2,466.03) (25,030.45) (19,301.69) (6,098.09) -------------------------------------------------------- -------------------------- Ending balance 596,449.94 9,327.96 51,108.89 127,070.26 465,272.17 85,355.59 ======================================================== ========================== The accompanying notes are an integral part of these financial statements.
F-54
NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) STATEMENTS OF CHANGES IN NET ASSETS FOR THE YEAR ENDED DECEMBER 31, 2005 FRANKLIN TEMPLETON VARIABLE INSURANCE JP MORGAN SERIES TRUST II PRODUCTS TRUST ----------------------------------------- ---------------------------- REAL SMALL SMALL INTERNATIONAL SMALL ESTATE CAP CAP VALUE EQUITY COMPANY ------ --- --------- ------ ------- NET INVESTMENT (LOSS) INCOME $ (446) $ (2,036) $ (4,893) $ (16,867) $ (27,153) REALIZED AND UNREALIZED GAIN ON INVESTMENTS: Capital gains distributions 134,243 -- 6,493 -- 242,298 Net realized gain from shares sold 88,018 5,521 55,510 284,669 78,661 Net unrealized appreciation (depreciation) on investments 71,487 7,014 20,265 19,435 (256,168) ----------------------------------------- -------------------------- NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS 293,748 12,535 82,268 304,104 64,791 ----------------------------------------- -------------------------- INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 293,302 10,499 77,375 287,237 37,638 ----------------------------------------- -------------------------- ACCUMULATION UNIT TRANSACTIONS: Participant deposits 440,879 89,689 248,403 281,913 136,659 Transfers between investment sub-accounts and general account, 1,797,290 29,662 351,213 137,590 (70,867) net Net surrenders and lapses (508,827) (14,931) (58,328) (337,704) (107,898) Contract benefits (54,370) -- (26,688) -- (768) Loan collateral interest received -- -- -- 13 6 Transfers for policy loans -- -- -- 39 (334) Contract charges (1,565) (91) (289) (2,205) (1,351) Other 1,368 (8) 221 (183) 291 ----------------------------------------- -------------------------- Total net accumulation unit 1,674,775 104,321 514,532 79,463 (44,262) transactions ----------------------------------------- -------------------------- Increase (decrease) in net assets 1,968,077 114,820 591,907 366,700 (6,624) Net assets, beginning of period 967,030 94,330 522,938 3,033,501 2,035,302 ----------------------------------------- -------------------------- NET ASSETS, END OF PERIOD $ 2,935,107 $ 209,150 $ 1,114,845 $ 3,400,201 $ 2,028,678 ========================================= ========================== UNITS ISSUED, TRANSFERRED AND REDEEMED: Beginning balance 71,208.31 8,615.03 43,564.50 285,762.15 138,936.30 Units issued 32,094.57 8,484.34 20,767.96 27,131.36 9,740.90 Units transferred 130,836.91 2,805.94 29,363.48 13,241.69 (5,051.32) Units redeemed (41,013.26) (1,421.81) (7,113.53) (32,725.52) (7,844.52) ----------------------------------------- -------------------------- Ending balance 193,126.53 18,483.51 86,582.41 293,409.68 135,781.36 ========================================= ========================== The accompanying notes are an integral part of these financial statements.
F-55
NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) STATEMENTS OF CHANGES IN NET ASSETS FOR THE YEAR ENDED DECEMBER 31, 2005 NEUBERGER BERMAN ADVISORS MANAGEMENT TRUST SCUDDER VARIABLE SERIES II ------------------------------------------------------------ ---------------------------- DREMAN DREMAN LIMITED MID CAP HIGH RETURN SMALL CAP FASCIANO MATURITY GROWTH PARTNERS EQUITY VALUE -------- -------- ------ -------- ------ ----- NET INVESTMENT (LOSS) INCOME $ (33,893) $ 167,062 $ (2,592) $ (8,275) $ (807) $ (17,778) REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS: Capital gains distributions 13,477 -- -- 713 -- 192,365 Net realized gain (loss) from 62,853 (37,314) 11,385 343,584 9,008 68,206 shares sold Net unrealized appreciation (depreciation) on investments 57,783 (114,843) 20,929 92,917 15,867 (45,522) ------------------------------------------------------------ ---------------------------- NET REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS 134,113 (152,157) 32,314 437,214 24,875 215,049 ------------------------------------------------------------ ---------------------------- INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 100,220 14,905 29,722 428,939 24,068 197,271 ------------------------------------------------------------ ---------------------------- ACCUMULATION UNIT TRANSACTIONS: Participant deposits 1,234,402 3,697,950 93,562 342,867 105,110 793,776 Transfers between investment sub-accounts and general 500,158 2,296,899 97,619 822,264 179,407 (343,787) account, net Net surrenders and lapses (137,492) (458,593) (6,913) (317,432) (11,970) (318,552) Contract benefits (12,096) (30,642) -- -- (26,755) (48,603) Loan collateral interest received -- -- -- 24 -- -- Transfers for policy loans -- -- -- 1,917 -- (338) Contract charges (1,339) (4,172) (73) (1,808) (162) (1,110) Other 252 21 (17) (978) (93) (530) ------------------------------------------------------------ ---------------------------- Total net accumulation unit 1,583,885 5,501,463 184,178 846,854 245,537 80,856 transactions ------------------------------------------------------------ ---------------------------- Increase in net assets 1,684,105 5,516,368 213,900 1,275,793 269,605 278,127 Net assets, beginning of period 1,570,132 5,842,981 70,067 2,177,869 245,061 1,456,626 ------------------------------------------------------------ ---------------------------- NET ASSETS, END OF PERIOD $ 3,254,237 $ 11,359,349 $ 283,967 $ 3,453,662 $ 514,666 $ 1,734,753 ============================================================ ============================ UNITS ISSUED, TRANSFERRED AND REDEEMED: Beginning balance 143,490.34 586,111.13 6,084.77 181,388.85 21,818.25 122,129.24 Units issued 116,569.39 371,606.14 8,121.70 26,595.80 9,159.22 119,926.74 Units transferred 47,231.87 230,814.85 8,319.77 63,782.07 15,633.42 (51,940.67) Units redeemed (14,228.83) (49,580.25) (542.16) (24,688.38) (3,396.69) (55,770.03) ------------------------------------------------------------ ---------------------------- Ending balance 293,062.77 1,138,951.87 21,984.08 247,078.34 43,214.20 134,345.28 ============================================================ ============================ The accompanying notes are an integral part of these financial statements.
F-56
NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) STATEMENTS OF CHANGES IN NET ASSETS FOR THE YEAR ENDED DECEMBER 31, 2005 SENTINEL VARIABLE PRODUCTS TRUST ------------------------------------------------------------------------------------------------------ COMMON GROWTH MID CAP MONEY SMALL BALANCED BOND STOCK INDEX GROWTH MARKET COMPANY -------- ---- ----- ----- ------ ------ ------- NET INVESTMENT INCOME (LOSS) $ 141,308 $ 545,382 $ (77,677) $ (13,446) $ (210,687) $ 143,759 $ (470,921) REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS: Capital gains distributions 280,098 -- -- -- -- -- 3,448,887 Net realized gain from shares 405,778 83,003 1,119,352 181,214 748,934 -- 3,420,500 sold Net unrealized (depreciation) appreciation on investments (145,609) (544,635) 1,170,815 (128,286) (263,743) -- (3,941,444) ------------------------------------------------------------------------------------------------------ NET REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS 540,267 (461,632) 2,290,167 52,928 485,191 -- 2,927,943 ------------------------------------------------------------------------------------------------------ INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 681,575 83,750 2,212,490 39,482 274,504 143,759 2,457,022 ------------------------------------------------------------------------------------------------------ ACCUMULATION UNIT TRANSACTIONS: Participant deposits 1,021,925 1,926,509 5,166,684 213,755 688,957 2,029,857 4,331,750 Transfers between investment sub-accounts and general 381,552 213,284 716,255 (422,044) (958,591) (1,443,025) (3,824,446) account, net Net surrenders and lapses (1,553,186) (1,724,583) (3,573,166) (194,856) (2,072,239) (2,375,157) (3,694,606) Contract benefits (234,613) (435,720) (364,421) (81,111) (50,347) (53,111) (330,833) Loan collateral interest received 10 340 10 -- 35 292 169 Transfers for policy loans 689 4,514 687 -- 2,376 10,401 2,971 Contract charges (12,294) (11,575) (24,691) (1,668) (12,026) (5,664) (23,851) Other 199 390 1,579 1,535 1,800 (2) 6,372 ------------------------------------------------------------------------------------------------------ Total net accumulation unit (395,718) (26,842) 1,922,938 (484,390) (2,400,033) (1,836,410) (3,532,474) transactions ------------------------------------------------------------------------------------------------------ Increase (decrease) in net assets 285,857 56,908 4,135,428 (444,908) (2,125,529) (1,692,651) (1,075,452) Net assets, beginning of period 16,562,823 18,110,108 34,448,642 2,836,872 16,749,696 11,086,345 37,157,107 ------------------------------------------------------------------------------------------------------ NET ASSETS, END OF PERIOD $ 16,848,680 $ 18,167,016 $ 38,584,070 $ 2,391,964 $ 14,624,167 $ 9,393,694 $ 36,081,655 ====================================================================================================== UNITS ISSUED, TRANSFERRED AND REDEEMED: Beginning balance 1,253,469.19 1,287,455.21 2,530,565.26 369,520.70 1,136,704.15 956,343.80 1,502,266.71 Units issued 76,522.09 171,997.13 374,299.94 27,692.96 47,914.28 173,994.28 165,888.85 Units transferred 28,570.74 19,041.82 51,889.03 (54,677.77) (66,666.27) (123,692.50) (146,461.12) Units redeemed (134,724.33) (193,435.29) (286,881.98) (35,770.05) (148,161.10) (207,714.18) (154,707.48) ------------------------------------------------------------------------------------------------------ Ending balance 1,223,837.69 1,285,058.87 2,669,872.25 306,765.84 969,791.06 798,931.40 1,366,986.96 ====================================================================================================== The accompanying notes are an integral part of these financial statements.
F-57
NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) STATEMENTS OF CHANGES IN NET ASSETS FOR THE YEAR ENDED DECEMBER 31, 2005 STRONG VARIABLE INSURANCE FUND T ROWE PRICE EQUITY SERIES -------------------------------- ------------------------------------------- MID CAP OPPORTUNITY BLUE CHIP EQUITY HEALTH GROWTH FUND II FUND II (2) GROWTH INCOME SCIENCES -------------- ----------- ------ ------ -------- (2) NET INVESTMENT (LOSS) INCOME $ -- $ -- $ (72,893) $ 242 $ (20,050) REALIZED AND UNREALIZED GAIN ON INVESTMENTS: Capital gains distributions -- -- -- 44,652 -- Net realized gain (loss) from -- -- 74,187 17,337 129,158 shares sold Net unrealized appreciation (depreciation) on investments -- -- 404,443 (37,134) 88,682 --------------------------------- -------------------------------------------- NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS -- -- 478,630 24,855 217,840 --------------------------------- -------------------------------------------- INCREASE IN NET ASSETS RESULTING FROM OPERATIONS -- -- 405,737 25,097 197,790 --------------------------------- -------------------------------------------- ACCUMULATION UNIT TRANSACTIONS: Participant deposits -- -- 2,781,587 165,801 493,700 Transfers between investment sub-accounts and general account, (7,995,238) (11,005,540) 4,153,136 397,163 448,898 net Net surrenders and lapses -- -- (261,869) (34,201) (636,278) Contract benefits -- -- (10,016) (26,104) (24,011) Loan collateral interest received -- -- -- -- -- Transfers for policy loans -- -- -- -- (539) Contract charges -- -- (2,956) (426) (787) Other -- -- 1,323 (65) 1 --------------------------------- -------------------------------------------- Total net accumulation unit -- -- 6,661,205 502,168 280,984 transactions --------------------------------- -------------------------------------------- Increase (decrease) in net assets -- -- 7,066,942 527,265 478,774 Net assets, beginning of period 7,995,238 11,005,540 3,019,123 461,943 1,100,429 --------------------------------- -------------------------------------------- NET ASSETS, END OF PERIOD $ -- $ -- $ 10,086,065 $ 989,208 $ 1,579,203 ================================= ============================================ UNITS ISSUED, TRANSFERRED AND REDEEMED: Beginning balance 543,989.20 583,347.53 279,899.33 41,206.26 106,209.88 Units issued -- -- 257,906.23 14,883.49 53,387.37 Units transferred (543,989.20) (583,347.53) 385,075.02 35,652.20 48,542.60 Units redeemed -- -- (25,360.34) (5,457.49) (71,545.13) --------------------------------- -------------------------------------------- Ending balance -- -- 897,520.24 86,284.46 136,594.72 ================================= ============================================ (2) In 2005, Wells Fargo acquired assets from Strong Financial Corporation which became part of the Wells Fargo Variable Trust Funds. The accompanying notes are an integral part of these financial statements.
F-58
NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) STATEMENTS OF CHANGES IN NET ASSETS FOR THE YEAR ENDED DECEMBER 31, 2005 VARIABLE INSURANCE PRODUCT FUNDS --------------------------------------------------------------------------------------------- EQUITY HIGH INVESTMENT CONTRAFUND INCOME GROWTH INCOME INDEX 500 GRADE BOND ---------- ------ ------ ------ --------- ---------- NET INVESTMENT INCOME (LOSS) $ (212,510) $ 53,550 $ (124,598) $ 1,357,070 $ 112,409 $ 547,039 REALIZED AND UNREALIZED (LOSS) GAIN ON INVESTMENTS: Capital gains distributions 3,534 690,359 -- -- -- 535,297 Net realized gain (loss) from shares sold 1,111,334 397,199 (339,749) 205,148 13,261 (252,327) Net unrealized (depreciation) appreciation on investments 1,909,318 (357,709) 1,021,743 (1,430,133) 737,988 (642,146) --------------------------------------------------------------------------------------------- NET REALIZED AND UNREALIZED (LOSS) GAIN ON INVESTMENTS 3,024,186 729,849 681,994 (1,224,985) 751,249 (359,176) --------------------------------------------------------------------------------------------- INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 2,811,676 783,399 557,396 132,085 863,658 187,863 --------------------------------------------------------------------------------------------- ACCUMULATION UNIT TRANSACTIONS: Participant deposits 1,174,739 721,206 640,127 1,154,839 1,362,822 2,405,068 Transfers between investment sub-accounts and general 5,095 (1,016,184) (1,239,622) (294,146) (991,021) (371,892) account, net Net surrenders and lapses (2,179,818) (2,064,476) (1,845,749) (984,968) (2,563,871) (2,873,438) Contract benefits (172,278) (134,998) (28,168) (102,061) (154,582) (265,403) Loan collateral interest received 24 28 124 245 293 180 Transfers for policy loans 1,903 97 (2,046) 2,083 (2,601) 3,585 Contract charges (13,336) (10,904) (10,960) (6,625) (22,032) (15,303) Other 512 5,013 2,121 802 6,262 (2,204) --------------------------------------------------------------------------------------------- Total net accumulation unit (1,183,159) (2,500,218) (2,484,173) (229,831) (2,364,730) (1,119,407) transactions --------------------------------------------------------------------------------------------- (Decrease) increase in net assets 1,628,517 (1,716,819) (1,926,777) (97,746) (1,501,072) (931,544) Net assets, beginning of period 18,916,970 20,229,082 15,767,604 10,144,330 28,063,565 24,936,299 --------------------------------------------------------------------------------------------- NET ASSETS, END OF PERIOD $ 20,545,487 $ 18,512,263 $ 13,840,827 $ 10,046,584 $ 26,562,493 $ 24,004,755 ============================================================================================= UNITS ISSUED, TRANSFERRED AND REDEEMED: Beginning balance 1,069,940.50 1,393,766.90 1,202,786.07 1,010,663.00 2,088,000.22 1,968,755.52 Units issued 61,871.97 49,647.54 49,191.04 112,740.48 101,590.00 189,643.18 Units transferred 268.35 (69,953.71) (95,259.67) (28,715.83) (73,874.53) (29,324.24) Units redeemed (124,455.76) (151,807.86) (144,829.49) (106,461.77) (203,991.56) (248,585.84) --------------------------------------------------------------------------------------------- Ending balance 1,007,625.06 1,221,652.87 1,011,887.95 988,225.88 1,911,724.13 1,880,488.62 ============================================================================================= The accompanying notes are an integral part of these financial statements.
F-59
NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) STATEMENTS OF CHANGES IN NET ASSETS FOR THE YEAR ENDED DECEMBER 31, 2005 VARIABLE INSURANCE PRODUCT WELLS FARGO VARIABLE TRUST FUNDS FUNDS ---------------------------- ------------------------------- MID CAP OVERSEAS DISCOVERY (2) OPPORTUNITY (2) NET INVESTMENT INCOME (LOSS) $ (36,291) $ (101,959) $ (100,247) $ (143,640) REALIZED AND UNREALIZED (LOSS) GAIN ON INVESTMENTS: Capital gains distributions 28,189 69,469 -- -- Net realized gain (loss) from 141,293 805,566 912,949 2,471,171 shares sold Net unrealized (depreciation) appreciation on investments 354,335 1,540,132 (296,787) (1,718,555) ---------------------------- ---------------------------- NET REALIZED AND UNREALIZED (LOSS) GAIN ON INVESTMENTS 523,817 2,415,167 616,162 752,616 ---------------------------- ---------------------------- INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 487,526 2,313,208 515,915 608,976 ---------------------------- ---------------------------- ACCUMULATION UNIT TRANSACTIONS: Participant deposits 933,439 1,104,736 158,338 463,824 Transfers between investment sub-accounts and general account, 1,280,948 (237,301) 7,407,693 10,376,609 net Net surrenders and lapses (191,805) (1,271,224) (822,003) (1,701,928) Contract benefits (10,577) (132,175) (107,790) (5,465) Loan collateral interest received -- 45 255 10 Transfers for policy loans -- 2,030 2,715 (16) Contract charges (1,483) (8,986) (6,302) (6,597) Other 1,239 (1,448) (49) 1,485 ---------------------------- ---------------------------- Total net accumulation unit 2,011,761 (544,323) 6,632,857 9,127,922 transactions ---------------------------- ---------------------------- (Decrease) increase in net assets 2,499,287 1,768,885 7,148,772 9,736,898 Net assets, beginning of period 1,319,406 13,531,954 -- -- ---------------------------- ---------------------------- NET ASSETS, END OF PERIOD $ 3,818,693 $ 15,300,839 $ 7,148,772 $ 9,736,898 ============================ ============================ UNITS ISSUED, TRANSFERRED AND REDEEMED: Beginning balance 107,584.37 1,185,510.33 -- -- Units issued 73,910.34 88,809.44 10,924.91 24,277.15 Units transferred 101,426.33 (19,076.56) 503,450.13 550,428.47 Units redeemed (16,044.06) (113,490.86) (64,386.57) (89,635.04) ---------------------------- ---------------------------- Ending balance 266,876.98 1,141,752.35 449,988.47 485,070.58 ============================ ============================ (2) In 2005, Wells Fargo acquired assets from Strong Financial Corporation which became part of the Wells Fargo Variable Trust Funds. The accompanying notes are an integral part of these financial statements.
F-60
NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) STATEMENTS OF CHANGES IN NET ASSETS FOR THE YEAR ENDED DECEMBER 31, 2004 AIM VARIABLE INSURANCE FUNDS ALGER AMERICAN FUND --------------------------------------------- --------------------------------------------- HEALTH LEVERAGED SMALL DYNAMICS (1) SCIENCES (1) TECHNOLOGY (1) GROWTH ALLCAP CAPITALIZATION ------------ ------------ -------------- ------ ------ -------------- NET INVESTMENT (LOSS) INCOME $ (36,246) $ (66,463) $ (31,717) $ (199,516) $ (26,511) $ (85,153) REALIZED AND UNREALIZED GAIN ON INVESTMENTS: Capital gains distributions -- -- -- -- -- -- Net realized gain from shares sold 116,093 123,849 177,672 875,438 112,532 548,979 Net unrealized appreciation (depreciation) on investments 201,226 189,662 (127,439) (240,575) 12,078 374,042 -------------------------------------------- -------------------------------------------- NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS 317,319 313,511 50,233 634,863 124,610 923,021 -------------------------------------------- -------------------------------------------- INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 281,073 247,048 18,516 435,347 98,099 837,868 -------------------------------------------- -------------------------------------------- ACCUMULATION UNIT TRANSACTIONS: Participant deposits 246,573 671,248 439,369 968,581 153,512 618,205 Transfers between investment sub-accounts and general account, (67,068) (208,111) (227,146) (1,553,387) (390,223) (220,884) net Net surrenders and lapses (271,328) (510,170) (225,514) (1,405,824) (220,694) (642,280) Contract benefits (4,449) (39,180) (20,200) (91,197) -- (38,433) Loan collateral interest received -- 28 22 52 9 43 Transfers for policy loans -- (2,864) (3,750) (2,718) (1,849) (284) Contract charges (1,889) (3,521) (1,564) (12,663) (2,113) (5,267) Other (388) (352) (148) (2,772) 1,332 1,059 -------------------------------------------- -------------------------------------------- Total net accumulation unit (98,549) (92,922) (38,931) (2,099,928) (460,026) (287,841) transactions -------------------------------------------- -------------------------------------------- Increase (decrease) in net assets 182,524 154,126 (20,415) (1,664,581) (361,927) 550,027 Net assets, beginning of period 2,527,665 4,571,873 2,213,203 15,155,342 2,100,871 5,765,569 -------------------------------------------- -------------------------------------------- NET ASSETS, END OF PERIOD $ 2,710,189 $ 4,725,999 $ 2,192,788 $ 13,490,761 $ 1,738,944 $ 6,315,596 ============================================ ============================================ UNITS ISSUED, TRANSFERRED AND REDEEMED: Beginning balance 381,357.65 534,106.75 547,768.82 1,147,661.68 292,149.77 638,099.32 Units issued 38,818.20 98,467.79 245,969.54 76,415.71 21,854.09 64,558.12 Units transferred (10,558.57) (30,528.55) (127,161.90) (122,553.69) (55,552.46) (23,066.55) Units redeemed (43,774.28) (81,570.30) (140,602.17) (119,534.79) (31,791.30) (71,550.33) -------------------------------------------- -------------------------------------------- Ending balance 365,843.00 520,475.69 525,974.29 981,988.91 226,660.10 608,040.56 ============================================ ============================================ (1) On October 15, 2004, INVESCO Dynamics Fund was renamed AIM Dynamics Fund, INVESCO Health Sciences Fund was renamed AIM Health Sciences Fund and INVESCO Technology Fund was renamed AIM Technology Fund. The accompanying notes are an integral part of these financial statements.
F-61
NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) STATEMENTS OF CHANGES IN NET ASSETS FOR THE YEAR ENDED DECEMBER 31, 2004 AMERICAN CENTURY VARIABLE PORTFOLIOS --------------------------------------------------------------------------------------------- INCOME & INFLATION GROWTH PROTECTION INTERNATIONAL ULTRA (2) VALUE VISTA (2) (2) (2) --------------------------------------------------------------------------------------------- NET INVESTMENT INCOME (LOSS) $ 3,462 $ 35,233 $ (10,667) $ (329) $ (70,472) $ (18,354) REALIZED AND UNREALIZED GAIN ON INVESTMENTS: Capital gains distributions -- -- -- -- 113,490 -- Net realized gain from shares sold 27,384 14,649 15,909 461 368,666 1,037 Net unrealized appreciation on investments 863,923 70,658 262,881 5,670 1,516,496 393,222 --------------------------------------------------------------------------------------------- NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS 891,307 85,307 278,790 6,131 1,998,652 394,259 --------------------------------------------------------------------------------------------- INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 894,769 120,540 268,123 5,802 1,928,180 375,905 --------------------------------------------------------------------------------------------- ACCUMULATION UNIT TRANSACTIONS: Participant deposits 760,031 2,521,959 1,256,282 47,081 2,606,527 1,909,623 Transfers between investment sub-accounts and general account, 58,947 2,364,942 927,152 26,421 760,095 1,806,364 net Net surrenders and lapses (753,734) (87,899) (52,733) (103) (1,002,279) (103,140) Contract benefits (74,237) (29,339) -- -- (144,756) -- Loan collateral interest received 21 -- -- -- 51 -- Transfers for policy loans (1,494) -- -- -- (7,589) -- Contract charges (5,392) (1,524) (578) -- (11,194) (1,129) Other 743 780 (1,578) (145) 1,282 305 --------------------------------------------------------------------------------------------- Total net accumulation unit (15,115) 4,768,919 2,128,545 73,254 2,202,137 3,612,023 transactions --------------------------------------------------------------------------------------------- Increase in net assets 879,654 4,889,459 2,396,668 79,056 4,130,317 3,987,928 Net assets, beginning of period 7,916,619 -- -- -- 13,929,528 -- --------------------------------------------------------------------------------------------- NET ASSETS, END OF PERIOD $ 8,796,273 $ 4,889,459 $ 2,396,668 $ 79,056 $ 18,059,845 $ 3,987,928 ============================================================================================= UNITS ISSUED, TRANSFERRED AND REDEEMED: Beginning balance 767,740.18 -- -- -- 963,627.66 -- Units issued 109,170.37 245,645.07 125,297.79 4,724.87 170,992.57 195,186.53 Units transferred 8,467.11 230,351.22 92,471.35 2,651.51 49,863.51 184,632.22 Units redeemed (119,808.59) (11,491.74) (5,474.46) (24.89) (76,392.18) (10,626.38) --------------------------------------------------------------------------------------------- Ending balance 765,569.07 464,504.55 212,294.68 7,351.49 1,108,091.56 369,192.37 ============================================================================================= (2) From the period of inception May 1, 2004 through December 31, 2004. The accompanying notes are an integral part of these financial statements.
F-62
NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) STATEMENTS OF CHANGES IN NET ASSETS FOR THE YEAR ENDED DECEMBER 31, 2004 FRANKLIN TEMPLETON VARIABLE DREYFUS VARIABLE INVESTMENT FUND INSURANCE PRODUCTS TRUST -------------------------------------------------------- ------------------------------ DEVELOPING QUALITY SOCIALLY FOREIGN MUTUAL APPRECIATION LEADERS (2) BOND (2) RESPONSIBLE SECURITIES SHARES (2) (2) (2) ------------ ------------ ----------- ----------- ----------- ----------- NET INVESTMENT INCOME (LOSS) $ 27,020 $ (63) $ 3,033 $ (10,708) $ (7,457) $ (1,472) REALIZED AND UNREALIZED GAIN ON INVESTMENTS: Capital gains distributions -- -- -- -- -- -- Net realized (loss) gain from (959) 26 153 (17,429) 19,909 1,059 shares sold Net unrealized appreciation on investments 71,718 2,165 4,582 72,462 275,111 30,010 ----------------------------------------- ----------------------------------------- NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS 70,759 2,191 4,735 55,033 295,020 31,069 ----------------------------------------- ----------------------------------------- INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 97,779 2,128 7,768 44,325 287,563 29,597 ----------------------------------------- ----------------------------------------- ACCUMULATION UNIT TRANSACTIONS: Participant deposits 1,327,967 15,477 95,473 46,676 1,398,513 138,525 Transfers between investment sub-accounts and general account, 1,204,165 14,413 120,397 8,057 1,054,184 221,038 net Net surrenders and lapses (73,346) -- (898) (50,312) (48,028) (6,287) Contract benefits -- -- -- (85,107) -- -- Loan collateral interest received -- -- -- -- -- -- Transfers for policy loans -- -- -- -- -- -- Contract charges (677) (15) (3) (656) (608) (94) Other 1,103 -- (37) 32 (473) (403) ----------------------------------------- ----------------------------------------- Total net accumulation unit 2,459,212 29,875 214,932 (81,310) 2,403,588 352,779 transactions ----------------------------------------- ----------------------------------------- Increase (decrease) in net assets 2,556,991 32,003 222,700 (36,985) 2,691,151 382,376 Net assets, beginning of period -- -- -- 1,059,438 -- -- ----------------------------------------- ----------------------------------------- NET ASSETS, END OF PERIOD $ 2,556,991 $ 32,003 $ 222,700 $ 1,022,453 $ 2,691,151 $ 382,376 ========================================= ========================================= UNITS ISSUED, TRANSFERRED AND REDEEMED: Beginning balance -- -- -- 159,344.69 -- -- Units issued 133,871.18 1,522.37 9,497.52 7,186.86 135,742.75 13,690.87 Units transferred 121,390.81 1,417.71 11,976.92 1,240.56 102,321.42 21,845.90 Units redeemed (7,351.01) (1.48) (93.31) (20,947.00) (4,766.63) (670.48) ----------------------------------------- ----------------------------------------- Ending balance 247,910.98 2,938.60 21,381.13 146,825.11 233,297.54 34,866.29 ========================================= ========================================= (2) From the period of inception May 1, 2004 through December 31, 2004. The accompanying notes are an integral part of these financial statements.
F-63
NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) STATEMENTS OF CHANGES IN NET ASSETS FOR THE YEAR ENDED DECEMBER 31, 2004 FRANKLIN TEMPLETON VARIABLE INSURANCE JP MORGAN SERIES TRUST II PRODUCTS TRUST ---------------------------------------- --------------------------- REAL SMALL SMALL INTERNATIONAL SMALL ESTATE (2) CAP (2) CAP VALUE EQUITY COMPANY ---------- ------- --------- ------ ------- (2) NET INVESTMENT (LOSS) INCOME $ (1,548) $ (314) $ (1,614) $ (20,795) $ (22,174) REALIZED AND UNREALIZED GAIN ON INVESTMENTS: Capital gains distributions 72 -- -- -- -- Net realized gain from shares sold 17,079 23 2,446 188,625 64,619 Net unrealized appreciation on investments 69,832 8,433 45,550 243,518 341,385 ----------------------------------------- -------------------------- NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS 86,983 8,456 47,996 432,143 406,004 ----------------------------------------- -------------------------- INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 85,435 8,142 46,382 411,348 383,830 ----------------------------------------- -------------------------- ACCUMULATION UNIT TRANSACTIONS: Participant deposits 312,810 31,423 197,942 671,695 248,888 Transfers between investment sub-accounts and general account, 590,479 54,768 279,204 27,085 126,970 net Net surrenders and lapses (21,839) -- (374) (151,406) (106,476) Contract benefits -- -- -- (3,749) -- Loan collateral interest received -- -- -- 2 10 Transfers for policy loans -- -- -- (475) (32) Contract charges (52) (3) (9) (1,722) (1,288) Other 197 -- (207) (392) 36 ----------------------------------------- -------------------------- Total net accumulation unit 881,595 86,188 476,556 541,038 268,108 transactions ----------------------------------------- -------------------------- Increase in net assets 967,030 94,330 522,938 952,386 651,938 Net assets, beginning of period -- -- -- 2,081,115 1,383,364 ----------------------------------------- -------------------------- NET ASSETS, END OF PERIOD $ 967,030 $ 94,330 $ 522,938 $ 3,033,501 $ 2,035,302 ========================================= ========================== UNITS ISSUED, TRANSFERRED AND REDEEMED: Beginning balance -- -- -- 228,845.56 118,426.04 Units issued 25,266.33 3,140.93 18,094.92 70,661.56 19,039.93 Units transferred 47,694.25 5,474.41 25,523.50 2,849.31 9,713.21 Units redeemed (1,752.27) (0.31) (53.92) (16,594.28) (8,242.88) ----------------------------------------- -------------------------- Ending balance 71,208.31 8,615.03 43,564.50 285,762.15 138,936.30 ========================================= ========================== (2) From the period of inception May 1, 2004 through December 31, 2004. The accompanying notes are an integral part of these financial statements.
F-64
NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) STATEMENTS OF CHANGES IN NET ASSETS FOR THE YEAR ENDED DECEMBER 31, 2004 NEUBERGER BERMAN ADVISORS MANAGEMENT TRUST SCUDDER VARIABLE SERIES II ------------------------------------------------------- ---------------------------- LIMITED MID CAP DREMAN DREMAN FASCIANO (2) MATURITY (2) GROWTH (2) PARTNERS HIGH RETURN SMALL CAP EQUITY (2) VALUE (2) ------------ ------------ ----------- ----------- ------------ ------------ NET INVESTMENT (LOSS) INCOME $ (6,675) $ 125,177 $ (282) $ (26,503) $ (1,127) $ (6,677) REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS: Capital gains distributions 2,889 -- -- -- -- -- Net realized gain (loss) from 9,512 (2,428) 20 36,042 1,062 30,357 shares sold Net unrealized appreciation (depreciation) on investments 92,350 (130,245) 7,993 292,817 19,582 154,918 -------------------------------------------------------- -------------------------- NET REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS 104,751 (132,673) 8,013 328,859 20,644 185,275 -------------------------------------------------------- -------------------------- INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 98,076 (7,496) 7,731 302,356 19,517 178,598 -------------------------------------------------------- -------------------------- ACCUMULATION UNIT TRANSACTIONS: Participant deposits 857,969 3,079,967 24,262 260,234 120,917 536,784 Transfers between investment sub-accounts and general account, 646,911 2,940,079 38,077 41,795 105,131 809,560 net Net surrenders and lapses (32,037) (125,364) -- (149,286) (229) (54,172) Contract benefits -- (43,101) -- (2,326) -- (12,226) Loan collateral interest received -- -- -- 21 -- -- Transfers for policy loans -- -- -- (1,962) -- -- Contract charges (289) (1,738) (7) (1,438) -- (225) Other (498) 634 4 (122) (275) (1,693) -------------------------------------------------------- -------------------------- Total net accumulation unit 1,472,056 5,850,477 62,336 146,916 225,544 1,278,028 transactions -------------------------------------------------------- -------------------------- Increase in net assets 1,570,132 5,842,981 70,067 449,272 245,061 1,456,626 Net assets, beginning of period -- -- -- 1,728,597 -- -- -------------------------------------------------------- -------------------------- NET ASSETS, END OF PERIOD $ 1,570,132 $ 5,842,981 $ 70,067 $ 2,177,869 $ 245,061 $ 1,456,626 ======================================================== ========================== UNITS ISSUED, TRANSFERRED AND REDEEMED: Beginning balance -- -- -- 168,915.14 -- -- Units issued 83,631.51 308,556.54 2,426.20 22,094.83 11,697.04 51,295.45 Units transferred 63,058.39 294,542.31 3,658.83 3,548.55 10,169.97 77,362.11 Units redeemed (3,199.56) (16,987.72) (0.26) (13,169.67) (48.76) (6,528.32) -------------------------------------------------------- -------------------------- Ending balance 143,490.34 586,111.13 6,084.77 181,388.85 21,818.25 122,129.24 ======================================================== ========================== (2) From the period of inception May 1, 2004 through December 31, 2004. The accompanying notes are an integral part of these financial statements.
F-65
NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) STATEMENTS OF CHANGES IN NET ASSETS FOR THE YEAR ENDED DECEMBER 31, 2004 SENTINEL VARIABLE PRODUCTS TRUST ------------------------------------------------------------------------------------------------------------ COMMON GROWTH MID CAP MONEY SMALL BALANCED BOND STOCK INDEX GROWTH MARKET COMPANY -------- ---- ----- ----- ------ ------ ------- NET INVESTMENT INCOME (LOSS) $ 120,386 $ 549,667 $ (77,268) $ (2,067) $ (226,150) $ (49,192) $ (403,569) REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS: Capital gains distributions 549,251 253,146 -- -- -- -- 3,156,247 Net realized gain (loss) from shares sold 409,243 222,212 367,358 125,950 (46,693) -- 1,398,832 Net unrealized (depreciation) appreciation on investments (165,308) (482,951) 2,221,636 (31,864) 1,874,781 -- 254,377 ------------------------------------------------------------------------------------------------------------ NET REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS 793,186 (7,593) 2,588,994 94,086 1,828,088 -- 4,809,456 ------------------------------------------------------------------------------------------------------------ INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 913,572 542,074 2,511,726 92,019 1,601,938 (49,192) 4,405,887 ------------------------------------------------------------------------------------------------------------ ACCUMULATION UNIT TRANSACTIONS: Participant deposits 1,735,707 2,491,767 6,263,017 207,050 1,974,447 3,977,688 6,864,021 Transfers between investment sub-accounts and general account, net 1,091,364 (1,089,431) 2,449,833 (149,996) (811,904) (2,923,733) 2,122,363 Net surrenders and lapses (1,224,324) (1,446,218) (2,677,867) (236,333) (1,666,594) (1,654,736) (2,845,180) Contract benefits (95,369) (141,984) (275,340) -- (167,616) (13,035) (236,897) Loan collateral interest received 8 401 8 -- 33 883 57 Transfers for policy loans (690) (82) (764) -- (4,235) (6,164) (8,308) Contract charges (11,526) (11,553) (22,512) (2,019) (12,819) (6,507) (21,984) Other 1,938 (562) (1,670) 102 (1,697) 471 1,269 ------------------------------------------------------------------------------------------------------------ Total net accumulation 1,497,108 (197,662) 5,734,705 (181,196) (690,385) (625,133) 5,875,341 unit transactions ------------------------------------------------------------------------------------------------------------ Increase (decrease) in net assets 2,410,680 344,412 8,246,431 (89,177) 911,553 (674,325) 10,281,228 Net assets, beginning of period 14,152,143 17,765,696 26,202,211 2,926,049 15,838,143 11,760,670 26,875,879 ------------------------------------------------------------------------------------------------------------ NET ASSETS, END OF PERIOD $ 16,562,823 $ 18,110,108 $ 34,448,642 $ 2,836,872 $ 16,749,696 $ 11,086,345 $ 37,157,107 ============================================================================================================ UNITS ISSUED, TRANSFERRED AND REDEEMED: Beginning balance 1,134,775.51 1,303,319.09 2,081,352.51 395,952.58 1,190,675.96 1,010,025.42 1,242,053.69 Units issued 137,610.28 199,983.31 490,596.66 30,203.33 154,355.15 341,573.30 304,000.67 Units transferred 86,525.50 (87,435.15) 191,901.10 (21,880.60) (63,471.73) (251,067.74) 93,997.35 Units redeemed (105,442.10) (128,412.04) (233,285.01) (34,754.61) (144,855.23) (144,187.18) (137,785.00) ------------------------------------------------------------------------------------------------------------ Ending balance 1,253,469.19 1,287,455.21 2,530,565.26 369,520.70 1,136,704.15 956,343.80 1,502,266.71 ============================================================================================================ The accompanying notes are an integral part of these financial statements.
F-66
NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) STATEMENTS OF CHANGES IN NET ASSETS FOR THE YEAR ENDED DECEMBER 31, 2004 STRONG VARIABLE INSURANCE FUNDS T ROWE PRICE EQUITY SERIES -------------------------------- ------------------------------------------- MID CAP BLUE CHIP EQUITY HEALTH GROWTH II OPPORTUNITY II GROWTH (2) INCOME (2) SCIENCES (2) --------- -------------- ---------- ---------- ------------ NET INVESTMENT (LOSS) INCOME $ (108,684) $ (139,741) $ (717) $ 1,185 $ (5,275) REALIZED AND UNREALIZED GAIN ON INVESTMENTS: Capital gains distributions -- -- -- 7,340 -- Net realized (loss) gain from (1,290,309) 71,312 7,022 801 (3,697) shares sold Net unrealized appreciation on investments 2,631,047 1,633,564 199,996 21,456 115,947 ---------------------------- -------------------------------------------- NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS 1,340,738 1,704,876 207,018 29,597 112,250 ---------------------------- -------------------------------------------- INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 1,232,054 1,565,135 206,301 30,782 106,975 ---------------------------- -------------------------------------------- ACCUMULATION UNIT TRANSACTIONS: Participant deposits 488,298 759,779 1,689,328 125,445 349,035 Transfers between investment sub-accounts and general account, (917,369) 372,239 1,162,826 310,300 705,831 net Net surrenders and lapses (762,051) (1,250,178) (25,939) (4,275) (59,768) Contract benefits (28,200) (106,876) (13,963) -- -- Loan collateral interest received 185 17 -- -- -- Transfers for policy loans (4,545) 3 -- -- -- Contract charges (7,142) (6,508) (794) (45) (152) Other (448) 1,515 1,364 (264) (1,492) ---------------------------- -------------------------------------------- Total net accumulation unit (1,231,272) (230,009) 2,812,822 431,161 993,454 transactions ---------------------------- -------------------------------------------- Increase in net assets 782 1,335,126 3,019,123 461,943 1,100,429 Net assets, beginning of period 7,994,456 9,670,414 -- -- -- ---------------------------- -------------------------------------------- NET ASSETS, END OF PERIOD $ 7,995,238 $ 11,005,540 $ 3,019,123 $ 461,943 $ 1,100,429 ============================ ============================================ UNITS ISSUED, TRANSFERRED AND REDEEMED: Beginning balance 639,147.81 597,575.44 -- -- -- Units issued 37,738.01 46,998.46 168,102.27 11,988.84 37,315.23 Units transferred (70,898.68) 23,025.99 115,710.92 29,655.51 75,460.19 Units redeemed (61,997.94) (84,252.36) (3,913.86) (438.09) (6,565.54) ---------------------------- -------------------------------------------- Ending balance 543,989.20 583,347.53 279,899.33 41,206.26 106,209.88 ============================ ============================================ (2) From the period of inception May 1, 2004 through December 31, 2004. The accompanying notes are an integral part of these financial statements.
F-67
NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) STATEMENTS OF CHANGES IN NET ASSETS FOR THE YEAR ENDED DECEMBER 31, 2004 VARIABLE INSURANCE PRODUCT FUNDS ------------------------------------------------------------ EQUITY HIGH CONTRAFUND INCOME GROWTH INCOME ---------- ------ ------ ------ NET INVESTMENT (LOSS) INCOME $ (184,326) $ 30,127 $ (179,745) $ 601,431 REALIZED AND UNREALIZED GAIN ON INVESTMENTS: Capital gains distributions -- 72,153 -- -- Net realized (loss) gain from (24,393) (33,282) (1,522,802) 400,531 shares sold Net unrealized appreciation (depreciation) on investments 2,503,097 1,774,610 1,923,702 (286,882) ------------------------------------------------------------ NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS 2,478,704 1,813,481 400,900 113,649 ------------------------------------------------------------ INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 2,294,378 1,843,608 221,155 715,080 ------------------------------------------------------------ ACCUMULATION UNIT TRANSACTIONS: Participant deposits 2,085,554 1,588,856 1,772,415 1,942,596 Transfers between investment sub-accounts and general account, 229,794 (142,825) (1,004,092) 105,208 net Net surrenders and lapses (1,880,478) (2,060,486) (1,151,820) (954,731) Contract benefits (140,864) (234,456) (98,502) (262,002) Loan collateral interest received 21 23 70 34 Transfers for policy loans (1,950) (260) (3,185) (4,256) Contract charges (12,520) (12,101) (13,079) (6,053) Other 2,761 (1,757) 306 227 ------------------------------------------------------------ Total net accumulation unit 282,318 (863,006) (497,887) 821,023 transactions ------------------------------------------------------------ Increase (decrease) in net assets 2,576,696 980,602 (276,732) 1,536,103 Net assets, beginning of period 16,340,274 19,248,480 16,044,336 8,608,227 ------------------------------------------------------------ NET ASSETS, END OF PERIOD $ 18,916,970 $ 20,229,082 $ 15,767,604 $ 10,144,330 ============================================================ UNITS ISSUED, TRANSFERRED AND REDEEMED: Beginning balance 1,052,447.54 1,458,610.93 1,247,702.58 926,868.19 Units issued 129,224.89 119,382.50 159,897.16 198,264.20 Units transferred 14,238.47 (10,731.50) (90,583.44) 10,737.68 Units redeemed (125,970.40) (173,495.03) (114,230.23) (125,207.07) ------------------------------------------------------------ Ending balance 1,069,940.50 1,393,766.90 1,202,786.07 1,010,663.00 ============================================================ The accompanying notes are an integral part of these financial statements.
F-68
NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) STATEMENTS OF CHANGES IN NET ASSETS FOR THE YEAR ENDED DECEMBER 31, 2004 VARIABLE INSURANCE PRODUCT FUNDS ------------------------------------------------------------ INVESTMENT INDEX 500 GRADE BOND MID CAP (2) OVERSEAS --------- ---------- ----------- -------- NET INVESTMENT (LOSS) INCOME $ (19,229) $ 645,849 $ (4,775) $ (37,770) REALIZED AND UNREALIZED GAIN ON INVESTMENTS: Capital gains distributions -- 706,363 -- -- Net realized (loss) gain from (1,843,823) (222,052) 23,421 437,003 shares sold Net unrealized appreciation (depreciation) on investments 4,194,709 (431,370) 137,973 1,040,266 ------------------------------------------------------------ NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS 2,350,886 52,941 161,394 1,477,269 ------------------------------------------------------------ INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 2,331,657 698,790 156,619 1,439,499 ------------------------------------------------------------ ACCUMULATION UNIT TRANSACTIONS: Participant deposits 1,471,250 4,095,995 434,374 2,189,588 Transfers between investment sub-accounts and general account, (726,673) 8,958 772,209 72,931 net Net surrenders and lapses (3,195,089) (2,649,715) (30,501) (927,215) Contract benefits (300,226) (379,981) (14,260) (73,377) Loan collateral interest received 201 103 -- 38 Transfers for policy loans (1,244) (3,787) -- (2,271) Contract charges (23,592) (15,863) (219) (8,410) Other -- (1,124) 1,184 (1,329) ------------------------------------------------------------ Total net accumulation unit (2,775,373) 1,054,586 1,162,787 1,249,955 transactions ------------------------------------------------------------ (Decrease) increase in net assets (443,716) 1,753,376 1,319,406 2,689,454 Net assets, beginning of period 28,507,281 23,182,923 -- 10,842,500 ------------------------------------------------------------ NET ASSETS, END OF PERIOD $ 28,063,565 $ 24,936,299 $ 1,319,406 $ 13,531,954 ============================================================ UNITS ISSUED, TRANSFERRED AND REDEEMED: Beginning balance 2,313,638.45 1,885,368.97 -- 1,064,456.93 Units issued 119,612.84 323,872.03 40,189.52 212,053.29 Units transferred (59,078.62) 708.31 71,446.98 7,063.09 Units redeemed (286,172.45) (241,193.79) (4,052.13) (98,062.98) ------------------------------------------------------------ Ending balance 2,088,000.22 1,968,755.52 107,584.37 1,185,510.33 ============================================================ (2) From the period of inception May 1, 2004 through December 31, 2004. The accompanying notes are an integral part of these financial statements.
F-69 NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) NOTES TO THE FINANCIAL STATEMENTS NOTE 1 - NATURE OF OPERATIONS National Variable Annuity Account II (the "Variable Account") began operations on June 20, 1997 and is registered as a unit investment trust under the Investment Company Act of 1940, as amended. The operations of the Variable Account are part of National Life Insurance Company ("National Life"). The Variable Account was established by National Life as a separate investment account to invest the net premiums received from the sale of certain variable annuity products. Equity Services, Inc., an indirect wholly-owned subsidiary of National Life, is the principal underwriter for the variable annuity contracts issued by National Life. Sentinel Advisors Company, an indirectly-owned subsidiary of National Life, provides investment advisory services for certain mutual fund portfolios within the Sentinel Variable Products Trust ("SVPT"). The Variable Account invests the accumulated contractholder account values in shares of mutual fund portfolios within AIM Variable Insurance Funds, Alger American Fund, American Century Variable Portfolios ("ACVP"), Dreyfus Variable Investment Fund, Franklin Templeton Variable Insurance Products Trust, JP Morgan Series Trust II, Neuberger Berman Advisors Management Trust, Scudder Variable Series II, SVPT, T. Rowe Price Equity Series, Fidelity Variable Insurance Product Funds ("VIPF"), and Wells Fargo Variable Trust Funds (formerly Strong Variable Insurance Funds). Net premiums received by the Variable Account are deposited in investment portfolios as designated by the contractholder. Contractholders may also direct the allocations of their account value between the various investment portfolios within the Variable Account and a declared interest account (within the General Account of National Life) through participant transfers. There are forty-nine sub-accounts within the Variable Account as of December 31, 2005. Each sub-account, which invests exclusively in the shares of the corresponding portfolio, comprises the accumulated contractholder account values of the underlying variable annuity contracts investing in the sub-account. During 2005, Wells Fargo purchased the Strong Variable Insurance Funds whose funds were merged into newly organized funds within the Wells Fargo Variable Trust Funds which substantially retained their prior objectives and characteristics. On July 1, 2005, AIM Health Sciences Fund was renamed AIM Global Health Care Fund. During 2004, several new fund choices were added to further enhance the investment options available to contractholders. These new fund choices included mutual fund portfolios within American Century Variable Portfolios, Dreyfus Variable Investment Fund, Franklin Templeton Variable Insurance Products Trust, Neuberger Berman Advisors Management Trust, Scudder Variable Series II, T. Rowe Price Equity Series and VIPF Mid Cap Portfolio. On April 25, 2003, two investment portfolios of the Market Street Fund, Inc. (MSF) were merged into two series of the Gartmore Variable Insurance Trust (GVIT). The GVIT Government Bond Fund and JP Morgan GVIT Balanced Fund replaced the Market Street Bond Fund and Market Street Managed Fund, respectively. Subsequently, on August 1, 2003, certain mutual fund substitutions were completed. The Company replaced the balance of mutual fund portfolios within GVIT with newly created funds of the SVPT. The SVPT Bond Fund and SVPT Balanced Fund replaced the GVIT Government Bond Fund and JP Morgan GVIT Balanced Fund, respectively. The investment portfolios within GVIT are no longer available to policyholders. See Note 9 for additional information on fund substitutions. F-70 NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) NOTES TO THE FINANCIAL STATEMENTS (CONTINUED) NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES These financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts and disclosures in the financial statements. Actual results could differ from those estimates. The following is a summary of significant accounting policies consistently followed in the preparation of the Variable Account's financial statements. INVESTMENTS The mutual fund portfolios consist of the AIM Dynamics Fund, AIM Global Health Care Fund (formerly AIM Health Sciences Fund), AIM Technology Fund, Alger American Growth Fund, Alger American Leveraged All Cap Fund, Alger American Small Cap Fund, ACVP Income & Growth Fund, ACVP Inflation Protection Fund, ACVP International Fund, ACVP Ultra Fund, ACVP Value Fund, ACVP Vista Fund, Dreyfus Appreciation Fund, Dreyfus Developing Leaders Fund, Dreyfus Quality Bond Fund, Dreyfus Socially Responsible Growth Fund, Franklin Templeton Foreign Securities, Franklin Templeton Mutual Shares, Franklin Templeton Real Estate, Franklin Templeton Small Cap, Franklin Templeton Small Cap Value, JP Morgan Series Trust II International Equity, JP Morgan Series Trust II Small Company, Neuberger Berman Fasciano, Neuberger Berman Limited Maturity, Neuberger Berman Mid Cap Growth, Neuberger Berman Partners, Scudder Dreman High Return Equity, Scudder Dreman Small Cap Value, SVPT Balanced Fund, SVPT Bond Fund, SVPT Common Stock, SVPT Growth Index, SVPT Mid Cap Growth, SVPT Money Market, SVPT Small Company, T Rowe Price Blue Chip Growth, T Rowe Price Equity Income, T Rowe Price Health Sciences, VIPF Equity Income, VIPF Growth, VIPF High Income, VIPF Mid Cap, VIPF Overseas, VIPF Contrafund, VIPF Index 500, VIPF Investment Grade Bond, Wells Fargo Discovery (formerly Strong Mid Cap Growth II), and Wells Fargo Opportunity (formerly Strong Opportunity II). The assets of each portfolio are held separate from the assets of the other portfolios and each has different investment objectives and policies. Each portfolio operates separately and the gains or losses in one portfolio have no effect on the investment performance of the other portfolios. INVESTMENT VALUATION The investments in the Portfolios are valued at the closing net asset value per share as determined by the portfolio at the end of each period. The change in the difference between cost and market value is reflected as unrealized gain (loss) in the Statements of Operations. INVESTMENT TRANSACTIONS Investment transactions are accounted for on the trade date (date the order to buy or sell is executed) and dividend income and capital gain distributions are recorded on the ex-dividend date. The cost of investments sold was determined using the first in, first out method. PARTICIPANT TRANSACTIONS Payments received from policyholders represent participant deposits under the contracts (but exclude amounts allocated to the guaranteed interest account, reflected in the General Account) reduced by F-71 NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) NOTES TO THE FINANCIAL STATEMENTS (CONTINUED) NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) PARTICIPANT TRANSACTIONS (CONTINUED) applicable deductions, charges and state premium taxes. Policyholders may allocate amounts in their individual accounts to variable investment options and to the guaranteed interest account of the Company's General Account. Transfers between funds and guaranteed interest account, net, are amounts that participants have directed to be moved among investment options, including permitted transfers to and from the guaranteed interest account. Surrenders, lapses and contract benefits are payments to participants and beneficiaries made under the terms of the contracts and amounts that participants have requested to be withdrawn and paid to them. Withdrawal charges, if applicable, are included in transfers for contract benefits and terminations and represent deferred contingent withdrawal charges that apply to certain withdrawals under the contracts. Included in contract charges are administrative, cost of insurance, and other variable charges deducted monthly from the contracts. See Note 10 for additional information on policy loans. FEDERAL INCOME TAXES The operations of the Variable Account are part of and taxed with, the total operations of National Life. Under existing federal income tax law, investment income and capital gains attributable to the Variable Account are not taxed. RECLASSIFICATIONS Certain amounts presented for the prior years were reclassified to conform with the presentation used in the current year. NOTE 3 - CHARGES AND EXPENSES The following table describes the charges and expenses assessed when buying, owning and surrendering a Policy within the Segment. Such charges reimburse the Company for the insurance and other benefits provided, its assumption of mortality and expense risks, and account administration. The mortality risk assumed is that the insureds under the policies may die sooner than anticipated. The expense risk assumed is that expenses incurred in issuing and administering the policies may exceed expected levels. F-72 NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) NOTES TO THE FINANCIAL STATEMENTS (CONTINUED) NOTE 3 - CHARGES AND EXPENSES (CONTINUED)
CHARGES AND DEDUCTIONS DESCRIPTION OF CHARGE WHEN CHARGE IS DEDUCTED AMOUNT DEDUCTED HOW DEDUCTED - --------------------- ----------------------- --------------- ------------ Annual Rate of 1.25% Mortality and Expense Daily of the average daily Deducted from sub-accounts Risk Charge net assets of as a Reduction in Unit Value each sub-account of the Separate Account - ----------------------------------------------------------------------------------------------------------------------- Annual Rate of 0.15% of the average daily Deducted from sub-accounts Administration Charge Daily net assets of each as a Reduction in Unit Value sub-account of the Separate Account - ----------------------------------------------------------------------------------------------------------------------- Upon Withdrawal or Surrender, 0% - 7% of Net Premium Deducted from Accumulated Contingent Deferred depending on the specifics Payments withdrawn or Value upon Surrender or Sales Charge and duration of the Policy surrendered Lapse - ----------------------------------------------------------------------------------------------------------------------- Annual Contract Fee Annually on Contract Unit Liquidation from Account Anniversary on Contract Values $30 Value under $50,000 - ----------------------------------------------------------------------------------------------------------------------- Currently no Amount is Deducted from Transfer Transfer Charge Upon making a Transfer assessed amount - ---------------------------------------------------------------------------------------------------------------------- Upon Premium Payment, Deducted from Premium Annuitization, Death of owner, Amount of Premium Taxes, Payment or by Unit Premium Taxes or Surrender, depending on up to 3.5% Liquidation from Account specifics of the Policy Value - ---------------------------------------------------------------------------------------------------------------------- On the Date of Issue of the Amounts vary depending on Unit liquidation from Policy and on each Monthly the specifics of the Account Value Riders Policy Date Policy - ---------------------------------------------------------------------------------------------------------------------
The SVPT mutual fund portfolios are managed by an affiliate of National Life. During the year ended December 31, 2005, management fees were paid directly by the sub-accounts to the affiliate investment manager. The advisory agreement provides for fees ranging from .25% to .55% based on individual portfolios and average daily net assets. The investment manager currently waives all or a portion of its management fees for some of the sub-accounts. The effective advisory fee rates paid by the sub-accounts in 2005, after taking these waivers into account, range from 0% to .39%. The investment manager expects to waive all or a portion of its management fees for some of the sub-accounts in 2006. F-73 NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) NOTES TO THE FINANCIAL STATEMENTS (CONTINUED) NOTE 4 - INVESTMENTS The number of shares held and cost for each of the portfolios at December 31, 2005 are set forth below: PORTFOLIO SHARES COST - -------------------------------------------------------------------------------- AIM Variable Insurance Funds Dynamics 175,043 $ 2,015,157 Global Health Care 230,962 3,817,827 Technology 167,509 1,957,800 Alger American Fund Growth 296,898 8,789,541 Leveraged AllCap 56,599 1,565,847 Small Capitalization 241,885 3,860,051 American Century Variable Portfolios Income & Growth 1,094,076 6,583,432 Inflation Protection 918,169 9,577,096 International 615,084 4,381,416 Ultra 7,589 73,286 Value 2,341,214 17,471,321 Vista 482,938 6,245,418 Dreyfus Variable Investment Fund Appreciation 170,646 6,115,984 Developing Leaders 2,411 97,815 Quality Bond 47,696 539,448 Socially Responsible Growth 34,672 771,091 Franklin Templeton Variable Insurance Products Trust Foreign Securities 373,322 5,251,201 Mutual Shares Securities 56,171 930,014 Real Estate 91,493 2,793,787 Small Cap 10,273 193,704 Small Cap Value Securities 66,399 1,049,029 JP Morgan Series Trust II International Equity 278,705 2,670,607 Small Company 127,429 1,730,020 Neuberger Berman Advisors Management Trust Fasciano 229,819 3,104,104 Limited Maturity 898,683 11,604,438 Mid Cap Growth 14,002 255,044 Partners 161,311 2,819,061 F-74 NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) NOTES TO THE FINANCIAL STATEMENTS (CONTINUED) NOTE 4 - INVESTMENTS (CONTINUED) The number of shares held and cost for each of the portfolios at December 31, 2005 are set forth below: PORTFOLIO SHARES COST - -------------------------------------------------------------------------------- Scudder Variable Series II Dreman High Return Equity 38,437 $ 479,218 Dreman Small Cap Value 87,042 1,625,357 Sentinel Variable Products Trust Balanced 1,448,726 15,770,667 Bond 1,846,241 18,836,649 Common Stock 3,300,605 32,271,706 Growth Index 297,138 2,136,604 Mid Cap Growth 1,517,030 11,292,591 Money Market 9,393,694 9,393,694 Small Company 2,588,354 34,798,709 T. Rowe Price Equity Series Blue Chip Growth 1,057,240 9,481,626 Equity Income 45,460 1,004,885 Health Sciences 135,904 1,374,575 Variable Insurance Product Funds Contrafund 662,117 14,491,758 Equity Income 726,256 15,282,705 Growth 410,707 11,862,357 High Income 1,628,296 10,686,050 Index 500 187,218 22,359,893 Investment Grade Bond 1,881,250 24,543,045 Mid Cap 108,764 3,326,385 Overseas 742,399 10,739,571 Wells Fargo Variable Trust Funds Discovery 498,520 6,183,406 Opportunity 402,019 8,781,881 The cost also represents the aggregate cost for federal income tax purposes. F-75 NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) NOTES TO THE FINANCIAL STATEMENTS (CONTINUED) NOTE 5 - PURCHASES AND SALES OF PORTFOLIO SHARES Purchases and proceeds from sales of shares in the portfolios for the year ended December 31, 2005 aggregated the following: SALES PORTFOLIO PURCHASES PROCEEDS - -------------------------------------------------------------------------------- AIM Variable Insurance Funds Dynamics $ 520,566 $ 914,122 Global Health Care (1) 551,127 921,232 Technology 455,061 566,456 Alger American Fund Growth 1,415,982 4,532,993 Leveraged AllCap 361,673 376,546 Small Capitalization 473,485 1,963,042 American Century Variable Portfolios Income & Growth 1,007,398 1,789,133 Inflation Protection 5,741,882 1,001,969 International 2,917,335 780,141 Ultra 28,781 30,650 Value 6,074,859 3,860,609 Vista 3,748,261 1,230,129 Dreyfus Variable Investment Fund Appreciation 4,469,034 884,656 Developing Leaders 77,841 11,293 Quality Bond 408,514 89,625 Socially Responsible Growth 75,879 223,275 Franklin Templeton Variable Insurance Products Trust Foreign Securities 3,619,268 918,421 Mutual Shares Securities 663,753 96,874 Real Estate 3,040,298 1,231,727 Small Cap 139,350 37,065 Small Cap Value Securities 989,433 473,302 JP Morgan Series Trust II International Equity 823,606 761,011 Small Company 536,898 366,014 (1) On July 1, 2005, AIM Health Sciences Fund was renamed AIM Global Health Care Fund. F-76 NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) NOTES TO THE FINANCIA STATEMENTS (CONTINUED) NOTE 5 - PURCHASES AND SALES OF PORTFOLIO SHARES (CONTINUED) Purchases and proceeds from sales of shares in the portfolios for the year ended December 31, 2005 aggregated the following: SALES PORTFOLIO PURCHASES PROCEEDS - -------------------------------------------------------------------------------- Neuberger Berman Advisors Management Trust Fasciano $ 2,355,276 $ 791,807 Limited Maturity 6,825,883 1,157,359 Mid Cap Growth 294,451 112,866 Partners 1,713,002 873,711 Scudder Variable Series II Dreman High Return Equity 339,944 95,214 Dreman Small Cap Value 2,262,369 2,006,926 Sentinel Variable Products Trust Balanced 2,925,262 2,899,575 Bond 4,490,643 3,972,102 Common Stock 9,047,503 7,202,241 Growth Index 356,387 854,222 Mid Cap Growth 1,183,506 3,794,225 Money Market 5,844,322 7,536,973 Small Company 10,697,443 11,251,952 T. Rowe Price Equity Series Blue Chip Growth 7,540,480 952,168 Equity Income 874,677 327,615 Health Sciences 1,140,486 879,551 Variable Insurance Product Funds Contrafund 2,590,758 3,982,894 Equity Income 2,524,807 4,281,115 Growth 1,131,129 3,739,899 High Income 3,957,479 2,830,241 Index 500 2,860,499 5,112,821 Investment Grade Bond 6,411,126 6,448,197 Mid Cap 2,730,176 726,517 Overseas 2,226,875 2,803,687 Wells Fargo Variable Trust Funds Discovery (2) 7,671,525 9,134,153 Opportunity (2) 11,670,727 13,691,986 (2) In 2005, Wells Fargo acquired assets from Strong Financial Corporation which became part of the Wells Fargo Variable Trust Funds. F-77 NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) NOTES TO THE FINANCIAL STATEMENTS (CONTINUED) NOTE 6 - FINANCIAL HIGHLIGHTS A summary of units outstanding and unit values for the Variable Account, the investment income ratios, the expense ratios, excluding expenses of the underlying funds, and total return for the years ended December 31, 2005, 2004, 2003, 2002, and 2001 are shown below. Information for the years ended December 31, 2005, 2004, and 2003 reflects the adoption of AICPA Statement of Position 03-5, Financial Highlights of Separate Accounts. Certain ratios presented for the prior years reflect the presentation used in the current year.
FOR THE YEAR ENDED AT DECEMBER 31, 2005 DECEMBER 31, 2005 ------------------------------------ ---------------------------------- UNIT INVESTMENT FAIR INCOME EXPENSE TOTAL PORTFOLIO UNITS VALUE NET ASSETS RATIO(A) RATIO (B) RETURN (C) - --------------------------------------------------------------------------------------------------------------------- AIM Variable Insurance Funds Dynamics 319,611.18 $ 8.09 $ 2,585,386 0.00% 1.40% 9.17% Global Health Care (1) 487,457.77 9.68 4,720,853 0.00% 1.40% 6.66% Technology 506,007.26 4.20 2,125,695 0.00% 1.40% 0.74% Alger American Fund Growth 767,708.36 15.18 11,653,244 0.24% 1.40% 10.47% Leveraged AllCap 227,328.46 8.66 1,968,511 0.00% 1.40% 12.90% Small Capitalization 478,400.25 11.97 5,727,835 0.00% 1.40% 15.23% American Century Variable Portfolios Income & Growth 693,014.06 11.86 8,216,514 2.05% 1.40% 3.19% Inflation Protection 891,208.84 10.57 9,420,417 4.43% 1.40% 0.38% International 401,457.13 12.61 5,062,144 0.81% 1.40% 11.69% Ultra 7,270.30 10.84 78,775 0.00% 1.40% 0.79% Value 1,137,146.59 16.88 19,197,958 0.86% 1.40% 3.57% Vista 607,473.06 11.52 6,997,778 0.00% 1.40% 6.66% Dreyfus Variable Investment Fund Appreciation 596,449.94 10.62 6,332,679 0.01% 1.40% 2.98% Developing Leaders 9,327.96 11.36 105,999 0.00% 1.40% 4.35% Quality Bond 51,108.89 10.53 538,009 3.34% 1.40% 1.02% Socially Responsible Growth 127,070.26 7.12 904,240 0.00% 1.40% 2.24% Franklin Templeton Variable Insurance Products Trust Foreign Securities 465,272.17 12.53 5,831,297 1.00% 1.40% 8.61% Mutual Shares Securities 85,355.59 11.96 1,020,623 0.80% 1.40% 9.00% Real Estate 193,126.53 15.20 2,935,107 1.27% 1.40% 11.91% Small Cap 18,483.51 11.32 209,150 0.00% 1.40% 3.34% Small Cap Value Securities 86,582.41 12.88 1,114,845 0.78% 1.40% 7.30% JP Morgan Series Trust II International Equity 293,409.68 11.59 3,400,201 0.83% 1.40% 9.12% Small Company 135,781.36 14.94 2,028,678 0.00% 1.40% 1.98% (1) On July 1, 2005, AIM Health Sciences Fund was renamed AIM Global Health Care Fund.
F-78 NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) NOTES TO THE FINANCIAL STATEMENTS (CONTINUED) NOTE 6 - FINANCIAL HIGHLIGHTS (CONTINUED)
For the Year Ended At December 31, 2005 December 31, 2005 -------------------------------------- ---------------------------------- Unit Investment Fair Income Expense Total PORTFOLIO Units Value Net Assets Ratio (a) Ratio (b) Return (c) - ----------------------------------------------------------------------------------------------------------------- Neuberger Berman Advisors Manageme Trust Fasciano 293,062.77 $ 11.10 $ 3,254,237 0.00% 1.40% 1.50% Limited Maturity 1,138,951.87 9.97 11,359,349 3.06% 1.40% 0.04% Mid Cap Growth 21,984.08 12.92 283,967 0.00% 1.40% 12.13% Partners 247,078.34 13.98 3,453,662 1.03% 1.40% 16.39% Scudder Variable Series II Dreman High Return Equity 43,214.20 11.91 514,666 1.01% 1.40% 6.05% Dreman Small Cap Value 134,345.28 12.91 1,734,753 0.40% 1.40% 8.24% Sentinel Variable Products Trust Balanced 1,223,837.69 13.77 16,848,680 2.23% 1.40% 4.22% Bond 1,285,058.87 14.14 18,167,016 4.36% 1.40% 0.48% Common Stock 2,669,872.25 14.45 38,584,070 1.16% 1.40% 6.18% Growth Index 306,765.84 7.80 2,391,964 0.88% 1.40% 1.53% Mid Cap Growth 969,791.06 15.08 14,624,167 0.00% 1.40% 2.30% Money Market 798,931.40 11.76 9,393,694 2.85% 1.40% 1.45% Small Company 1,366,986.96 26.40 36,081,655 0.08% 1.40% 6.73% T. Rowe Price Equity Series Blue Chip Growth 897,520.24 11.24 10,086,065 0.15% 1.40% 4.15% Equity Income 86,284.46 11.46 989,208 1.36% 1.40% 2.27% Health Sciences 136,594.72 11.56 1,579,203 0.00% 1.40% 11.59% Variable Insurance Product Funds Contrafund 1,007,625.06 20.39 20,545,487 0.29% 1.40% 15.33% Equity Income 1,221,652.87 15.15 18,512,263 1.69% 1.40% 4.43% Growth 1,011,887.95 13.68 13,840,827 0.53% 1.40% 4.33% High Income 988,225.88 10.17 10,046,584 15.12% 1.40% 1.26% Index 500 1,911,724.13 13.89 26,562,493 1.82% 1.40% 3.38% Investment Grade Bond 1,880,488.62 12.77 24,004,755 3.64% 1.40% 0.75% Mid Cap 266,876.98 14.31 3,818,693 0.00% 1.40% 16.71% Overseas 1,141,752.35 13.40 15,300,839 0.63% 1.40% 17.45% Wells Fargo Advantage Funds Discovery (2) 449,988.47 15.89 7,148,772 0.00% 1.40% 8.07% Opportunity (2) 485,070.58 20.07 9,736,898 0.00% 1.40% 6.38% (2) In 2005, Wells Fargo acquired assets from Strong Financial Corporation which became part of the Wells Fargo Variable Trust Funds. (a) These amounts represent dividends, excluding distributions of capital gains, received by the sub-account from fund, net of the underlying mutual management fees assessed by the fund manager, divided by the average net assets. These ratios exclude those expenses, such as mortality and expense charges, that are assessed against contract owner accounts either through reductions in the unit values units. The recognition or the redemption of of investment income by the sub-account is affected by the timing of the declaration of dividends by the underlying fund in which the sub-account invests. (b) These amounts represent the annualizedcontracexpenses of the separate consisting primarily of expense charges, for each account, mortality and period indicated. The ratios include only those expenses that result in a direct reduction to unit values. Charges made directly to contract owner accounts through the redemption of units and expenses of the underlying fund have been excluded. (c) These amounts represent the total return for the periods indicated, including changes in the value of the underlying fund, and expenses assessed through the reduction of unit values. These ratios do not include any expenses assessed through the redemption of units.
F-79 NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) NOTES TO THE FINANCIAL STATEMENTS (CONTINUED) NOTE 6 - FINANCIAL HIGHLIGHTS (CONTINUED)
FOR THE YEAR ENDED AT DECEMBER 31, 2004 DECEMBER 31, 2004 ------------------------------------------------------------------------ UNIT INVESTMENT FAIR INCOME EXPENSE TOTAL PORTFOLIO UNITS VALUE NET ASSETS RATIO (A) RATIO (B) RETURN(C) - ----------------------------------------------------------------------------------------------------------------------------- AIM Variable Insurance Funds Dynamics (3) 365,843.00 $ 7.41 $ 2,710,189 0.00% 1.40% 11.74% Health Sciences (3) 520,475.69 9.08 4,725,999 0.00% 1.40% 6.08% Technology (3) 525,974.29 4.17 2,192,788 0.00% 1.40% 3.19% Alger American Fund Growth 981,988.91 13.74 13,490,761 0.00% 1.40% 4.00% Leveraged AllCap 226,660.10 7.67 1,738,944 0.00% 1.40% 6.70% Small Capitalization 608,040.56 10.39 6,315,596 0.00% 1.40% 14.90% American Century Variable Portfolios Income & Growth (4) 765,569.07 11.49 8,796,273 1.41% 1.40% 11.44% Inflation Protection (4) 464,504.55 10.53 4,889,459 2.54% 1.40% 5.26% International (4) 212,294.68 11.29 2,396,668 0.00% 1.40% 12.89% Ultra (4) 7,351.49 10.75 79,056 0.00% 1.40% 7.54% Value 1,108,091.56 16.30 18,059,845 0.00% 1.40% 12.71% Vista (4) 369,192.37 10.80 3,987,928 0.00% 1.40% 8.02% Dreyfus Variable Investment Fund Appreciation (4) 247,910.98 10.31 2,556,991 3.31% 1.40% 3.14% Developing Leaders (4) 2,938.60 10.89 32,003 0.40% 1.40% 8.91% Quality Bond (4) 21,381.13 10.42 222,700 3.68% 1.40% 4.16% Socially Responsible Growth 146,825.11 6.96 1,022,453 0.38% 1.40% 4.72% Franklin Templeton Variable Insurance Products Trust Foreign Securities (4) 233,297.54 11.54 2,691,151 0.34% 1.40% 15.35% Mutual Shares Securities (4) 34,866.29 10.97 382,376 0.19% 1.40% 9.67% Real Estate (4) 71,208.31 13.58 967,030 0.30% 1.40% 35.80% Small Cap (4) 8,615.03 10.95 94,330 0.00% 1.40% 9.50% Small Cap Value Securities (4) 43,564.50 12.00 522,938 0.01% 1.40% 20.04% JP Morgan Series Trust II International Equity 285,762.15 10.62 3,033,501 0.54% 1.40% 16.78% Small Company 138,936.30 14.65 2,035,302 0.00% 1.40% 25.42% Neuberger Berman Advisors Management Trust Fasciano (4) 143,490.34 10.94 1,570,132 0.00% 1.40% 9.42% Limited Maturity (4) 586,111.13 9.97 5,842,981 5.50% 1.40% (0.31%) Mid Cap Growth (4) 6,084.77 11.52 70,067 0.00% 1.40% 15.15% Partners 181,388.85 12.01 2,177,869 0.01% 1.40% 17.37% Scudder Variable Series II Dreman High Return Equity (4) 21,818.25 11.23 245,061 0.00% 1.40% 12.32% Dreman Small Cap Value (4) 122,129.24 11.93 1,456,626 0.00% 1.40% 19.27% (3) On October 15, 2004, INVESCO Dynamics Fund was renamed AIM Dynamics Fund, INVESCO Health Sciences Fund was renamed AIM Health Sciences Fund and INVESCO Technology Fund was renamed AIM Technology Fund. (4) The Investment Income Ratio, Expense Ratio and Total Return are for the period of inception May 1, 2004 through December 31, 2004.
F-80 NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) NOTES TO THE FINANCIAL STATEMENTS (CONTINUED) NOTE 6 - FINANCIAL HIGHLIGHTS (CONTINUED)
For the Year Ended At December 31, 2004 December 31, 2004 --------------------------------------- --------------------------------- Unit Investment Fair Income Expense Total Portfolio Units Value Net Assets Ratio (a) Ratio (b) Return (c) - ------------------------------------------------------------------------------------------------------------------- Sentinel Variable Products Trust Balanced 1,253,469.19 $ 13.21 $16,562,823 2.11% 1.40% 5.96% Bond 1,287,455.21 14.07 18,110,108 4.43% 1.40% 3.20% Common Stock 2,530,565.26 13.61 34,448,642 1.08% 1.40% 8.13% Growth Index 369,520.70 7.68 2,836,872 1.34% 1.40% 3.89% Mid Cap Growth 1,136,704.15 14.74 16,749,696 0.00% 1.40% 10.79% Money Market 956,343.80 11.59 11,086,345 0.93% 1.40% (0.41%) Small Company 1,502,266.71 24.73 37,157,107 0.09% 1.40% 14.30% Strong Variable Insurance Funds Mid Cap Growth II 543,989.20 14.70 7,995,238 0.00% 1.40% 17.49% Opportunity II 583,347.53 18.87 11,005,540 0.00% 1.40% 16.60% T. Rowe Price Equity Series Blue Chip Growth (4) 279,899.33 10.79 3,019,123 0.90% 1.40% 7.86% Equity Income (4) 41,206.26 11.21 461,943 1.55% 1.40% 12.11% Health Sciences (4) 106,209.88 10.36 1,100,429 0.00% 1.40% 3.61% Variable Insurance Product Funds Contrafund 1,069,940.50 17.68 18,916,970 0.32% 1.40% 13.85% Equity Income 1,393,766.90 14.51 20,229,082 1.53% 1.40% 9.95% Growth 1,202,786.07 13.11 15,767,604 0.26% 1.40% 1.94% High Income 1,010,663.00 10.04 10,144,330 7.70% 1.40% 8.04% Index 500 2,088,000.22 13.44 28,063,565 1.33% 1.40% 9.09% Investment Grade Bond 1,968,755.52 12.67 24,936,299 4.03% 1.40% 2.98% Mid Cap (4) 107,584.37 12.26 1,319,406 0.00% 1.40% 22.64% Overseas 1,185,510.33 11.41 13,531,954 1.03% 1.40% 12.02%
(4) The Investment Income Ratio, Expense Ratio and Total Return are for the period of inception May 1, 2004 through December 31, 2004. (a) These amounts represent dividends, distributions of gains, received by the sub-account from the underlying mutual excluding capital fund, net of management fees assessed by the fund manager, divided by the average net assets. These ratios exclude those expenses, such as mortality and expense charges, that are assessed against contract owner either reductions in the unit the of units. recognition of accounts through values or redemption The investment income by the sub-account is affected by the timing of the declaration of dividends by the underlying fund in which the sub-account invests. (b) These amounts represent the annualized contract expenses of the separate account, consisting primarily of mortality and expense charges, for each period indicated. The ratios include only those expenses that result in a direct reduction to unit values. Charges made directly to contract owner accounts through the redemption of units and expenses of the underlying fund have been excluded. (c) These amounts represent the total return for the periods indicated, including changes in the value of the underlying fund, and expenses assessed through the reduction of unit values. These ratios do not include any expenses assessed through the redemption of units. F-81 NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) NOTES TO THE FINANCIAL STATEMENTS (CONTINUED) NOTE 6 - FINANCIAL HIGHLIGHTS (CONTINUED)
FOR THE YEAR ENDED AT DECEMBER 31, 2003 DECEMBER 31, 2003 ----------------------------------------------------------------------------- UNIT INVESTMENT FAIR INCOME EXPENSE TOTAL PORTFOLIO UNITS VALUE NET ASSETS RATIO (A) RATIO (B) RETURN (C) - ---------------------------------------------------------------------------------------------------------------- Alger American Fund Growth 1,147,661.68 $13.21 $15,155,342 0.00% 1.40% 33.25% Leveraged AllCap 292,149.77 7.19 2,100,871 0.00% 1.40% 32.92% Small Capitalization 638,099.32 9.04 5,765,569 0.00% 1.40% 40.30% American Century Variable Portfolios Income & Growth 767,740.18 10.31 7,916,619 1.15% 1.40% 27.62% Value 963,627.66 14.46 13,929,528 0.95% 1.40% 27.14% Dreyfus Variable Investment Fund Socially Responsible Growth 159,344.69 6.65 1,059,438 0.12% 1.40% 24.28% Gartmore Variable Insurance Trust Government Bond (5) -- -- -- 8.40% 1.40% (8.58%) JP Morgan Balanced (5) -- -- -- 2.46% 1.40% (15.85%) INVESCO Variable Investment Funds Dynamics 381,357.65 6.63 2,527,665 0.00% 1.40% 35.82% Health Sciences 534,106.75 8.56 4,571,873 0.00% 1.40% 26.07% Technology 547,768.82 4.04 2,213,203 0.00% 1.40% 43.28% JP Morgan Series Trust II International Equity 228,845.56 9.09 2,081,115 0.72% 1.40% 30.66% Small Company 118,426.04 11.68 1,383,364 0.00% 1.40% 34.11% Neuberger Berman Advisors Management Trust Partners 168,915.14 10.23 1,728,597 0.00% 1.40% 33.25% Sentinel Variable Products Trust Balanced(5) 1,134,775,51 12.47 14,152,143 0.83% 1.40% 24.71% Bond(5) 1,303,319.09 13.63 17,765,696 1.71% 1.40% 36.31% Common Stock 2,081,352.51 12.59 26,202,211 0.93% 1.40% 29.65% Growth Index 395,952.58 7.39 2,926,049 0.90% 1.40% 22.35% Mid Cap Growth 1,190,675.96 13.30 15,838,143 0.00% 1.40% 39.87% Money Market 1,010,025.42 11.64 11,760,670 0.82% 1.40% (0.65%) Small Company 1,242,053.69 21.64 26,875,879 0.12% 1.40% 37.56% Strong Variable Insurance Funds Mid Cap Growth II 639,147.81 12.51 7,994,456 0.00% 1.40% 32.36% Opportunity II 597,575.44 16.18 9,670,414 0.08% 1.40% 35.08% Variable Insurance Product Funds Contrafund 1,052,447.54 15.53 16,340,274 0.41% 1.40% 26.64% Equity Income 1,458,610.93 13.20 19,248,480 1.66% 1.40% 28.50% Growth 1,247,702.58 12.86 16,044,336 0.25% 1.40% 30.95% High Income 926,868.19 9.29 8,608,227 5.67% 1.40% 25.51% Index 500 2,313,638.45 12.32 28,507,281 1.37% 1.40% 26.63% Investment Grade Bond 1,885,368.97 12.30 23,182,923 3.48% 1.40% 3.77% Overseas 1,064,456.93 10.19 10,842,500 0.73% 1.40% 41.47%
(5) On April 25, 2003, balances within the Market Street Fund, Inc. were merged with the Gartmore Variable Insurance Trust (GVIT). Subsequently, on August 1, 2003, newly created funds of the Sentinel Variable Products Trust replaced GVIT. See Note 1 for additional information on fund mergers and substitutions in 2003. F-82 NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) NOTES TO THE FINANCIAL STATEMENTS (CONTINUED) NOTE 6 - FINANCIAL HIGHLIGHTS (CONTINUED) (a) These amounts represent dividends, excluding distributions of capital gains, received by the sub-account from the underlying mutual fund, net of management fees assessed by the fund manager, divided by the average net assets. These ratios exclude those expenses, such as mortality and expense charges, that are assessed against contract owner accounts either through reductions in the unit values or the redemption of units. The recognition of investment income by the sub-account is affected by the timing of the declaration of dividends by the underlying fund in which the sub-account invests. (b) These amounts represent the annualized contract expenses of the separate account, consisting primarily of mortality and expense charges, for each period indicated. The ratios include only those expenses that result in a direct reduction to unit values. Charges made directly to contract owner accounts through the redemption of units and expenses of the underlying fund have been excluded. (c) These amounts represent the total return for the periods indicated, including changes in the value of the underlying fund, and expenses assessed through the reduction of unit values. These ratios do not include any expenses assessed through the redemption of units. F-83 NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) NOTES TO THE FINANCIAL STATEMENTS (CONTINUED) NOTE 6 - FINANCIAL HIGHLIGHTS (CONTINUED)
2002 - ----------------------------------------------------------------------------------------------------------------------------- UNIT VALUE UNIT VALUE INVESTMENT (BEGINNING (END OF EXPENSE INCOME TOTAL PORTFOLIO UNITS OF YEAR) YEAR) NET ASSETS RATIO(A) RATIO(B) RETURN(C) - ----------------------------------------------------------------------------------------------------------------------------- Alger American Fund Growth 1,112,587.18 $ 14.99 $ 9.91 $11,022,333 1.40% 0.04% (33.91%) Small Capitalization 627,551.21 8.85 6.44 4,039,286 1.40% 0.00% (27.27%) Leveraged AllCap 183,800.39 8.30 5.41 994,790 1.40% 0.01% (34.79%) American Century Variable Portfolios Value 816,576.88 13.19 11.37 9,281,419 1.40% 0.74% (13.83%) Income & Growth 647,417.35 10.17 8.08 5,233,281 1.40% 1.04% (20.52%) Dreyfus Socially Responsible Growth 148,267.80 7.64 5.35 793,311 1.40% 0.28% (29.97%) INVESCO Variable Investment Funds Dynamics 321,110.70 7.26 4.88 1,565,885 1.40% 0.00% (32.83%) Technology 283,490.20 5.38 2.82 799,400 1.40% 0.00% (47.59%) Health Sciences 414,706.10 9.12 6.79 2,816,940 1.40% 0.00% (25.52%) Market Street Fund Managed 916,629.63 11.55 10.22 9,368,062 1.40% 2.58% (11.51%) Bond 1,213,264.09 12.14 13.06 15,843,081 1.40% 3.48% 7.56% JP Morgan Series Trust II International Opportunities 158,604.86 8.64 6.96 1,104,290 1.40% 0.45% (19.42%) Small Company 115,400.73 11.27 8.71 1,005,241 1.40% 0.20% (22.71%) Neuberger Berman Advisors Management Trust Partners 134,673.05 10.27 7.68 1,034,497 1.40% 0.45% (25.20%) Sentinel Variable Products Trust Money Market 1,551,827.66 11.73 11.72 18,186,639 1.40% 1.28% (0.09%) Common Stock 1,800,411.01 11.91 9.71 17,486,431 1.40% 1.23% (18.45%) Small Company 937,943.44 18.54 15.73 14,758,188 1.40% 0.30% (15.13%) Mid Cap Growth 1,000,052.44 12.70 9.51 9,508,939 1.40% 0.00% (25.13%) Growth Index 357,764.90 8.07 6.04 2,162,452 1.40% 0.75% (25.10%) Strong Variable Insurance Funds Opportunity II 593,692.26 16.60 11.98 7,110,699 1.40% 0.47% (27.85%) Mid Cap Growth II 593,006.69 15.34 9.45 5,603,885 1.40% 0.00% (38.40%) Variable Insurance Product Funds Equity Income 1,336,207.02 12.54 10.27 13,719,121 1.40% 1.61% (18.12%) Overseas 956,027.37 9.16 7.20 6,887,404 1.40% 0.79% (21.35%) Growth 1,116,957.82 14.24 9.82 10,963,029 1.40% 0.27% (31.07%) High Income 683,024.77 7.25 7.40 5,054,349 1.40% 9.87% 2.07% Index 500 2,177,585.48 12.69 9.73 21,187,584 1.40% 1.37% (23.33%) Contrafund 895,933.04 13.71 12.26 10,979,788 1.40% 0.79% (10.61%) Investment Grade Bond 1,702,427.77 10.89 11.85 20,176,879 1.40% 2.42% 8.83%
F-84 NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) NOTES TO THE FINANCIAL STATEMENTS (CONTINUED) NOTE 6 - FINANCIAL HIGHLIGHTS (CONTINUED) (a) These ratios represent annualized contract expenses, consisting of mortality, expense and administrative fee charges for the year, divided by the average net assets. The ratios include only those expenses that result in a direct reduction to unit values. Charges, such as policy issue fees, premium loads and transaction fees made directly to contract owner accounts through the redemption of units and expenses of the underlying mutual fund are excluded. (b) These amounts represent dividends, excluding distributions of capital gains, received by the sub-account from the underlying mutual fund, net of management fees assessed by the fund manager, divided by the average net assets. These ratios exclude those expenses, such as mortality, expense and administrative charges, that result in direct reductions in the unit values. The recognition of investment income by the sub-accounts is affected by the timing of the declaration of dividends by the underlying fund in which the sub-accounts invest. (c) These amounts represent the total return for the year, including changes in the value of the underlying fund, and reflect deductions for all items included in the expense ratio. The total return does not include any expenses assessed through the redemption of units; inclusion of these expenses in the calculation would result in a reduction in the total return presented. F-85 NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) NOTES TO THE FINANCIAL STATEMENTS (CONTINUED) NOTE 6 - FINANCIAL HIGHLIGHTS (CONTINUED)
2001 - ---------------------------------------------------------------------------------------------------------------------- UNIT UNIT VALUE VALUE INVESTMENT (BEGINNING (END OF EXPENSE INCOME TOTAL PORTFOLIO UNITS OF YEAR) YEAR) NET ASSETS RATIO(A) RATIO(B) RETURN(C) - ---------------------------------------------------------------------------------------------------------------------- Alger American Fund Growth 1,176,016.07 $ 17.24 $ 14.99 $17,631,187 1.40% 0.24% (13.04%) Small Cap 713,337.23 12.73 8.85 6,310,943 1.40% 0.05% (30.50%) Leveraged All Cap 122,328.68 10.02 8.30 1,015,869 1.40% -- (17.12%) American Century Variable Portfolios Value 497,921.29 11.86 13.19 6,567,803 1.40% 0.71% 11.22% Income & Growth 513,559.72 11.25 10.17 5,220,862 1.40% 0.74% (9.64%) Dreyfus Socially Responsible Growth 64,416.84 10.00 7.64 491,883 1.40% 0.09% (23.64%) INVESCO Variable Investment Funds Dynamics 185,977.17 10.69 7.26 1,350,413 1.40% -- (32.08%) Technology 140,047.82 10.07 5.38 753,392 1.40% -- (46.58%) Health Sciences 185,979.64 10.58 9.12 1,695,623 1.40% 0.47% (13.83%) Market Street Fund Managed 742,241.96 12.60 11.55 8,571,857 1.40% 3.37% (8.34%) Bond 831,321.19 11.46 12.14 10,090,540 1.40% 4.30% 5.92% JP Morgan Series Trust II International Opportunities 129,932.62 10.84 8.64 1,122,947 1.40% 1.19% (20.27%) Small Company 94,501.13 12.43 11.27 1,065,428 1.40% 0.04% (9.30%) Neuberger Berman Advisors Management Trust Partners 92,299.75 10.72 10.27 947,777 1.40% 0.34% (4.21%) Sentinel Variable Products Trust Money Market 1,339,572.89 11.47 11.73 15,709,999 1.40% 3.19% 2.25% Common Stock 1,550,727.39 13.15 11.91 18,475,038 1.40% 1.26% (9.40%) Small Company 641,556.80 17.84 18.54 11,892,223 1.40% 0.40% 3.90% Mid Cap Growth 1,037,504.10 17.01 12.70 13,178,022 1.40% -- (25.33%) Growth Index 152,290.12 9.45 8.07 1,228,844 1.40% 0.47% (14.61%) Strong Variable Insurance Funds Opportunity II 422,080.77 17.48 16.60 7,004,736 1.40% 0.41% (5.06%) Mid Cap Growth 649,737.70 22.48 15.34 9,969,426 1.40% -- (31.74%) Variable Insurance Product Funds Equity Income 1,100,806.66 13.38 12.54 13,799,430 1.40% 1.59% (6.31%) Overseas 943,360.18 11.79 9.16 8,644,667 1.40% 5.20% (22.28%) Growth 1,161,109.49 17.54 14.24 16,534,064 1.40% 0.08% (18.81%) High Income 572,401.28 8.33 7.25 4,152,143 1.40% 12.68% (12.92%) Index 500 2,179,936.83 14.64 12.69 27,662,843 1.40% 1.19% (13.32%) Contrafund 802,651.88 15.84 13.71 11,003,332 1.40% 0.81% (13.46%) Investment Grade Bond 759,750.40 10.18 10.89 8,274,781 1.40% 1.02% 6.99% Bond 831,321.19 11.46 12.14 10,090,540 1.40% 4.30% 5.92%
F-86 NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) NOTES TO THE FINANCIAL STATEMENTS (CONTINUED) NOTE 6 - FINANCIAL HIGHLIGHTS (CONTINUED) (a) These ratios represent annualized contract expenses, consisting of mortality, expense and administrative fee charges for the year, divided by the average net assets. The ratios include only those expenses that result in a direct reduction to unit values. Charges, such as policy issue fees, premium loads and transaction fees made directly to contract owner accounts through the redemption of units and expenses of the underlying mutual fund are excluded. b) These amounts represent dividends, excluding distributions of capital gains, received by the sub-account from the underlying mutual fund, net of management fees assessed by the fund manager, divided by the average net assets. These ratios exclude those expenses, such as mortality, expense and administrative charges, that result in direct reductions in the unit values. The recognition of investment income by the sub-accounts is affected by the timing of the declaration of dividends by the underlying fund in which the sub-accounts invest. (c) These amounts represent the total return for the year, including changes in the value of the underlying fund, and reflect deductions for all items included in the expense ratio. The total return does not include any expenses assessed through the redemption of units; inclusion of these expenses in the calculation would result in a reduction in the total return presented. NOTE 7 - DISTRIBUTION OF NET INCOME The Variable Account does not expect to declare dividends to contractholders from accumulated net income. The accumulated net income will be distributed to contractholders as withdrawals (in the form of death benefits, surrenders or contract loans) in excess of the contractholders' net contributions to the Variable Account. NOTE 8 - DIVERSIFICATION REQUIREMENTS Under the provisions of Section 817(h) of the Internal Revenue Code (IRC), a variable annuity contract, other than a contract issued in connection with certain types of employee benefit plans, will not be treated as a variable annuity contract for federal income tax purposes for any period for which the investments of the segregated asset account on which the contract is based are not adequately diversified. The IRC provides that the adequately diversified requirement may be met if the underlying investments satisfy either a statutory safe harbor test or diversification requirements set forth in regulations issued by the Secretary of the Treasury. National Life believes that the Variable Account satisfies the current requirements of the regulations, and it intends that the Variable Account will continue to meet such requirements. NOTE 9 - FUND SUBSTITUTIONS Substitution transactions that occurred on August 1, 2003 are shown below. Immediately after the transaction, an Owner of the Variable Account held the same total dollar value of units in his or her account; only the investment option of the sub-account was changed. August 1, 2003 Removed Portfolio Surviving Portfolio - -------------------------------------------------------------------------------- GVIT GOVERNMENT BOND FUND SVPT BOND FUND Shares 1,558,748.29 1,861,145.46 NAV $ 11.94 $ 10.00 Net assets before $ 18,611,455 Net assets after $ 18,611,455 - -------------------------------------------------------------------------------- GVIT JP MORGAN BALANCED FUND SVPT BALANCED FUND Shares 1,269,190.65 1,091,503.96 NAV $ 8.60 $ 10.00 Net assets before $ 10,915,040 Net assets after $ 10,915,040 F-87 NATIONAL VARIABLE ANNUITY ACCOUNT II (A SEPARATE ACCOUNT OF NATIONAL LIFE INSURANCE COMPANY) NOTES TO THE FINANCIAL STATEMENTS (CONTINUED) NOTE 10 - LOANS Policyholders may obtain loans as outlined in the variable annuity contract. At the time a loan is granted, accumulated value equal to the amount of the loan is designated as collateral and transferred from the Segment to the General Account of National Life. Interest is credited by National Life at predetermined rates on collateral held in the General Account. This interest is periodically transferred to the Variable Account. F-88 PART C - OTHER INFORMATION ITEM 24. FINANCIAL STATEMENTS AND EXHIBITS (a) Financial Statements (1) Financial statements and schedule included in the Prospectus (2) Financial statements and schedule included in Statement of Additional Information (b) Exhibits (1) Resolution of the Depositor's Board of Directors authorizing the establishment of the Registrant.(1) (2) Not Applicable (3) (a) Form of Distribution Agreement between National Life Insurance Company and Equity Services, Inc (12) (b) Form of Selling Agreement (12) (4) (a) The form of the variable annuity contract (2) (b) Enhanced Death Benefit Rider (c) Guaranteed Account Endorsement (d) Accelerated Benefits Rider - Covered Chronic Illness (6) (e) Accelerated Benefits Rider - Terminal Illness (6) (f) Endorsement to the Death Benefit, Systematic Withdrawals, and General Withdrawal Terms Provisions (8) (g) Limited Power of Attorney (9) (h) Roth IRA Endorsement (i) SIMPLE IRA Endorsement (j) IRA Endorsement (k) TDA Endorsement (l) Endorsement to the Payment Options (m) Loan Endorsement (n) Endorsement to the Limit on Transfers Provision (5) Variable Annuity Application (6) Articles of Incorporation and By-Laws of Depositor (12) (7) Reinsurance agreement: Automatic Modified -Coinsurance (Mod-Co) Reinsurance and Service Agreement - National Life Insurance Company and xxxxx, effective December 31, 1998 (9) (8)(a) Participation Agreement by and among The Alger American Fund, National Life Insurance Company and Fred Alger and Company, dated January 31, 1995 (3) 1. Form of amended Schedule A to the Participation Agreement by and among The Alger American Fund, National Life Insurance Company and Fred Alger Company, dated April 25, 1997 (2) (b) Form of Participation Agreement between National Life Insurance Company and American Century Investment, Inc. (4). 1. Form of Amendment to Shareholder Services Agreement (10) (c) Form of Participation Agreement between National Life Insurance Company and Neuberger & Berman Advisers Managers Trust (4) 1. Form of Amendment to Participation Agreement (10) (d) Form of Participation Agreement between National Life Insurance Company and J. P. Morgan Series Trust II (4) (e) Participation Agreement between National Life Insurance Company and The Dreyfus Socially Responsible Growth Fund, Inc.(5) 1. Form of Amendment to Participation Agreement among National Life Insurance Company, The Dreyfus Socially Responsible Growth Fund, Inc., and Dreyfus Variable Investment Fund(10) (f) Form of Amended and Restated Participation Agreement between National Life Insurance Company, Fidelity Variable Insurance Products Fund III and Fidelity Distributors Corporation (10) (g) Form of Participation Agreement - National Life Insurance Company, Franklin Templeton Variable Insurance Products Trust and Franklin Templeton Distributors, Inc. (10) (h) Form of Participation Agreement - National Life Insurance Company, Scudder Variable Series II, Scudder Distributors, Inc. and Deutsche Investment Management Americas, Inc. (10) (i) Form of Participation Agreement - National Life Insurance Company, T. Rowe Price Equity Services, Inc. and T. Rowe Price Investment Services, Inc. (10) (j) Form of Participation Agreement - AIM Variable Insurance Funds, A I M Distributors, Inc., National Life Insurance Company and Equity Services, Inc.(11) (k) Participation Agreement between Sentinel Variable Products Trust, National Life Insurance Company and Equity Services, Inc. (7) (l) Form of Participation Agreement - Wells Fargo Variable Trust, Wells Fargo Funds Distributor, LLC and National Life Insurance Company (12) C-1 (9) Opinion and consent of Counsel (10)(a) Consent of Sutherland Asbill & Brennan LLP (b) Consent of PriceWaterhouseCoopers LLP (11) Not Applicable. (12) Not Applicable. (13) Performance Advertising Calculation Schedules (2) (14) Powers of Attorney (12) (1) Incorporated herein by reference to Registration Statement (File No. 333-19583) for National Variable Annuity Account II filed on January 10, 1997. (2) Incorporated herein by reference to Pre-Effective Amendment No. 1 to the Form N-4 Registration Statement (File No. 333-19583) for National Variable Annuity Account II filed May 28, 1997. (3) Incorporated herein by reference to Post-Effective Amendment No. 1 to the Form S-6 Registration Statement (File No. 33-91938) for National Variable Life Insurance Account (VariTrak) filed March 12, 1996. (4) Incorporated herein by reference to Pre-Effective Amendment No. 1 to the Form S-6 Registration Statement (File No. 333-44723) for National Variable Life Insurance Account (Sentinel Estate Provider) filed April 16, 1998. (5) Incorporated herein by reference to Post-Effective Amendment No. 4 to the Form S-6 Registration Statement (File No. 333-44723) for National Variable Life Insurance Account (Sentinel Estate Provider) filed May 1, 2001. (6) Incorporated herein by reference to Post-Effective Amendment No. 7 to the Form N-4 Registration Statement (File No. 333-19583) for National Variable Annuity Account II (Sentinel Advantage) filed May 1, 2001. (7) Incorporated herein by reference to Post Effective Amendment No. 12 to the Form N-6 Registration Statement (File No. 33-91938) for National Variable Life Insurance Account (VariTrak) filed February 28, 2003 (8) Incorporated herein by reference to Post-Effective Amendment No. 12 to the Form N-4 Registration Statement (File No. 33-19583 for National Variable Annuity Account II (Sentinel Advantage) filed July 30, 2003. (9) Incorporated herein by reference to Post-Effective Amendment No. 14 to the Form N-6 Registration Statement for National Variable Life Insurance Account (VariTrak - File No. 33-91938) filed March 1, 2004 (10) Incorporated herein by reference to Post-Effective Amendment No. 15 to the Form N-6 Registration Statement for National Variable Life Insurance Account (VariTrak - File No. 33-91938) filed May 1, 2004 (11) Incorporated herein by reference to Post-Effective Amendment No. 17 to the Form N-6 Registration Statement for National Variable Life Insurance Account (VariTrak - File No. 33-91938) filed May 2, 2005 (12) Incorporated herein by reference to Post-Effective Amendment No. 18 to the Form N-6 Registration Statement for National Variable Life Insurance Account (VariTrak - File No. 33-91938) filed May 1,2006 ITEM 25. DIRECTORS AND OFFICERS OF THE DEPOSITOR NAME AND PRINCIPAL BUSINESS ADDRESS* POSITION WITH DEPOSITOR Thomas H. MacLeay Chairman of the Board, President, CEO and Director Bruce Lisman Director Bear Stearns Companies 383 Madison Avenue, 5th Floor New York, NY 1 0179 E. Miles Prentice Director Eaton & Van Winkle 3 Park Ave., 16th Floor New York, NY 10016 A. Gary Shilling Director A. Gary Shilling & Co., Inc. 500 Morris Avenue Springfield, NJ 07081-1020 Patricia K. Woolf Director 506 Quaker Road Princeton, NJ 08540 C-2 Mehran Assadi Executive Vice President Edward J. Bonach Executive Vice President & Chief Financial Officer Michele S. Gatto Executive Vice President - Corporate Services & General Counsel Christian W. Thwaites Executive Vice President Thomas H. Brownell Senior Vice President & Chief Investment Officer Joel Conrad Senior Vice President & Chief Information Officer Don W. Cummings Senior Vice President - Finance William E. Decker Senior Vice President - Human Resources Gregory H. Doremus Senior Vice President - New Business & Customer Service Kenneth R. Ehinger Senior Vice President - NL Financial Alliance Charles C. Kittredge Senior Vice President - Marketing Development & Operations Wade H. Mayo Senior Vice President Ruth B. Smith Senior Vice President - Life Event Distribution. James K. McQueston Secretary Robert E. Cotton Vice President & Treasurer *Unless otherwise indicated, the principal business address is National Life Drive, Montpelier, Vermont 05604. Item 26. Persons Controlled by or Under Common Control with the Depositor or Registrant. A list of all persons directly or indirectly controlled by or under common control with National Life Insurance Company ("National Life") is set forth below. All of the stock of National Life is owned by NLV Financial Corporation, a Delaware corporation. All of the stock of NLV Financial Corporation is owned by National Life Holding Company, a mutual insurance holding company organized under Vermont law. National Life owns 100% of LSW National Holdings, Inc., a Vermont corporation; LSW National Holdings Inc. owns 100% of Life Insurance Company of the Southwest, a Texas corporation. NLV Financial Corporation is majority owner of American Guaranty & Trust Company, a Delaware corporation, and owns 100% of National Retirement Plan Advisors, a Vermont corporation, NL Group Statutory Trust I, a Connecticut trust; Equity Services, Inc., a Vermont corporation, and Sentinel Asset Management, Inc. ("SAMI"), a Vermont corporation. SAMI owns 100% of Sentinel Asset Management Advisors, Inc., a Delaware corporation, Sentinel Administrative Services, Inc., a Vermont corporation, and Sentinel Financial Services, Inc., a Delaware corporation. SAMI and Sentinel Financial Services, Inc. are partners of Sentinel Financial Services Company, a Vermont general partnership. Equity Services, Inc. owns 100% of Equity Services of Colorado, LLC, a Colorado LLC, and Equity Services of Nevada, Inc., a Nevada corporation. Item 27. Number of Contract Owners. As of March 31, 2006, 7,932 contracts are in force. Item 28. Indemnification The By-Laws of Depositor provide, in part in Article VI, as follows 7.1 Indemnification. (a) The Corporation shall indemnify and hold harmless any officer, director, employee or agent of the Corporation to the fullest extent permitted under Title 11A, Chapter 8, Subchapter 5 of the Vermont Statutes Annotated, as the same may be amended from time to time. Any repeal or modification of this Section 7.1 or of Title 11A, Chapter 8, Subchapter 5 of the Vermont Statutes Annotated shall not adversely affect any right of indemnification of any officer, director or employee of the Corporation existing at any time prior to such repeal or modification. Provided, however, that the Corporation shall not be required to indemnify a person in connection with a proceeding initiated by such person, including a counterclaim or crossclaim, unless the proceeding was authorized by the Board of Directors. C-3 (b) The Corporation may pay or reimburse the reasonable expenses incurred in defending any proceeding in advance of its final disposition if the Corporation has received in advance an undertaking by the person receiving such payment or reimbursement to repay all amounts advanced if it should be ultimately determined that he or she is not entitled to be indemnified under this article or otherwise. The Corporation may require security for any such undertaking. Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers, and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any such action, suit or proceeding) is asserted by such director, officer, or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question of whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. ITEM 29 PRINCIPAL UNDERWRITER (a) Equity Services, Inc. (ESI) is also the principal underwriter for National Variable Life Insurance Account and Sentinel Variable Products Trust. (b) The following information is furnished with respect to the officers and directors of ESI:
- ---------------------------------------------- --------------------------------------- ------------------------------------------- NAME AND PRINCIPAL BUSINESS ADDRESS* POSITIONS AND OFFICES WITH ESI POSITIONS AND OFFICES WITH DEPOSITOR - ---------------------------------------------- --------------------------------------- ------------------------------------------- Kenneth R. Ehinger Chief Executive Officer & Director Senior Vice President - NL Financial Alliance - ---------------------------------------------- --------------------------------------- ------------------------------------------- Christopher Maryanopolis President None - ---------------------------------------------- --------------------------------------- ------------------------------------------- Stephen A. Englese Senior Vice President None - ---------------------------------------------- --------------------------------------- ------------------------------------------- Gregory D. Teese Vice President - Compliance & Chief None Compliance Officer - ---------------------------------------------- --------------------------------------- ------------------------------------------- Isabelle Keiser Vice President None - ---------------------------------------------- --------------------------------------- ------------------------------------------- James Canavan Assistant Vice President None - ---------------------------------------------- --------------------------------------- ------------------------------------------- Kerry A. Jung Counsel Senior Counsel - ---------------------------------------------- --------------------------------------- ------------------------------------------- Sharon E. Bernard Treasurer & Controller None - ---------------------------------------------- --------------------------------------- ------------------------------------------- James K. McQueston Secretary Assistant General Counsel & Secretary - ---------------------------------------------- --------------------------------------- ------------------------------------------- Kathy M. Trussell Assistant Secretary Assistant Secretary - ---------------------------------------------- --------------------------------------- ------------------------------------------- Thomas H. MacLeay Chairman Chairman, President & & Chief Executive Officer - ---------------------------------------------- --------------------------------------- ------------------------------------------- Edward J. Bonach Director Executive Vice President & Chief Financial Officer - ---------------------------------------------- --------------------------------------- -------------------------------------------
*Unless otherwise indicated, principal business address is One National Life Drive, Montpelier, Vermont 05604. (c) Commission and other compensation received, directly or indirectly from the Registrant during Registrant's last fiscal year by each principal underwriter:
- ---------------------------- -------------------------- ------------------------ ----------------------- ---------------------- NAME OF NET UNDERWRITING COMPENSATION ON BROKERAGE COMMISSIONS OTHER PRINCIPAL DISCOUNTS AND COMMISSIONS REDEMPTION COMPENSATION UNDERWRITER - ---------------------------- -------------------------- ------------------------ ----------------------- ---------------------- Equity Services, Inc. $3,997,084 -0- $3,997,084 -0- - ---------------------------- -------------------------- ------------------------ ----------------------- ----------------------
ITEM 30. LOCATION OF ACCOUNTS AND RECORDS All accounts and records required to be maintained by Section 31(a) of the Investment Company Act of 1940 and the rules thereunder are maintained by National Life Insurance Company at One National Life Drive, Montpelier, Vermont 05604. ITEM 31. MANAGEMENT SERVICES All management contracts are discussed in Part A or Part B. C-4 ITEM 32 UNDERTAKINGS (a) Registrant hereby undertakes to file a post-effective amendment to this registration statement as frequently as is necessary to ensure that the audited financial statements in the registration statement are never more than sixteen (16) months old for so long as payments under the variable annuity contracts may be accepted; (b) Registrant hereby undertakes to include either (1) as part of any application to purchase a contract offered by the Prospectus, a space that an applicant can check to request a Statement of Additional Information, or (2) a postcard or similar written communication affixed to or included in the Prospectus that the applicant can remove to send for a Statement of Additional Information; and (c) Registrant hereby undertakes to deliver any Statement of Additional Information and any financial statement required to be made available under this form promptly upon written or oral request. (d) Reliance on No-Action Letter Regarding Section 403(b) Retirement Plan. National Life Insurance Company and the Registrant/Variable Account rely on a no-action letter issued by the Division of Investment Management to the American Council of Life Insurance on November 28, 1988 and represent that the conditions enumerated therein have been or will be complied with. (e) National Life Insurance Company hereby represents that the fees and charges deducted under the Contract, in the aggregate, are reasonable in relation to the services rendered, the expenses expected to be incurred, and the risks assumed by National Life Insurance Company. C-5 SIGNATURES Pursuant to the requirements of the Securities Act of 1933 and the Investment Company Act of 1940, the Registrant, National Variable Annuity Account II, certifies that it meets the requirements of Securities Act Rule 485(b) for effectiveness of this registration statement and has duly caused this Post-Effective Amendment No. 19 to be signed on its behalf by the undersigned thereunto duly authorized, in the City of Montpelier and the State of Vermont, on the 1st day of May, 2006. NATIONAL VARIABLE ANNUITY ACCOUNT II (Registrant) By: NATIONAL LIFE INSURANCE COMPANY (SEAL) Attest: /s/ KMT By: /s/ THM ------- ------- Kathy M. Trussell Thomas H. MacLeay Assistant Secretary Chairman of the Board, President and Chief Executive Officer Pursuant to the requirements of the Securities Act of 1933 and the Investment Company Act of 1940, National Life Insurance Company certifies that it meets the requirements of Securities Act Rule 485(b) for effectiveness of this registration statement and has duly caused this Post-Effective Amendment No. 19 to the Registration Statement to be signed on its behalf by the undersigned thereunto duly authorized, and its seal affixed and attested, in the City of Montpelier and the State of Vermont, on the 1st day of May, 2006. NATIONAL LIFE INSURANCE COMPANY (Depositor) By: /s/ Thomas H. MacLeay --------------------- Thomas H. MacLeay Chairman of the Board & Chief Executive Officer C-6 Pursuant to the requirements of the Securities Act of 1933, this Post-Effective Amendment No. 19 to the Registration Statement has been signed below by the following persons in the capacities indicated on the date(s) set forth below. Signature Title Date /s/THM Chairman, President, Chief May 1, 2006 - ----------------- Executive Officer, and Director Thomas H. MacLeay /s/EJB Executive Vice President & May 1, 2006 - ------------------ Chief Financial Officer Edward J. Bonach - ----------------- Bruce Lisman* Director May 1, 2006 - ----------------- E. Miles Prentice, III* Director May 1, 2006 - ------------------ A. Gary Shilling* Director May 1, 2006 - ------------------ Patricia K. Woolf* Director May 1,2006 *Kerry A. Jung signs this document pursuant to the power of attorney filed with Post-Effective Amendment No. 18 to this Registration Statement. /s/ KAJ - ------------- Kerry A. Jung C-7 EXHIBIT INDEX (4) (b) Enhanced Death Benefit Rider (4) (c) Guaranteed Account Endorsement (4) (h) Roth IRA Endorsement (4) (i) SIMPLE IRA Endorsement (4) (j) IRA Endorsement (4) (k) TDA Endorsement (4) (l) Endorsement to the Payment Options (4) (m) Loan Endorsement (4) (n) Endorsement to the Limit on Transfers Provision (5) Variable Annuity Application (9) Opinion and consent of Counsel (10)(a) Consent of _Sutherland Asbill & Brennan LLP (10)(b) Consent of PriceWaterhouseCoopers LLP C-8 EX-99.B 2 exh4b.txt ENHANCED DEATH BENEFIT RIDER ENHANCED DEATH BENEFIT RIDER If any human Owner, or the Annuitant if the Owner is not a human being, died: 1. prior to the Maturity Date; 2. prior to his or her Attained Age 81; and 3. while this Enhanced Death Benefit Rider was in force; the Death Benefit provided in the contract is enhanced as described below. ENHANCED DEATH BENEFIt. If the deceased died according to the terms of this rider, the Death Benefit is calculated as of the date we receive due proof of death and is the greater of: 1. The Contract Value; 2. the sum of all Net Premiums less cumulative withdrawals made since the Date of Issue of this contract; and 3. the Maximum Contract Anniversary Value; less any state premium tax that is assessed on distribution. All other aspects of the Death Benefit provision of the contract remain unchanged. MAXIMUM CONTRACT ANNIVERSARY VALUE. A Contract Anniversary Value is equal to the Contract Value on any given Contract Anniversary adjusted by the amount of Net Premiums paid into this contract and withdrawals taken from this contract since that Contract Anniversary. The Maximum Contract Anniversary Value is the largest of these Contract Anniversary Values falling prior to the deceased's Attained Age 81 and while this rider is in force. Charges for this Rider. Rider charges will be deducted at issue and on each Contract Anniversary that this rider remains in force, unless a Contract Anniversary falls on a non-market day, in which case the deduction will be made on the first market day following that Contract Anniversary. Rider charges will be deducted on a pro-rata basis from the Contract Value held in the Sub-Accounts of the Variable Account and the unloaned portion of the Fixed Account. TERMINATION. This rider shall terminate on the earliest of: 1. the Attained Age 81 of the oldest human Owner, or of the Annuitant if the Owner is non-human; or 2. the date the contract terminates; or 3. any Contract Anniversary requested if before that date we receive at our Home Office written request for termination. When this rider terminates: 1. all rights under this rider shall cease; and 2. no further charges will be deducted for this rider; and 3. the contract shall be considered as separate and complete without this rider. Signed for National Life Insurance Company at Montpelier, Vermont as of the date of issue of this rider, by /s/ Thomas H. Macleay - ----------------------- Chairman of the Board and Chief Executive Officer - ----------------------------------------- 1 ------------------------------------ NATIONAL LIFE INSURANCE COMPANY ONE NATIONAL LIFE DRIVE (Y) MONTPELIER, VERMONT 05064 (Y) TEL: 802 229-3333 EX-99.C 3 exh4c.txt GUARANTEED ACCOUNT ENDORSEMENT INDEX SECTION PAGE - -------------------------------------------------------------------------------- GUARANTEED ACCOUNT ENDORSEMENT Guaranteed Account 1 Removal of Contract Value from Guaranteed Accounts 2 Market Value Adjustment 2 Options on the Fulfillment Date 4 Transfers 4 Allocation of Loans and Loan Repayments 5 Valuation Date and Valuation Period 5 Annuitization 5 Payment of Premiums 5 Effective Date 6 9280(0501) -I- GUARANTEED ACCOUNT ENDORSEMENT - -------------------------------------------------------------------------------- This contract contains a Market Value Adjustment formula. Operation of this formula may result in both upward and downward adjustments in cash surrender benefits. No Market Value Adjustment will be applied during the Right to Review period of this contract or on the contract's Maturity Date. Contract Value may also be removed or transferred from a Guaranteed Account on its Fulfillment Date without the imposition of a Market Value Adjustment. GUARANTEED ACCOUNT Guaranteed Accounts are components of the Fixed Account of the contract. Contract Value in a Guaranteed Account will earn interest at a fixed, guaranteed interest rate for a specified investment duration. Each allocation of funds to a Guaranteed Account is assigned a Fulfillment Date. The Fulfillment Date is the final day of the specified investment duration for those funds in that Guaranteed Account. No allocation of funds may be made into a Guaranteed Account with a Fulfillment Date later than the Maturity Date of the contract. Multiple allocations to a particular Guaranteed Account made at different times may be credited interest at different rates. The interest rate credited to a given allocation of Contract Value in a Guaranteed Account remains fixed until the Fulfillment Date associated with that allocation. Guaranteed interest will not be credited on Contract Value removed following such removal of Contract Value from a Guaranteed Account prior to its Fulfillment Date. A Premature Distribution from a Guaranteed Account will be any surrender, withdrawal, or transfer occurring prior to the 30th day before the Fulfillment Date associated with the funds to be distributed. Each allocation into a Guaranteed Account must be $500 or more. If the allocation to a Guaranteed Account is less than $500, that allocation will be deemed insufficient and the funds slated for that Guaranteed Account will be placed in the Money Market Fund Sub-Account instead. National Life Insurance Company One National Life Drive * Montpelier, Vermont 05604 * (802) 229-3333 - -------------------------------------------------------------------------------- 9280(O5O1) Page 1 REMOVAL OF CONTRACT VALUE FROM GUARANTEED ACCOUNTS Unless the Owner specifies otherwise, any removal of Contract Value from the Guaranteed Accounts, including withdrawals and transfers, will be assessed on a pro-rata basis over all existing Guaranteed Accounts. Within each individual Guaranteed Account, Contract Value will be assessed on a first-in-first-out basis wherein the Contract Value with the earliest Fulfillment Date is taken first. If applicable, any Market Value Adjustment will be made to the funds before any Contingent Deferred Sales Charge is assessed. No deductions will be made from any Guaranteed Account for the Annual Contract Fee or Rider Charges unless there is insufficient Contract Value in the other accounts to cover these charges. Unless the Owner specifies otherwise, withdrawals will be made from the Guaranteed Accounts only following depletion of the Contract Value in the Variable Account and the other components of the Fixed Account. MARKET VALUE ADJUSTMENT A Premature Distribution from a Guaranteed Account will trigger a Market Value Adjustment to the Contract Value surrendered, withdrawn, or transferred from that Guaranteed Account. Removal of Contract Value from a Guaranteed Account will occur on a first-in-first-out basis, whereby Contract Value with the earliest Fulfillment Date is taken first. To the extent that a given removal of Contract Value impacts Contract Value segments with different Fulfillment Dares, each segment is addressed independently in calculating the Market Value Adjustment through the following formulas. For each impacted segment of Contract Value, the magnitude of the Market Value Adjustment will be the lesser of the absolute value of (1) and (2), where: (1) = (the amount of Contract Value to be removed from this segment) x (((1+i)/(1+j+.0025))n/12 - 1); and (2) = (the amount of the allocation to this segment of the Guaranteed Account) x ((1+k)d/365 - (1.03)d/365), minus the sum, for all prior removals of Contract Value from the same segment of the Guaranteed Account, of (the amount of Contract Value removed on date T) x ((1+k)e/365 - (1.03)e/365); where: i = the Market Value Adjustment Index for the duration of the Guaranteed Account at the time of the original allocation into this segment; National Life Insurance Company One National Life Drive * Montpelier, Vermont 05604 * (802) 229-3333 - -------------------------------------------------------------------------------- 9280(O5O1) Page 2 n = the number of whole months between the date on which this calculation is made and the Fulfillment Date for this segment; j= the Market Value Adjustment Index., as of the date on which this calculation is made, for a period of length n/12, rounded down to the next whole year (use the one year rate if n/12 is less than or equal to 1). If a rate for that guarantee period is not available in the Federal Reserve Statistical Release H.15, a rate will be determined by linearly intetp01ating between the two nearest available rates; k = the guaranteed interest rate associated with this segment of the Guaranteed Account; d = (365 x the number of complete years since the original allocation to this segment) + the number of days since the last anniversary of that allocation (or the number of days since that 3l1ocation, if less than one year has elapsed since the allocation); and e = (365 x the number of complete years since T to the date on which this calculation is made) + the number of days since the last anniversary of T (or the number of days since T if less than one year has elapsed). The sign of the Market Value Adjustment will be determined by the result of (1) prior to taking its absolute value. If the result is negative, the Market Value Adjustment is negative and reduces the distribution. If the result is positive, the Market Value Adjustment is positive and the distribution is increased. The Market Value Adjustment will not reduce Contract Values removed from a Guaranteed Account below those guaranteed through application of the Minimum Fixed Account Interest Rate shown in the Data Section of the contract. Item (2) of the above formula ensures that any negative impact of the Market Value Adjustment will be restricted to just those investment earnings in excess of earnings attributable to the Minimum Fixed Account Interest Rate. The Market Value Adjustment Index is the Treasury Constant Maturities series, as stated in the Federal Reserve Statistical Release H.15, updated weekly. In the event that this index becomes no longer available, a suitable replacement index, selected subject to the approval of the Insurance Commissioner of the state in which this contract was issued, will be utilized. The Cash Surrender Value and Withdrawal Benefit of this contract will be adjusted for any Market Value Adjustment prior to the assessment of any Contingent Deferred Sales Charge applicable to the surrender or withdrawal. No Market Value Adjustment will be applied to: 1. the Contract Value if this Contract is surrendered during its Right to Review period; 2. the Death Benefit; 3. this contract on its Maturity Date; or 4. any deduction from a Guaranteed Account made to cover the Annual Contract Fee or rider Charges. National Life Insurance Company One National Life Drive * Montpelier, Vermont 05604 * (802) 229-3333 - -------------------------------------------------------------------------------- 9280(O5O1) Page 3 OPTIONS ON THE FULFILLMENT DATE During a 30-day period immediately preceding the Fulfillment Dare for any given segment of Contract Value in a Guaranteed Account, the Owner may request the withdrawal of such Contract Value without a Market Value Adjustment. Alternatively, upon the Owner's direction we will transfer the Contract Value into a Sub-Account of the Variable Account, into another component of the Fixed Account, or into another Guaranteed Account where it will be treated as a new allocation of funds. No Market Value Adjustment will be applied to funds so transferred. We will mail a notice to the Owner at least 15 but not more than 45 days prior to the beginning of this 30-day period. This notice will advise the Owner of the upcoming Fulfillment Dare, and solicit instructions regarding the reinvestment of Contract Value. Such notice will provide the guaranteed interest rates and associated investment durations at which the Contract Value may be reinvested in Guaranteed Accounts. If the rates to be effective for new allocations to a Guaranteed Account made on the Fulfillment Date are not known at the time of the mailing, that fact will be disclosed to the Owner and the rates in effect on the date of the mailing will be disclosed instead. Unless the Owner notifies us otherwise during this 30-day period ending on the Fulfillment Date, funds maturing in a Guaranteed Account will be invested in the Money Market Fund Sub-Account at the end of the day on the Fulfillment Date, or the end of the next Valuation Date if the Fulfillment Date is not a Valuation Date. Alternative investment instructions received from the Owner will be effected at the end of the day on the Fulfillment Date or, again, at the end of the next Valuation Dare if the Fulfillment Date is not a Valuation Date. TRANSFERS The first sentence of the Transfers provision of the contract ("Subject to any applicable Transfer Charges, the Owner may transfer Contract Value among the Sub-Accounts or to the Fixed Account without limitation.") is replaced by the following text: "Subject to any applicable Transfer Charges and Market Value Adjustment, the Owner may transfer Contract Value among the Sub-Accounts of the Variable Account, among the components of the Fixed Account, or from the Variable Account to the Fixed Account, except that we may reject any transfer instruction if we or an affected Sub-Account's investment fund manager reasonably believe that the Owner's transfer activity has been or may become disruptive to the management of the investment fund in which a Sub-Account is invested." National Life Insurance Company One National Life Drive * Montpelier, Vermont 05604 * (802) 229-3333 - -------------------------------------------------------------------------------- 9280(O5O1) Page 4 ALLOCATION OF LOANS AND LOAN REPAYMENTS If this contract contains a Loan Endorsement., and there is insufficient Contract Value in the Sub-Accounts of the Variable Account and the unimpaired portion of the Fixed Account to collateralize a loan, additional Contract Value will be taken from the Guaranteed Accounts. Contract Value taken from the Guaranteed Accounts to collateralize a loan will be taken pro-rata from all Guaranteed Accounts in this contract. Within each individual Guaranteed Account, Contract Value will be: taken on a first-in-first-out basis wherein the Contract Value with the earliest Fulfillment Date is taken first. Any Premature Distribution of Contract Value from a Guaranteed Account to collateralize a loan will be subject to a Market Value Adjustment. Loan repayments will be allocated to the Sub-Accounts of the Variable Account and the unimpaired portion of the Fixed Account according to the premium allocation percentages in effect at the time of the payment. These allocations are subject to the $500 minimum deposit requirement for Guaranteed Accounts. VALUATION DATE AND VALUATION PERIOD The Valuation Date and Valuation Period provision of the contract is replaced in its entirety by the following text. "A Valuation Date is any day that the New York Stock Exchange is customarily open for trading, except for any day on which trading is restricted by directive of the Securities and Exchange Commission. A Valuation Period is the period between any two successive Valuation Dates." ANNUITIZATION Any distribution, against which a Market Value Adjustment has been applied, placed under a Payment Option of this contract will be credited then current annuity purchase rates based on new monies. PAYMENT OF PREMIUMS The following statement is added to the Payment of Premiums provision of the contract. "We retain the right to refuse to credit any premium paid if in our estimation the investment activity of the Owner has been disruptive to the management of any investment fund in which an affected Sub-Account is invested." National Life Insurance Company One National Life Drive * Montpelier, Vermont 05604 * (802) 229-3333 - -------------------------------------------------------------------------------- 9280(O5O1) Page 5 EFFECTIVE DATE The effective date of this endorsement is the same as that of the contract to which it is attached unless a later date is shown below. Effective Date of this Endorsement, if other than the effective date of the contract: Signed for National Life Insurance Company at its Home Office in Montpelier, Vermont, as of the effective dare of this endorsement, by /s/ Patrick E Welch - -------------------------- Chairman, President & CEO National Life Insurance Company One National Life Drive * Montpelier, Vermont 05604 * (802) 229-3333 - -------------------------------------------------------------------------------- 9280(O5O1) Page 6 EX-99.H 4 exh4h.txt ROTH IRA ENDORSEMENT INDEX SECTION PAGE - -------------------------------------------------------------------------------- ROTH INDIVIDUAL RETIREMENT ANNUITY (IRA) ENDORSEMENT Contributions 1 Distributions 4 Nonforfeitability 6 Transferability Restrictions 6 Limit on Withdrawals 6 Reinstatement 6 General Terms 7 9513(0303) - I - ROTH INDIVIDUAL RETIREMENT ANNUITY (IRA) - -------------------------------------------------------------------------------- ENDORSEMENT Effective as of the later of the Date of Issue of the contract or January 1, 2002, the contract is amended and modified as follows. In the event of a conflict between this endorsement and the underlying contract to which it is attached, the provisions of this endorsement will prevail. The contract is established for the exclusive benefit of the Owner or the Owner's beneficiaries. While this endorsement is in effect during the lifetime of the Annuitant, the Annuitant must be the Owner of the contract. CONTRIBUTIONS 1. Maximum Permissible Amount Except in the case of a qualified rollover contribution or a re-characterization (as defined in item (6), below), no contribution will be accepted unless it is in cash and the total of such contributions to all the individual's Roth IRA's for a taxable year does not exceed the applicable amount (as defined in item (2), below), or the individual's compensation (as defined in item (8), below), if less, for that taxable year. The contribution described in the previous sentence that may not exceed the lesser of the applicable amount or the individual's compensation is referred to as a "regular contribution." A "qualified rollover contribution" is a rollover contribution that meets the requirements of section 408(d)(3) of the Internal Revenue Code, except the one-rollover-per-year rule of section 408(d){3){B) does not apply if the rollover contribution is from an IRA other than a Roth IRA (a "non-Roth IRA" ). Contributions may be limited under items (3) through (5), below. 2. Applicable Amount The applicable amount is determined under (a) or (b), below: a) If the individual is under age 50, the applicable amount is $3,000 for any taxable year beginning in 2002 through 2004, $4,000 for any taxable year beginning in 2005 through 2007, and $5,000 for any taxable year beginning in 2008 and years thereafter. b) If the individual is 50 or older, the applicable amount is $3,500 for any taxable year beginning in 2002 through 2004, $4,500 for any taxable year beginning in 2005, $5,000 for any taxable year beginning in 2006 through 2007, and $6,000 for any taxable year beginning in 2008 and years thereafter. After 2008, these limits will be adjusted by the Secretary of the Treasury for cost-of-living increases under Code section 219(b)(5)(C}. Such adjustments will be in multiples of $500. National Life Insurance Company One National Life Drive * Montpelier, Vermont 05604 * (802) 229-3333 - -------------------------------------------------------------------------------- 9513(0303) Page 1 3. Regular Contribution Limit If (a) and/or (b), below, apply, the maximum regular contribution that can be made to all the individual's Roth IRA's for a taxable year is the smaller amount determined under (a) or (b): a) The maximum regular contribution is phased out ratably between certain levels of modified adjusted gross income ("modified AGI" defined in item (7), below) in accordance with the following table: Filing Status Full Contribution Phase Out Range No Contribution Modified AGI Single or Head $95,000 or less Between $95,000 $110,000 or more of Household and $110,000 Joint Return $150,OOO or less Between $150,000 $160,000 or more or Qualifying and $160,OOO Widow(er) Married Separate Return $0 Between $0 and $10,000 $10,000 or more If the individual's modified 'AGI for a taxable year is in the phase-out range, the maximum regular contribution determined under this table for that taxable year is rounded up to the next multiple of $10 and is not reduced below $200. b) If the individual makes regular contributions to both Roth and non-Roth IRA's for a taxable year, the maximum regular contribution that can be made to all the individual's Roth IRA's for that taxable year is reduced by the regular contributions made to the individual's non-Roth IRA's for the taxable year. 4. Qualified Rollover Contribution Limit A rollover from a non-Roth IRA cannot be made to this IRA if, for the year the amount is distributed from the non-Roth IRA, the individual: a) is married and files a separate return; b) is not married and has modified AGI in excess of $100,000; or c) is married and together the individual and the individual's spouse have modified AGI in excess of $100,000. In determining the Qualified Rollover Contribution Limit, a husband and wife are not treated as married for a taxable year if they have lived apart at all times during that taxable year and file separate returns for the taxable year. 5. SIMPLE-IRA Limits National Life Insurance Company One National Life Drive * Montpelier, Vermont 05604 * (802) 229-3333 - -------------------------------------------------------------------------------- 9513(0303) Page 2 No contributions will be accepted under a SIMPLE-IRA plan established by any employer pursuant to section 408(p). Also, no transfer or rollover of funds attributable to contributions made by a particular employer under its SIMPLE-IRA plan will be accepted from a SIMPLE-IRA, that is, an IRA used in conjunction with a SIMPLE-IRA plan, prior to the expiration of the 2-year period beginning on the date the individual first participated in that employer's SIMPLE-IRA plan. 6. Re-characterization A regular contribution to a non-Roth IRA may be re-characterized pursuant to the rules in section 1.408A-S of the regulations as a regular contribution to this IRA, subject: to the limits in item (3), above. 7. Modified AGI For purposes of items (3) and (4), above, an individual's modified AGI for a taxable year is defined in section 408A(c)(3)(C)(i) and does not include any amount included in adjusted gross income as a result of a rollover from a non-Roth IRA (a "conversion" ). 8. Compensation For purposes of item (I), above, compensation is defined as wages, salaries, professional fees, or other amounts derived from or received for personal services actually rendered (including, bur not limited to, commissions paid salesmen, compensation for services on the basis of a percentage of profits, commissions on insurance premiums, tips, and bonuses) and includes earned income, as defined in section 401(c)(2) (reduced by the deduction the self-employed individual takes for contributions made to a self-employed retirement plan). For purposes of this definition, section 401(c)(2) shall be applied as if the term "trade or business" for purposes of section 1402 include service described in subsection (c)(6). Compensation docs not include amounts derived from or received as earnings or profits from property (including but not limited to interest and dividends) or amounts not includible in gross income. Compensation does not include any amount received as a pension or annuity or as deferred compensation. The term "compensation" shall include any amount includible in the individual's gross income under section 71 with respect to a divorce or separation instrument described in subparagraph (A) of section 71(b)(2). In the case of a married individual filing a joint return, the greater compensation of his or her spouse is treated as his or her own compensation, but only to the extent that such spouse's compensation is not being used for purposes of the spouse making a contribution to a Roth IRA or a deductible contribution to a non-Roth IRA. National Life Insurance Company One National Life Drive * Montpelier, Vermont 05604 * (802) 229-3333 - -------------------------------------------------------------------------------- 9513(0303) Page 3 DISTRIBUTIONS No amount is required to be distributed prior to the earlier of: a) the death of the individual for whose benefit the account was originally established; and b) the maturity of the contract. 1. Notwithstanding any provision of this IRA to the contrary, the distribution of the individual's interest in the.1RA shall be made in accordance with the requirements of Code section 408(b)(3), as modified by section 408A(c){S), and the regulations thereunder, the provisions of which are herein incorporated by reference. If distributions are not made in the form of an annuity on an irrevocable basis (except for acceleration), then distribution of the interest in the IRA (as determined under item (3) of this provision) must satisfy the requirements of Code section 408(a)(6), as modified by section 408A(c)(5), and the regulations thereunder, rather than the distribution rules in items (2), (3), (4) and (5), below. 2. Upon the death of the individual, his or her entire interest will be distributed at least as rapidly as follows: a) If the designated beneficiary is someone other than the individual's surviving spouse, the entire interest will be distributed, starting by the end of the calendar year following the calendar year of the individual's death, over the remaining life expectancy of the designated beneficiary, with such life expectancy determined using the age of the beneficiary as of his or her birthday in the year following the year of the individual's death, or, if elected, in accordance with item (2)(c), below, National Life Insurance Company One National Life Drive * Montpelier, Vermont 05604 * (802) 229-3333 - -------------------------------------------------------------------------------- 9513(0303) Page 4 b) If the individual's sole designated beneficiary is the individual's surviving spouse, the entire interest will be distributed, starting by the end of the calendar year following the calendar year of die individual's death (or by the end of the calendar year in which the individual would have attained age 70 112, of later), over such spouse's life, or, if elected, in accordance with item (2)(c), below. If the surviving spouse dies before required distributions commence to him or her, the remaining interest will be distributed, starting by the end of the calendar year following the calendar year of the spouse's death, over the spouse's designated beneficiary's remaining life expectancy determined using such beneficiary's age as of his or her birthday in the year following the death of the spouse, or, if elected, will be distributed in accordance with item (2)(c), below. If the surviving spouse dies after required distributions commence to him or her, any remaining interest will continue to be distributed under the contract option chosen. c) If there is no designated beneficiary, or if applicable by operation of item (2)(a) or (2)(b), above, the entire interest will be distributed by the end of the calendar year containing the fifth anniversary of the individual's death (or of the spouse's death in the case of the surviving spouse's death before distributions are required to begin under item (2)(b), above). d) Life expectancy is determined using the Single Life Table in Q&A-1 of section 1.401(a)(9)-9 of the Income Tax Regulations. If distributions are being made to a surviving spouse as the sale" designated beneficiary, such spouse's remaining life expectancy for a year is the number in the Single Life Table corresponding to such spouse's age in the year. In all other cases, remaining life "expectancy for a year is the number in the Single Life Table corresponding to the beneficiary's age in the year specified in item (2)(a) or (2)(b) and reduced by 1 for each subsequent year. 3. The "interest" in the IRA includes the amount of any outstanding rollover, transfer and re-characterization under Q&As-7 and -8 of section 1.408-8 of the Income Tax Regulations and the actuarial value of any other benefits provided under the IRA, such as guaranteed death benefits. National Life Insurance Company One National Life Drive * Montpelier, Vermont 05604 * (802) 229-3333 - -------------------------------------------------------------------------------- 9513(0303) Page 5 4. For purposes of paragraph (2)(b), above, required distributions are considered to commence on the date distributions are required to begin to the surviving spouse under such paragraph. However, if distributions start prior to the applicable date in the preceding sentence, on an irrevocable basis (except for acceleration) under an annuity contract meeting the requirements of section 1.401(a)(9)-6T of the Temporary Income Tax Regulations, then required distributions arc considered to commence on the annuity starting date. 5. If the sale designated beneficiary is the individual's surviving spouse, the spouse may elect to treat the IRA as his or her own IRA. This election will be deemed to have been made if such surviving spouse makes a contribution to the IRA or fails to take required distributions as a beneficiary. NONFORFEITABILITY The interest of the Owner is nonforfeitable. TRANSFERABILITY RESTRICTIONS This contract is not transferable by the Owner to anyone except to us. The Limit on Transfer provision of the contract applies. LIMIT ON WITHDRAWALS We will not pay a Withdrawal Benefit if the Owner is under S9 1/2 and not disabled unless the intended use of the funds is set forth in the withdrawal request. REINSTATEMENT If the premium payments are interrupted, the contract will be reinstated at any date prior to maturity upon payment of a premium to the insurance company, and the minimum premium amount for reinstatement shall be $50, however, the insurance company may at its option either accept additional future payments or terminate the contract by payment in cash of the then present value of the paid up benefit if no premiums have been received for two full consecutive policy years and the paid up annuity benefit at maturity would be less than $20 per month. National Life Insurance Company One National Life Drive * Montpelier, Vermont 05604 * (802) 229-3333 - -------------------------------------------------------------------------------- 9513(0303) Page 6 GENERAL TERMS References to IRC sections and to Income Tax Regulations are intended also to reference those items as amended and supplemented. We may amend the terms of this contract without the prior consent of the Owner if such amendment: a) applies to all contracts with this endorsement; and b) is in response to changes to federal law. Any refund of premiums (other than those attributable to excess contributions) will be applied, before the close of the calendar year following the year of the refund, toward the payment of future premiums or the purchase of additional benefits. We will send annual calendar year reports to the Owner concerning the Status of this contract and such information concerning required minimum distributions as is prescribed by the Commissioner of Internal Revenue. Signed for National Life Insurance Company at its Home Office in Montpelier, Vermont, by /s/ Thomas H. MacLeay - --------------------- Chairman of the Board and Chief Executive Officer National Life Insurance Company One National Life Drive * Montpelier, Vermont 05604 * (802) 229-3333 - -------------------------------------------------------------------------------- 9513(0303) Page 7 EX-99.I 5 exh4i.txt SIMPLE IRA ENDORSEMENT INDEX SECTION PAGE - -------------------------------------------------------------------------------- SIMPLE INDIVIDUAL RETIREMENT ANNUITY (SIMPLE-IRA) ENDORSEMENT Contributions 1 Distributions to the Owner 2 Distributions After the Owner's Death 2 Nonforfeitability 4 Transferability Limitations 4 Rollover or Transfer of Funds 5 General Terms 5 7459(0303) - I- SIMPLE INDIVIDUAL RETIREMENT ANNUITY - -------------------------------------------------------------------------------- (SIMPLE-IRA) ENDORSEMENT Effective as of the later of the Date of Issue of the contract or January 1, 2002, the contract is amended and modified as follows. In the event of a conflict between this endorsement and the underlying contract to which it is attached, the provisions of this endorsement will prevail. The contract is established for the exclusive benefit of the Owner or the Owner's beneficiaries. While this endorsement is in effect during the lifetime of the Annuitant, the Annuitant must be the Owner of the contract. CONTRIBUTIONS This SIMPLE-IRA will accept only: 1. a cash contribution made by an employer on behalf of the individual under a SIMPLE-IRA plan that meets the requirements of section 408(p) of the Internal Revenue Code; and 2. a rollover contribution or a transfer of assets from another SIMPLE-IRA of the individual. No other contributions will be accepted. National Life Insurance Company One National Life Drive o Montpelier, Vermont 05604 o (802) 229-3333 - -------------------------------------------------------------------------------- 7459(0303) Page 1 DISTRIBUTIONS TO THE OWNER a) Notwithstanding any provision of this IRA to the contrary, the distribution of the individual's interest in the IRA shall be made in accordance with the requirements of IRC section 408(b)(3) and the regulations thereunder, the provisions of which are herein incorporated by reference. If distributions are not made in the form of an annuity on an irrevocable basis (except for acceleration), then distribution of the interest in the IRA (as determined under item 3 of the Distributions After the Owner's Death provision of this endorsement) must satisfy the requirements of IRC section 408(a)(6) and the regulations thereunder, rather than paragraphs (b), (c) and (d), below, and the Distributions After the Owner's Death provision. b) The entire interest of the individual for whose benefit the contract is maintained will commence to be distributed no later than the first day of April following the calendar year in which such individual attains age 70 1/2 (the "required beginning date" ) over (a) the life of such individual or the lives of such individual and his or her designated beneficiary, or (b) a period certain not extending beyond the life expectancy of such individual or the joint and last survivor expectancy of such individual and his or her designated beneficiary. Payments must be made in periodic payments at intervals of no longer than one year and must be either non-increasing or they may increase only as provided in Q&As-l and -4 of section 1.408(a)(9)-6T of the Temporary Income Tax Regulations. In addition, any distribution must satisfy the incidental benefit requirements specified in Q&A-2 of section 1.408{a)(9)-6T. c) The distribution periods described in paragraph (b), above, cannot exceed the periods specified in section 1.401(a)(9)-6T of the Temporary Income Tax Regulations. d) The first required payment can be made as late as April 1 of the year following the year the individual attains age 70 1/2 and must be the payment that is required for one payment interval. The second payment need not be made until the end of the next payment interval. DISTRIBUTIONS AFTER THE OWNER'S DEATH 1. Death On or After Required Distributions Commence. If the individual dies on or after required distributions commence, the remaining portion of his or her interest will continue to be distributed under the contract option chosen. National Life Insurance Company One National Life Drive o Montpelier, Vermont 05604 o (802) 229-3333 - -------------------------------------------------------------------------------- 7459(0303) Page 2 2. Death Before Required Distributions Commenced. If the individual dies before required distributions commence, his or her entire interest will be distributed at least as rapidly as follows: a) If the designated beneficiary is someone other than the individual's surviving spouse, the entire interest will be distributed, starting by the end of the ca1endar year following the calendar year of the individual's death., over the remaining life expectancy of the designated beneficiary, with such life: expectancy determined using the age of the beneficiary as of his or her birthday in the year following the year of the individual's death, or, if elected, in accordance with paragraph (2)(c), below. b) If the individual's sole designated beneficiary is the individual's surviving spouse, the entire interest will be distributed, starting by the end of the calendar year following the calendar year of the individual's death (or by the end of the calendar year in which the individual would have attained age 70 1/2, if later), over such spouse's life, or, if elected, in accordance with paragraph (2)(c), below. If the surviving spouse dies before required distributions commence to him or her, any remaining interest will be distributed, starting by the end of the calendar year following the calendar year of the spouse's death, over the spouse's designated beneficiary's remaining life expectancy determined using such beneficiary's age as of his or her birthday in the year following the death of the spouse, or, if elected, will be distributed in accordance with paragraph (2)(c), below. If the surviving spouse dies after required distributions commence to him or her, any remaining interest will continue to be distributed under the contract option chosen. c) If there is no designated beneficiary, or if applicable by operation of paragraph (2) (a) or (2)(b), above, the entire interest will be distributed by the end of the calendar year containing the fifth anniversary of the individual's death (or of the spouse's death in the case of the surviving spouse's death before distributions are required to begin under paragraph (2)(b), above). National Life Insurance Company One National Life Drive o Montpelier, Vermont 05604 o (802) 229-3333 - -------------------------------------------------------------------------------- 7459(0303) Page 3 d) Life expectancy is determined using the Single Life Table in Q&A-l of section 1.401(a)(9)-9 of the Income Tax Regulations. If distributions are being made to a surviving spouse as the sole designated beneficiary, such spouse's remaining life expectancy for a year is the number in the Single Life Table corresponding to such spouse's age in the year. In all other cases, remaining life expectancy for a year is the number in the Single Life Table corresponding to the beneficiary's age in the year specified in paragraph (2)(a) or (2)(b) and reduced by 1 for each subsequent year. 3. The "interest" in the IRA includes the amount of any outstanding rollover, transfer and re-characterization under Q&As-7 and -8 of section 1.408-8 of the Income Tax Regulations and the actuarial value of any other benefits provided under the IRA, such as guaranteed death benefits. 4. For purposes of items (1) and (2) above, required distributions are considered to commence on the individual's required beginning date or, if applicable, on the date distributions are required to the begin to the surviving spouse under paragraph (2)(b), above. However, if distributions start prior to the applicable date in the preceding sentence, on an irrevocable basis (except for acceleration) under an annuity contract meeting the requirements of section 1.401(a)(9)-6T of the Temporary Income Tax Regulations, then required distributions are considered to commence on the annuity starting date. 5. If the sole designated beneficiary is the individual's surviving spouse, the spouse may elect to treat the IRA as his or her own IRA. This election will be deemed to have been made if such surviving spouse makes a contribution to the IRA or fails to take required distributions as a beneficiary. NONFORFEITABILITY The interest of the Owner is nonforfeitable. TRANSFERABILITY LIMITATIONS This contract is not transferable by the Owner to anyone except to us. The contract may not be sold, encumbered, or assigned to anyone except to us. National Life Insurance Company One National Life Drive o Montpelier, Vermont 05604 o (802) 229-3333 - -------------------------------------------------------------------------------- 7459(0303) Page 4 ROLLOVER OR TRANSFER OF FUNDS Prior to the expiration of the 2-year period beginning on the dale the Owner first participated in any SIMPLE-IRA plan maintained by the Owner's employer, any rollover or transfer of funds from this SIMPLE-IRA by the Owner must be made to another SIMPLE-IRA of the Owner. Any distribution of funds to the Owner during this 2-year period may be subject to a 25 percent additional tax if the Owner does not roll over the amount distributed into a SIMPLE-IRA. After the expiration of this 2-year period, the Owner may roll over or transfer funds to any IRA of the Owner that is qualified under IRC section 408(a),{b), or (p), or to another eligible retirement plan described in IRC section 402(c)(8){B). GENERAL TERMS We may amend the terms of this contract without the prior consent of the Owner if such amendment: 1. applies to all contracts with this endorsement; and 2. is in response to changes to federal law. Any refund of premiums (ocher than those attributable to excess contributions) will be applied, before the dose of the calendar year following the year of the refund, toward the payment of future premiums or the purchase of additional benefits. We will send annual calendar year reports to the Owner concerning the Status of this contract and such information concerning required minimum distributions as is prescribed by the Commissioner of Internal Revenue. If contributions made on behalf of the Owner pursuant to a SIMPLE-IRA plan maintained by the Owner's employer are received directly by us from the employer, we will provide the employer with the summary description required by section 408(1)(2)(B) of the IRC. This contract, with this endorsement, may not be used in connection with a SIMPLE plan as to which the Company is a designated financial institution (as defined in IRC section 408(p)(7)) or as to which any trustee or custodian which is listed as Owner is a designated financial institution. Signed for National Life Insurance Company at its Home Office in Montpelier, Vermont, by /s/ Thomas H. MacLeay - --------------------- Chairman of the Board and Chief Executive Officer National Life Insurance Company One National Life Drive o Montpelier, Vermont 05604 o (802) 229-3333 - -------------------------------------------------------------------------------- 7459(0303) Page 5 EX-99.J 6 exh4j.txt IRA ENDORSEMENT INDEX SECTION PAGE - -------------------------------------------------------------------------------- INDIVIDUAL RETIREMENT ANNUITY (IRA) ENDORSEMENT Contributions 1 Distributions to the Owner 2 Distributions After the Owner's Death 2 Nonforfeitabiliry 4 Transferability Restrictions 4 Limitations on Withdrawals 5 General Terms 5 7422(0303) - I - INDIVIDUAL RETIREMENT ANNUITY (IRA) ENDORSEMENT - -------------------------------------------------------------------------------- Effective as of the later of the Date of Issue of the contract or January 1, 2002, the contract is amended and modified as follows. In the event of a conflict between this endorsement and the underlying contract to which it is attached, the provisions of this endorsement will prevail. The contract is established for the exclusive benefit of the Owner or the Owner's beneficiaries. While this endorsement is in effect during the lifetime of the Annuitant, the Annuitant must be the Owner of the contract. CONTRIBUTIONS Except in the case of a rollover contribution (as permitted by Internal Revenue Code, (IRC) section 402(c), 402(e)(6), 403(a)(4), 403(b)(8), 403(b)(10), 408(d)(3) and 457(e)(16)) or a contribution made in accordance with the terms of a Simplified Employee Pension Program (a SEP, as described in section 408{k)), no contributions will be accepted unless they are in cash, and the total of such contributions shall not exceed: o $3,000 for any taxable year beginning in 2002 through 2004; o $4,000 for any taxable year beginning in 2005 through 2007; and o $5,000 for any taxable year beginning in 2008 and years thereafter. After 2008, the limit will be adjusted by the Secretary of the Treasury for cost-of-Iiving increases under Code section 219(b}{5)(C). Such adjustments will be in multiples of $500. In the case of an individual who is 50 or older, the annual cash contribution limit is increased by: o $500 for any taxable year beginning in 2002 through 2005; and o $1,000 for any taxable year beginning in 2006 and years thereafter. No contributions will be accepted under a SIMPLE-IRA plan established by any employer pursuant: to section 408(p). Also, no transfer or rollover of funds attributable to contributions made by a particular employer under its SIMPLE-IRA plan will be accepted from a SIMPLE-IRA, that is, an IRA used in conjunction with a SIMPLE-IRA plan, prior to the expiration of the 2-year period beginning on the date the Owner first participated in that employer's SIMPLE-IRA plan. National Life Insurance Company One National Life Drive * Montpelier, Vermont 05604 * (802) 229-3333 - -------------------------------------------------------------------------------- 7422(0303) Page 1 DISTRIBUTIONS TO THE OWNER a) Notwithstanding any provision of this IRA to the Contrary, the distribution of the individual's interest in the IRA shall be made in accordance with the requirements of IRC section 40B(b)(3) and the regulations thereunder, the provisions of which are herein incorporated by reference. If distributions are not made in the form of an annuity on an irrevocable basis (except for acceleration), then distribution of the interest in the IRA (as determined under item 3 of the Distributions After the Owner's Death provision of this endorsement) must satisfy the requirements of IRC section 4OB(a)(6) and the regulations thereunder, rather than paragraphs (b), (c) and (d), below, and the Distributions After the Owner's Death provision. b) The entire interest of the individual for whose benefit the contract is maintained will commence to be distributed no later than the first day of April following the calendar year in which such individual attains age 70 1/2 (the "required beginning date" ) over (a) the life of such individual or the lives of such individual and his or her designated beneficiary, or (b) a period ctrtlin not extending beyond the life expectancy of such individual or the joint and last survivor expectancy of such individual and his or her designated beneficiary. Payments must be made in periodic payments at intervals of no longer than one year and must be either non-increasing or they may increase only as provided in Q&As-1 and -4 of section 1.40B(a)(9)a6T of the Temporary Income Tax Regulations. In addition, any distribution must satisfy the incidental benefit requirements specified in Q&Aa2 of section 1.408(a)(9)a6T. c) The distribution periods described in paragraph (b), above, cannot exceed the periods specified in section 1.401(a)(9}-6T of the Temporary Income Tax Regulations. d) The first required payment can be made as late as April 1 of the year following the year the individual attains age 70 1/2 and must be the payment that is required for one payment interval. The second payment need not be made until the end of the next payment interval. DISTRIBUTIONS AFTER THE OWNER'S DEATH 1. Death On or After Required Distributions Commence. If the individual dies on or after required distributions commence, the remaining portion of his or her interest will continue to be distributed under the contract option chosen. National Life Insurance Company One National Life Drive * Montpelier, Vermont 05604 * (802) 229-3333 - -------------------------------------------------------------------------------- 7422(0303) Page 2 2. Death Before Required Distributions Commence. If the individual dies before required distributions commence, his or her entire interest will be distributed at least as rapidly as follows: a) If the designated beneficiary is someone other than the individual's surviving spouse, the entire interest will be distributed, starting by the end of the calendar year following the calendar year of the individual's death, over the remaining life expectancy of the designated beneficiary, with such life expectancy determined using the age of the beneficiary as of his or her birthday in the year following the year of the individual's death, or, if elected, in accordance with paragraph (2)(c), below. b) If the individual's sole designated beneficiary is the individual's surviving spouse, the entire interest will be distributed, starting by the end of the calendar year following the calendar year of the individual's death (or by the end of the calendar year in which the individual would have attained age 70 1/2, if later), over such spouse's life, or, if elected, in accordance with paragraph (2)(c), below. If the surviving spouse dies before requited distributions commence to him or her, the remaining interest will be distributed, starring by the end of the calendar year following the calendar year of the spouse's death, over the spouse's designated beneficiary's remaining life expectancy determined using such beneficiary's age as of his or her birthday in the year following the death of the spouse, or, if elected, will be distributed in accordance with paragraph (2)(c), below. If the surviving spouse dies after required distributions commence to him or her, any remaining interest will continue to be distributed under the contract option chosen. c) If there is no designated beneficiary, or if applicable by operation of paragraph (2)(a) or (2)(b), above, the entire interest will be distributed by the end of the calendar year containing the fifth anniversary of the individual's death (or of the spouse's death in the case of the surviving spouse's death before distributions are required to begin under paragraph (2)(b), above). National Life Insurance Company One National Life Drive * Montpelier, Vermont 05604 * (802) 229-3333 - -------------------------------------------------------------------------------- 7422(0303) Page 3 d) Life expectancy is determined using the Single Life Table in Q&A-l of section 1.401(a)(9)-9 of the Income Tax Regulations. If distributions are being made to a surviving spouse as the sole designated beneficiary, such spouse's remaining life expectancy for a year is the number in the Single Life Table corresponding to such spouse's age in the year. In all other cases, remaining life expectancy for a year is the number in the Single Life Table corresponding to the beneficiary's age in the year specified in paragraph (2)(a) or (2)(b) and reduced by t for each subsequent year. 3. The "interest" in the IRA includes the amount of any outstanding rollover. transfer and re-characterization under Q&A5-7 and -8 of section 1.408-8 of the Income Tax Regulations and the actuarial value of any other benefits provided under the IRA, such as guaranteed death benefits. 4. For purposes of items (1) and (2) above, required distributions are considered to commence on the individual's required beginning date or, if applicable, on the dare distributions are required to the begin to the surviving spouse under paragraph (2)(b), above. However, if distributions start prior to the applicable date in the preceding sentence, on an irrevocable basis (except for acceleration) under an annuity contract meeting the requirements of section 1.401(a)(9)-6T of the Temporary Income Tax Regulations, then required distributions are considered to commence on the annuity starting date. 5. If the sale designated beneficiary is the individual's surviving spouse, the spouse may elect to treat the IRA as his or her own IRA. This election will be deemed to have been made if such surviving spouse makes a contribution to the IRA or fails to take required distributions as a beneficiary. NONFORFEITABILITY The interest of the Owner is nonforfeitable. TRANSFERABILITY RESTRICTIONS This contract is not transferable by the Owner to anyone except to us. This contract may not be sold, encumbered, or assigned to anyone except to us. National Life Insurance Company One National Life Drive * Montpelier, Vermont 05604 * (802) 229-3333 - -------------------------------------------------------------------------------- 7422(0303) Page 4 LIMITATIONS ON WITHDRAWALS We will not pay a Withdrawal Benefit if the Owner is under 59 1/2 and not disabled unless the intended use of the funds is set forth in the withdrawal request. GENERAL TERMS References to IRC sections and to Income Tax Regulations are intended also to reference those items as amended and supplemented. We may amend the terms of this contract without the prior consent of the Owner if such amendment: 1. applies to all contracts with this endorsement; and 2. is in response to changes to federal law. Any refund of premiums (other than those attributable to excess contributions) will be applied, before the dose of the calendar year following the year of the refund, toward the payment of future premiums or the purchase of additional benefits. We will send annual calendar year reports to the Owner concerning the status of this contract and such information concerning required minimum distributions' as is prescribed by the Commissioner of Internal Revenue. Signed for National Life Insurance Company at its Home Office in Montpelier, Vermont, by /s/ Thomas H MacLeay - -------------------- Chairman of the Board and Chief Executive Officer National Life Insurance Company One National Life Drive * Montpelier, Vermont 05604 * (802) 229-3333 - -------------------------------------------------------------------------------- 7422(0303) Page 5 EX-99.K 7 exh4k.txt TDA ENDORSEMENT INDEX SECTION PAGE - -------------------------------------------------------------------------------- TAX DEFERRED ANNUITY (IDA) ENDORSEMENT Transferability Restrictions 1 Premium Payments and Other Contributions 1 Nonforfeitability 2 Limitations on Withdrawals from 403(h) Annuities 2 Direct Rollovers 3 Required Distribution While the Owner is Alive 4 Distribution Upon Death of the Owner 4 Loan Restrictions 7 General Terms 7 7421(0103) - I - TAX DEFERRED ANNUITY (TDA) ENDORSEMENT ----------------------------------------------------------------------- Effective as of the later of the Date of Issue of this contract or January 1, 2002, this contract is amended and modified to maintain it as qualified under the roles found in Internal Revenue Code (IRC) section 403(b) and the Regulations pertaining to that section, as set forth below. While this endorsement is in effect, the Owner must he: 1. the Annuitant; 2. the Payee; and 3. one of the chosen human beings in any Payment Option elected by the Owner which has a life contingency. TRANSFERABILITY RESTRICTIONS This contract is not transferable to anyone except to us. This contract may not be sold, encumbered, or assigned to anyone except to us. PREMIUM PAYMENTS AND OTHER CONTRIBUTIONS Except for transfers and rollover contributions described below, premium payments may only be made by the Owner's employer pursuant to a salary reduction agreement between the Owner and his or her employer, which is a public school system or an organization described in IRC section 501(e)(3), including, but not limited to a: 1. private or parochial school; 2. church, as well as conventions or associations of churches; 3. hospital; 4. home health service agency; or 5. health and welfare service agency. Rollover contributions in the form of an eligible rollover distribution from an eligible retirement plan, as described in IRC section 402(c), may be made to the contract by the Owner. Contributions can also be made by transfers of monies from other IRC section 403(b) plans whose distribution restrictions are the same or less stringent than those of this contract. However, only amounts which would have been includible in the Owner's gross income if received by the Owner and not rolled over may be rolled or transferred into this contract by the Owner. In no event may total contributions exceed the limits of IRC sections 415 or 402(g), as modified by section 414(v). National Life Insurance Company One National Life Drive * Montpelier, Vermont 05604 * (802) 229-3333 - -------------------------------------------------------------------------------- 7421(0103) Page 1 For purposes of the incidental death benefit limits, all contracts, policies, and other investment vehicles that contain IRC section 403(b) contributions maintained by the Owner are combined in applying the limits. NONFORFEITABILITY The interest of the Owner is nonforfeitable. LIMITATIONS ON WITHDRAWALS FROM 403(B) ANNUITIES Withdrawals that are in violation of the "premature" distribution rules of IRC section 403(b)(11) may not be made. Withdrawals of the Cash Value attributable to premium payments made after December 31, 1988 through a salary reduction agreement may be made only when the Owner: 1. attains age 59 1/2; 2. has a severance from employment; 3. becomes disabled as defined in IRC Section n(m)(7); 4. dies; or 5. has a hardship, as defined in the Internal Revenue Code and Regulations issued thereunder. In the case of hardship, withdrawals may not exceed an amount equal to the total of all premium payments made through a salary reduction agreement after December 31, 1988 and not previously withdrawn. An Owner who receives a distribution after December 31, 2001 on account of hardship shall be prohibited from making any elective deferral contributions to this contract for 6 months after receipt of the hardship withdrawal. National Life Insurance Company One National Life Drive * Montpelier, Vermont 05604 * (802) 229-3333 - -------------------------------------------------------------------------------- 7421(0103) Page 2 DIRECT ROLLOVERS A direct rollover is a payment by the Company to an Eligible Retirement Plan. A Distributee may elect, at the time and in the manner prescribed by the Company, to have any portion of an Eligible Rollover Distribution paid directly to an Eligible Retirement Plan in a direct rollover. An Eligible Rollover Distribution is any distribution of all or any portion of the balance to the credit of the Distributee, except: 1. any distribution that is one of a series of substantially equal periodic payments (not less frequently than annually) made for: a) the life of the Distributee or the joint lives of the Distributee and the Distributee's designated beneficiary; b) the life expectancy of the Distributee or the joint life and last survivor expectancy of the Distributee and the Distributee's designated beneficiary; or c) a specified period of ten (10) years or more; 2. any distribution to the extent such distribution is required under Section 401(a)(9) of the Internal Revenue Code; 3. any hardship distribution described in IRC section 401(k){2)(B)(i)(IV) made after 1998; or 4. any other amounts designated in published federal income tax guidance. An Eligible Retirement Plan is a retirement plan described in IRC section 401(a), an individual retirement arrangement described in IRC section 408(a) or 408(b), an arrangement described in IRC section 403(b), or an eligible plan under IRC section 457(b) which is maintained by a state, political subdivision of a state, or any agency or instrumentality of a state or political subdivision of a state and which agrees to separately account for rollover contributions. However, if the Eligible Rollover Distribution consists of any portion that is not includible in gross income (determined without regard to the exclusion for net unrealized appreciation with respect to employer securities), then an Eligible Retirement Plan is only an individual retirement arrangement described in IRC section 408(a) or 408(b), or another 403(b) arrangement which provides separate accounting for amounts rolled over, including separate accounting for after-tax contributions and earnings on those contributions. A Distributee includes the Owner. In addition, the Owner's surviving spouse and the Owner's spouse or former spouse who is the alternative payee under a qualified domestic relations order, as defined in Section 414(p) of the Internal Revenue Code, are Distributees with regard to the interest of the spouse or former spouse. National Life Insurance Company One National Life Drive * Montpelier, Vermont 05604 * (802) 229-3333 - -------------------------------------------------------------------------------- 7421(0103) Page 3 REQUIRED DISTRIBUTION WHILE THE OWNER IS ALIVE The Owner's entire interest in this contract attributable to amounts that accrued alter December 31, 1986 must either be distributed or begin distribution no later than the Required Beginning Date. The Required Beginning Date is the April 1st of the next calendar year following the later of the calendar years in which the Owner retires from employment with the employer maintaining the 403(b) arrangement or reaches age 70 1/2. All distributions of benefits under this contract shall be governed by IRC sections 401(a)(9), 403(b)(10), and all supporting Regulations, which include the incidental death benefit rules of IRC section 401(a)(9)(G). The amount to be distributed each year, beginning with the later of the calendar yean in which the Owner retires from employment with the employer maintaining the 403(b) arrangement or reaches age 70 112 and continuing through the year of death, shall not be less than the quotient obtained by dividing the value of the contract as of the end of the preceding year by the distribution period in the Uniform Lifetime Table in Q&A-l of section 1.401(a)(9)-9 of the Income Tax Regulations, using the Owner's age as of his or her birthday in the year. However, if the Owner's sole designated beneficiary is his or her surviving spouse and such spouse is more than 10 yean younger than the Owner, then the distribution period is determined under the Joint and Last Survivor Table in Q&Aa3 of section 1.401(30)(9)-9, using the ages as of the Owner's and spouse's birthdays in the year. DISTRIBUTION UPON DEATH OF THE OWNER 1. Death Before Required Beginning Date. If the Owner dies before the Required Beginning Date, his or her entire interest will be distributed at least as rapidly as follows: a) If the designated beneficiary is someone other than the Owner's surviving spouse, the entire interest will be distributed, starting by the end of the calendar year following the calendar year of the Owner's death, over the remaining life expectancy of the designated beneficiary, with such life-expectancy determined using the age of the beneficiary as of his or her birthday in the year following the year of the Owner's death, or, if elected, in accordance with item (1)(c), below. National Life Insurance Company One National Life Drive * Montpelier, Vermont 05604 * (802) 229-3333 - -------------------------------------------------------------------------------- 7421(0103) Page 4 b) If the Owner's sole designated beneficiary is the Owner's surviving spouse, the entire interest will be distributed, starting by the end of the calendar year following the calendar year of the Owner's death (or by the end of the calendar year in which the Owner would have attained age 70 112, if later), over such spouse's life, or, if elected, in accordance with item (1)(c), below. If the surviving spouse dies before distributions are required to begin. the remaining interest will be distributed, starting by the end of the calendar year following the calendar year of the spouse's death., over the spouse's designated beneficiary's remaining life expectancy determined using such beneficiary's age as of his or her birthday in the year following the death of the spouse, or, if elected, will be distributed in. accordance with item (t)(c), below. If the surviving spouse dies after distributions are required to begin. any remaining interest will be distributed over the spouse's remaining life expectancy determined using the spouse's age as of his or her birthday in the year of the spouse's death. c) If there is no designated beneficiary, or if applicable by operation of item (t)(a) or (t)(b), above, the entire interest will be distributed by the end of the calendar year containing the fifth anniversary of the Owner's death (or of the spouse's death in the case of the surviving spouse's death before distributions are required to begin under item (l)(b), above). National Life Insurance Company One National Life Drive * Montpelier, Vermont 05604 * (802) 229-3333 - -------------------------------------------------------------------------------- 7421(0103) Page 5 d) The amount to be distributed each year under item (1)(a) or (b) is the quotient obtained by dividing the value of the contract as of the end of the preceding year by the remaining life expectancy specified in such paragraph. Life expectancy is determined using the Single Life Table in Q&A-l of section 1.401(a)(9)-9 of the Income Tax Regulations. If distributions are being made to a surviving spouse as the sole designated beneficiary, such spouse's remaining life expectancy for a year is the number in the Single Life Table corresponding to such spouse's age in the year. In all other cases, remaining life expectancy for a year is the number in the Single Life Table corresponding to the beneficiary's age in the year specified in item (1)(a) or (b) and reduced by 1 for each subsequent year. 2. Death On or After Requited Beginning Date. If the Owner dies on or after the required beginning date, the remaining portion of his or her interest will be distributed at least as rapidly as follows. These provisions describe the minimum amount which must be distributed in any year and do not limit the ability to take more if the contract provisions permit or require a larger distribution in that year. a) If the designated beneficiary is someone other than the Owner's surviving spouse, the remaining interest will be distributed over the remaining life expectancy of the designated beneficiary, with such life expectancy determined using the beneficiary's age as of his or her birthday in the year following the year of the Owner's death, or over the period described in item (2)(c), below, if longer. b) If the Owner's sole designated beneficiary is the Owner's surviving spouse, the remaining interest will be distributed over such spouse's life or over the period described in item (2)(c), below, if longer. Any interest remaining after such spouse's death will be distributed over such spouse's remaining life expectancy determined using the spouse's age as of his or her birthday in the year of the spouse's death, or, if the distributions are being made over the period described in item (2){c), below, over such period. c) If there is no designed beneficiary, or if applicable by operation of item (1)(a) or (2)(b), above, the remaining interest will be distributed over the Owner's remaining life expectancy determined in the year of the Owner's death. National Life Insurance Company One National Life Drive * Montpelier, Vermont 05604 * (802) 229-3333 - -------------------------------------------------------------------------------- 7421(0103) Page 6 d) The amount to be distributed each year under item (2)(a), (b), or (c), beginning with the calendar year following the calendar year of the Owner's death, is the quotient obtained by dividing the value of the contract as of the end of the preceding year by the remaining life expectancy specified in such paragraph. Life expectancy is determined using the Single Life Table in Q&A-l of section 1.401(a)(9)-9 of the Income Tax Regulations. If distributions are being made to a surviving spouse as the sole designated beneficiary, such spouse's remaining life expectancy for a year is the number in the Single Life Table corresponding to such spouse's age in the year. In all other cases, remaining life expectancy for a year is the number in the Single Life Table corresponding to the beneficiary's or Owner's age in the year specified in item (2)(a), (b), or (c} and reduced by 1 for each subsequent year. 3. The "value" of the contract referenced in items (1)(d) and (2)(d), above, includes the amount of any outstanding rollover and transfer under Q&As-7 and ~8 of section 1.408a8 of the Income Tax Regulations. LOAN RESTRICTIONS Contract loans (under IRC section 72(p). if otherwise available, may not be made while this endorsement is in effect. GENERAL TERMS References to me sections and to Income Tax Regulations arc: intended also to reference: those items as amended and supplemented. We may amend any term of this contract without the prior consent of the Owner if such amendment: 1. applies to all contracts with this endorsement; and 2. is in response to changes to federal law. The Owner is fully responsible for compliance with the terms of this endorsement. In the event that any provision of this endorsement is in conflict with a provision of the contract, the terms of this endorsement will control. National Life Insurance Company One National Life Drive * Montpelier, Vermont 05604 * (802) 229-3333 - -------------------------------------------------------------------------------- 7421(0103) Page 7 Signed for National Life Insurance Company at its Home Office in Montpelier, Vermont, by /s/ Patrick E. Welch - ---------------------- Chairman, President & CEO National Life Insurance Company One National Life Drive * Montpelier, Vermont 05604 * (802) 229-3333 - -------------------------------------------------------------------------------- 7421(0103) Page 8 EX-99.L 8 exh4l.txt ENDORSEMENT TO THE PAYMENT OPTIONS INDEX SECTION PAGE - -------------------------------------------------------------------------------- ENDORSEMENT TO THE PAYMENT OPTIONS Postponement of Payments 1 Values 1 Payment Options 1 Payments for a Stated Time Option 1 Payments for Life Option 2 Stretch Annuity 1RA/403(b) Payment Option 4 9617(0803) - 1- ENDORSEMENT TO THE PAYMENT OPTIONS - -------------------------------------------------------------------------------- Effective as of the contract Date of Issue, the contract is amended and modified as set forth below. POSTPONEMENT OF PAYMENTS The following text is deleted from the Postponement of Payments provision of the contract: "If any payment under this contract is deferred for more than 30 days, we will add to the payment interest of at least 4 % per year from the date we receive the request to the date of payment." In its place, the following text is added to the Postponement of Payments provision of the contract: "If any 'payment under this contract is deferred for more than 30 days, we will add to the payment interest of at least 2.50% per year from the date we receive the request to the date of payment." VALUES Notwithstanding any declaration to the contrary within the contract, the tabled values in Payment Options are based on the 2000 Table for Individual Annuitant Mortality (IAM) and compound interest at a rate of 1.50% per year. PAYMENT OPTIONS The Option 1, 2 and 3 Provisions and the Options 2 and 3 Table appearing in the contract are re moved and replaced with the following: PAYMENTS FOR A STATED TIME OPTION Equal monthly payments shall be made for a stated number of years. The first payment shall be made on t he Option Effective Date. The amount of each monthly payment is shown in the table. The monthly payments are based on an interest rate of 1.50% per year. We may pay more interest in any year. National Life Insurance Company One National Life Drive * Montpelier, Vermont 05604 * (802) 229-3333 9617(0803) Page 1 Payments for a Stated Time Option Monthly Payments for Each $1,000 of Proceeds Stated Number of Years Monthly Payments 5 17.28 6 14.51 7 12.53 8 11.04 9 9.89 10 8.96 11 8.21 12 7.58 13 7.05 14 6.59 15 6.20 16 5.85 17 5.55 18 5.27 19 5.03 20 4.81 21 4.62 22 4.44 23 4.28 24 4.13 25 3.99 26 3.86 27 3.75 28 3.64 29 3.54 30 3.44 PAYMENTS FOR LIFE OPTION Equal monthly payments shall be made for any guaranteed period chosen and thereafter during the life of a chosen human being. The first payment shall be made on the Option Effective Date. The amount of each monthly payment depends on the age and sex of the chosen human being on the Option Effective Date and on any guaranteed period chosen. We may require proof to our satisfaction of such age. We may require like proof that such human being is alive on the date any payment is due. The guaranteed period may be five or ten years or a Refund period. A Refund period extends until the sum of the payments is equal to the proceeds placed under the option. The monthly payments are based on an interest rate of 1.50% per year. We may pay mote interest in any year during the guaranteed period. Upon request we will quote the amount of monthly payments for lower ages and guaranteed periods not shown in the table of Payments for Life. National Life Insurance Company One National Life Drive * Montpelier, Vermont 05604 * (802) 229-3333 9617(0803) Page 2 Payments for Life Option Monthly Payments for Each $1,000 of Proceeds (Amounts shown are for the age nearest birthday on the Option Effective Date) Guaranteed Period Male Female -------------------------- --------------------------- Age None 10 Years Refund None 10 Years Refund - ----------------------------------- --------------------------- 50 $3.24 $3.22 $3.02 $3.00 $2.99 $2.86 51 3.31 3.29 3.08 3.06 3.05 2.91 52 3.39 3.36 3.13 3.13 3.11 2.96 53 3.47 3.44 3.19 3.19 3.18 3.02 54 3.55 3.51 3.25 3.26 3.25 3.07 55 3.63 3.60 3.31 3.34 3.32 3.13 56 3.73 3.68 3.38 3.41 3.39 3.19 57 3.82 3.77 3.45 3.50 3.47 3.26 58 3.92 3.87 3.52 3.58 3.56 3.32 59 4.03 3.97 3.60 3.68 3.64 3.39 60 4.15 4.07 3.67 3.78 3.74 3.46 61 4.27 4.19 3.76 3.88 3.83 3.54 62 4.40 4.30 3.84 3.99 3.94 3.62 63 4.54 4.42 3.93 4.11 4.05 3.70 64 4.69 4.55 4.02 4.23 4.16 3.79 65 4.85 4.69 4.12 4.37 4.28 3.88 66 5.02 4.83 4.23 4.51 4.41 3.98 67 5.20 4.98 4.33 4.66 4.55 4.08 68 5.39 5.13 4.45 4.83 4.69 4.19 69 5.60 5.29 4.57 5.00 4.84 4.30 70 5.82 5.45 4.70 5.19 5.00 4.43 71 6.05 5.62 4.82 5.39 5.17 4.55 72 6.30 5.79 4.96 5.61 5.34 4.68 73 6.57 5.96 5.11 5.85 5.52 4.82 74 6.85 6.14 5.25 6.11 5.71 4.98 75 7.15 6.32 5.41 6.39 5.91 5.13 76 7.47 6.51 5.59 6.69 6.11 5.30 77 7.82 6.69 5.75 7.01 6.31 5.47 78 8.19 6.87 5.93 7.36 6.52 5.66 79 8.59 7.05 6.14 7.74 6.73 5.85 80 9.01 7.22 6.34 8.16 6.93 6.04 81 9.47 7.39 6.55 8.60 7.13 6.29 82 9.95 7.56 6.77 9.09 7.33 6.50 83 10.47 7.71 7.00 9.61 7.52 6.76 84 11.02 7.86 7.25 10.18 7.69 7.00 85 11.61 8.00 7.52 10.79 7.86 7.26 + Higher ages the same National Life Insurance Company One National Life Drive * Montpelier, Vermont 05604 * (802) 229-3333 9617(0803) Page 3 STRETCH ANNUIIT IRA/403(B) PAYMENT OPTION The following Stretch Annuity IRA/403(b) Payment Option is added to the Payment Options section of the contract: "Annual payments will be made for the number of full years determined as the joint life expectancy of a chosen human being and a beneficiary assumed to be at least 10 years younger than the chosen human being. The life expectancy will be calculated based on the Uniform Lifetime Table or Table VI (whichever is applicable) of Section 1.401(a)(9)-9 of the Income Tax Regulations. The first payment made under this option will be made on the Option Effective Date. Subsequent payments will be made at 12-month intervals from the Option Effective Date. The amount of the first payment will be the proceeds placed under this option divided by the applicable divisor. In each successive year, the payment will equal the balance of the proceeds on the December 31"immediately preceding the date of payment divided by the then applicable divisor. The applicable divisor in any year will equal the larger of: 1. the calculated life expectancy; or 2. the minimum permitted under the rules of sections 401(a)(9), 403(b)(10), 408(a)(6), or 408(b)(3) of the federal Internal Revenue Code of 1986 and the regulations thereunder, if and as applicable to this arrangement. Interest will be credited to the balance of the proceeds at our current settlement rate in effect in each year, but at not less than 1.50% per year. At the death of the contract holder, the Beneficiary's actual life expectancy will be used to calculate minimum distribution payments, reduced by one for each subsequent year." Signed for National Life Insurance Company at its Home Office in Montpelier, Vermont, by /s/ Thomas H. MacLeay - --------------------- Chairman of the Board and Chief Executive Officer National Life Insurance Company One National Life Drive * Montpelier, Vermont 05604 * (802) 229-3333 9617(0803) Page 4 EX-99.M 9 exh4m.txt LOAN ENDORSEMENT LOAN ENDORSEMENT LOANS You may borrow against this contract prior to the Maturity Date and during the lifetime of the Owner. This contract will be the collateral for the loan. We require that a written loan agreement be executed. We may defer payment of any loan which is allocated to the Fixed Account for a period of up to six months from the date of request for the loan. LOAN AMOUNT The maximum amount that you may borrow on this contract equals the Cash Surrender Value less loan interest payable at the next Contract Anniversary. The amount borrowed will be added to the sum of all prior loans outstanding. The total will become the new loan balance. In no event may the aggregate amount borrowed from all of your tax-sheltered annuities, exceed the lesser of: 1. $10,000 or one half of the combined Cash Surrender Value of all your tax-sheltered annuities, whichever is greater; or 2. $50,000, reduced by the excess (if any) of your highest outstanding loan balance during the preceding 12 month period over your outstanding loan balance on the date the loan is made. A loan may not be made for less than$1,500. LOAN INTEREST The loan interest rate is adjustable. Loan interest is payable in arrears. If interest is not paid when due, it will be treated as a loan and added to the loan balance and will bear interest at the same rate. Loan balance means the total outstanding loan with interest. ADJUSTABLE LOAN INTEREST RATE The loan interest rate is adjustable on the Contract Anniversary date. You will be notified of the loan interest rate: o when a loan is requested; and o in advance if a loan exists and the interest rate is changed. The loan interest rate is based on a Published Monthly Average. That average is: o The Moody's Corporate Bond Yield Average-Monthly Average Corporates as published by Moody's Investors Service, Inc., or any successor thereto; or o If that average is no longer published, a substantially similar average, established by regulation of the Commissioner of Insurance. The maximum loan interest is the greater of: o The Published Monthly Average for the calendar month ending two months before the date the rate is determined; or o 4%. We must reduce the loan interest rate if the maximum loan interest rate is lower than the loan interest rate for the previous Contract Year by 1/2% or more. We may increase the loan interest rate if the maximum loan interest rate is at least 1/2% higher than the loan interest rate for the previous Contract Year. No increase may be made if the loan interest rate would exceed the maximum loan interest rate. The loan interest rate being charged will be equal to or less than the maximum loan interest rate, but will never exceed fifteen percent per annum. INTEREST CREDITED TO LOANS On the day a loan is made, a portion of the Contract Value equal to the loan amount will be placed in the Fixed Account as collateral for the loan. Loan amounts will be segregated from other unimpaired amounts in the Fixed Account and will earn interest at a rate not less than the Minimum Fixed Account Interest Rate shown in the Data Section. LOAN REPAYMENT You must repay each loan within five years from the date it is made. You may repay a loan in full anytime prior to the expiration of the five-year repayment term. Each payment must be at least S 25.00. The five-year repayment requirement does not apply to any loan used to acquire any dwelling unit that will be used as your principal residence. Repayment of principal and interest must be made in substantially equal installments, no less frequently than quarterly. If loan repayments are not made when scheduled, the loan will be treated as a distribution, if allowed by law, or a deemed distribution if a qualifying event bas not occurred. - --------------------------------------- 1 -------------------------------------- NATIONAL LIFE INSURANCE COMPANY ONE NATIONAL LIFE DRIVE o MONTPELIER, VERMONT 05604 o TEL: 802 229-3333 ALLOCATION OF LOANS AND LOAN REPAYMENTS On the day a loan is made, a portion of the Contract Value equal to the loan amount will be transferred from the Sub-Accounts of the Variable Account and the unimpaired portion of the Fixed Account and placed in the Fixed Account as collateral for the loan. Amounts transferred from the Sub-Accounts of the Variable Account and the unimpaired portion of the Fixed Account will be made in the same proportion as such amounts bear to the total Contract Value. Loan repayments will be allocated to the Sub-Accounts of the Variable Account and the unimpaired portion of the Fixed Account according to the premium allocation percentages in effect at the time of the payment. CONTRACT TERMINATION FOR INDEBTEDNESS If the loan balance ever exceeds the Cash Surrender Value, the contract will terminate thirty-one days afterwards or as soon thereafter as permitted by law. We will send a notice of termination to your last known address. COORDINATION OF LOANS WITH OTHER CONTRACT FEATURES If the Owner dies before the Maturity Date, any amount owed to us will be deducted from the Death Benefit or the Enhanced Death Benefit, if applicable. The Cash Surrender Value of this contract will be reduced by any amount owed to us when determining the amount payable under a Withdrawal or Cash Surrender. If any amount is owed to us when a Payment Option is elected, such amount will be treated as a distribution. Any amount owed to us will be deducted from the Contract Value in determining the amount of any Rider Charges, the amount of the Waiver of Contingent Deferred Sales Charges for withdrawals, the maximum Withdrawal Benefit allowed, and whether the Annual Contract Fee applies. Loans may not be taken if a schedule of Systematic Withdrawals has been elected on this contract. A schedule of Systematic Withdrawals may not be elected on this contract if there is also a policy loan. EFFECTIVE DATE The effective date of this endorsement is the same as that of the contract to which it is attached unless a later date is shown below. TERMINATION This endorsement will terminate on the date that the contract terminates. Effective date of this Endorsement, if other than the effective date of the Contract: Signed for National Life Insurance Company at Montpelier, Vermont, as of the effective date of this endorsement, by /s/ Patrick E Welch - ---------------------------- Chairman of the Board and Chief Executive Officer - --------------------------------------- 2 -------------------------------------- NATIONAL LIFE INSURANCE COMPANY ONE NATIONAL LIFE DRIVE o MONTPELIER, VERMONT 05604 o TEL: 802 229-3333 EX-99.N 10 exh4n.txt ENDORSEMENT TO THE LIMIT ON TRANSFERS PROVISION ENDORSEMENT TO THE LIMIT ON TRANSFER PROVISION Effective as of the later of the contract Date of Issue and any Effective Date noted below, the contract to which this endorsement is attached is amended as follows. LIMIT ON TRANSFER The Limit on Transfer provision is replaced in its entirety with the following text: "If we receive at our Home Office written request by the Owner for this Limit on Transfer provision, the Owner may not: 1. sell or assign the contract, except to us; or 2. use the contract as collateral for a loan; or 3. pledge the contract as security. This provision shall not apply if the Owner is a trustee of a trust that is described in Section 401(a) and is exempt from tax under Section 501(a) of the Internal Revenue Code." Signed for National Life Insurance Company at its Home Office in Montpelier, Vermont, by /s/ Thomas A Martin Chairman of the Board and Chief Executive Officer Effective Date of this Endorsement, if different than the contract Date of Issue: NATIONAL LIFE INSURANCE COMPANY ONE NATIONAL LIFE DRIVE o MONTPELIER, VERMONT 05604 o TEL: (802) 229-3333 - -------------------------------------------------------------------------------- 9583(0503) Page 1 EX-99.E.5 11 exh5.txt VARIABLE ANNUITY APPLICATION SENTINEL ADVANTAGE VARIABLE ANNUITY APPLICATION - -------------------------------------------------------------------------------- Agency/Branch # Pension Code Contract No. - -------------------------------------------------------------------------------- PART A.1 - OWNER INFORMATION PART A.2 -D JOINT OWNER INFORMATION - -------------------------------------------------------------------------------- a. Full Name a. Full Name b. Soc. Sec. #/TIN f. Full Address b. Soc. Sec. #/TIN f. Full Address c. D.O.B./Trust Date c. D.O.B./Trust Date d. Sex [] M [] F d. Sex [] M [] F e. Daytime Phone (with area code) g. E-mail Addresse e. Daytime Phone (with area code) g. E-mail Address - -------------------------------------------------------------------------------- PART B - ANNUITANT INFORMATION (Complete if different from Owner.) - -------------------------------------------------------------------------------- 1. Full Name 6. Full Address 2. D.O.B. 3. Soc. Sec. # 4. Sex [] M [] F 5. Daytime Phone (with area code) - -------------------------------------------------------------------------------- PART C - BENEFICIARY(IES) (If 401(a) plan, do not complete. The Beneficiary will be the Owner.) - -------------------------------------------------------------------------------- Primary Secondary D.O.B. Soc. Sec. # Relationship to Owner/Annuitant D.O.B. Soc. Sec. # Relationship to Owner/Annuitant [] As per supplemental request Payment will be shared equally by all Primary Beneficiaries who survive the Owner. If none, by all Secondary Beneficiaries who so survive; if none, payment will be made to the Owner's estate. - -------------------------------------------------------------------------------- PART D - TYPE OF PLAN - -------------------------------------------------------------------------------- 1. Non-Qualified 2. Qualified [] Individually Owned [] Pension or Profit-Sharing Plan *401(a) or *403(a) [] Jointly Owned [] Tax-Deferred Annuity *403(b) [] 1035 Exchange [] Individual IRA [] SEP IRA [] SIMPLE IRA* [] Roth IRA* *Original Participation Year [] Other (Describe) [] Regular Contribution: Year $ [] Transfer [] Rollover - -------------------------------------------------------------------------------- PART E - REMINDER NOTICE - -------------------------------------------------------------------------------- 1. Send a periodic reminder to fund this contract? [] Yes [] No 5. [] I authorize the Company to draft monthly payments from my 2. Amount $ account. (Attach a void check/deposit slip) 3. Frequency [] Annual [] Monthly (Group) [] Checking Draft on the []1st []15th [] Semi-Annual [] EFTJCOM (Complele#5) [] Savings [] 8th [] 22nd [] Quarterly [] Money Market 4. Notice to [] Annuitant [] Other (Street, City, State & Zip) [] Owner Part - -------------------------------------------------------------------------------- PART F - REPLACEMENT (If 'Yes', Replacement forms must be provided according to state requirements; list company name and policy numbers.) - -------------------------------------------------------------------------------- 1. Has there been or will there be a lapse, surrender, replacement, reissue, conversion, or change to reduce amount, premium or period of coverage of any existing life, disability, or annuity contract if the applied for contract or rider is issued? [] Yes [] No 2. Will there be any substantial borrowing on any life insurance policy if the applied for contract or rider is issued? [] Yes [] No Company Name(s) and Policy Number(s): - -------------------------------------------------------------------------------- PART G - EXISTING POLICY OR CONTRACT INFORMATION (The following question must be answered whether or not any policies or contracts are being replaced.) - -------------------------------------------------------------------------------- Does the Applicant have existing policies or contracts with any financial institution? [] Yes [] No (If 'Yes', list financial institution name(s) and policy or contract number(s) below.) - -------------------------------------------------------------------------------- PART H - RIDERS [] Enhanced Death Benefit Rider [] Other [] Other - -------------------------------------------------------------------------------- National Life Variable Contracts Distributed By Equity Services, Inc. o Broker-Dealer affiliate of National Life Insurance Company One National Life Drive o Montpelier, Vermont 05604 Tel: (802) 229-3900 Page 1 SENTINEL ADVANTAGE VARIABLE ANNUITY APPLICATION - Continued - -------------------------------------------------------------------------------- PART I - INVESTMENT INFORMATION - (You may elect Portfolio Rebalancing or Dollar Cost Averaging. but not both. See Investment Allocation form 9293.) (Do NOT complete Part I if p1lfljcipating in Illuminations.) - -------------------------------------------------------------------------------- 1. Portfolio Rebalancing 2. Dollar Cost Averaging a. Does the Owner request Portfolio Rebalancing, through which the Does the Owner request Dollar Cost Averaging 10 reallocate Contract Values will be automatically redistributed according to funds once each month as indicated on the Investment the fund allocation percentages? [] Yes [] No Allocation, form 9293 [] Yes [] No b. Frequency [] Annual [] Semi-Annual [] Quarterly - -------------------------------------------------------------------------------- PART J - TELEPHONE TRANSACTION AGREEMENT - -------------------------------------------------------------------------------- Unless waived below, I appoint the Company as my agent to act upon telephoned instructions reasonably believed to be authorized by me. I hereby ratify any telephoned instructions so given and consent to the tape recording of these instructions. So long as the Company employs reasonable procedures to confirm that the instructions are genuine, I agree that I will not hold the Company liable for any unauthorized telephoned instructions. This will allow me and my representative named below to transfer funds among Sub-Accounts, change the fund allocation percentages, and add, cancel or change the Portfolio Rebalancing or Dollar Cost Averaging features. In the case of 403{b) Tax Sheltered Annuities, the Owner may request policy loans up to $10,000 over the telephone. Representative(s): [] I do not authorize the Company to accept telephone instructions. - -------------------------------------------------------------------------------- PART K - REMARKS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- PART L - AUTHORIZATION - -------------------------------------------------------------------------------- I hereby represent my answers to the above questions to be true and correct to the best of my knowledge and belief. I understand that annuity payments or surrender values, when based upon the investment experience 01 a separate account, are variable and not guaranteed as to a fixed dollar amount. I acknowledge Receipt of the Sentinel Advantage Variable Annuity Prospectus. I have paid $ for Variable Annuity with this application. Monies remitted via: [] Check [] Wire [] 1035 [] Transfer - -------------------------------------------------------------------------------- PART M - OWNER'S TAXPAYER ID NUMBER CERTIFICATION - -------------------------------------------------------------------------------- Under penalties of perjury, I certify that (1) the number shown on this application is my correct taxpayer identification number; (2) the IRS has never notified me that I am subject to backup withholding, or has notified me that I am no longer subject to such withholding or r am exempt from such withholding; and (3) I am a U,S. person (including a U.S, resident alien}, You must cross out item 2 if you have been notified by the IRS that you are currently subject to backup withholding because of underreporting interest or dividends on your tax return. - -------------------------------------------------------------------------------- Part N - Signatures - -------------------------------------------------------------------------------- The Internal Revenue Service does not require your consent to any provision of this document other than the certifications required to avoid backup withholding. Signed at: (City & Slate) on this day of: (mm/dd/yyyy) Owner's Annuitants Signature: Signature: (if different than Owner.) - -------------------------------------------------------------------------------- AR, CO, DC, KY, LA, ME, NM, OH, AND PA RESIDENTS, PLEASE NOTE: Any person who knowingly, and with intent to defraud any insurance company or other person, files an application for insurance or statement 01 claim containing any materially false information or conceals for the purpose of misleading, information concerning any fact material thereto, commits a fraudulent insurance act, which is a crime and subjects such person to criminal and civil penalties. In Colorado, any insurance company, or agent 01 an insurance company, who knowingly provides false, incomplete, or misleading facts or information to a policyholder or claimant for the purpose of defrauding, or attempting to defraud, the policyholder or claimant with regard to a settlement or award payable from insurance proceeds, shall be reported to the Colorado Division of Insurance within the Department of Regulatory Agencies. - -------------------------------------------------------------------------------- PART O - REGISTERED REPRESENTATIVE'S REPORT & SCHEDULE - -------------------------------------------------------------------------------- 1. Will there be any replacement, as defined by any regulation of the state in which this application is taken? [] Yes [] No (If 'Yes', fulfill all state requirements.) 2. % of Credit Signature of Registered Representative Date Signed (mm/ddlyyyy) Registered Representative Name & No. (Print) 3. (Select one of the following) [] Schedule 1 [] Schedule 2 [] Schedule 3 [] Schedule 4 Signature of Broker Dealer B/D Name (Print) B/D Phone, Page 2 EX-10.A 12 exh10a.txt CONSENT OF SAB [SUTHERLAND ASBILL & BRENNAN LLP LETTERHEAD] May 1, 2006 Board of Directors National Life Insurance Company One National Life Drive Montpelier, Vermont 05604 Re: National Variable Annuity Account II Ladies and Gentlemen: We hereby consent to the reference to our name under the caption "Legal Matters" in the Statement of Additional Information filed as part of Post-Effective Amendment No. 19 to the Registration Statement on Form N-4 by National Variable Annuity Account II for certain variable annuity contracts (File No. 333-19583). In giving this consent, we do not admit that we are in the category of persons whose consent is required under Section 7 of the Securities Act of 1933. Very truly yours, SUTHERLAND ASBILL & BRENNAN LLP By: /s/ Stephen E. Roth -------------------------- Stephen E. Roth EX-10.B 13 exh10b.txt CONSENT OF ACCOUNTING FIRM CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We hereby consent to the use in the Statement of Additional Information constituting part of this Post-Effective Amendment No. 19 to the Registration Statement on Form N-4 of our report dated April 7, 2006 relating to the statutory basis financial statements of the National Life Insurance Company for the years ended December 31, 2005 and 2004 and our report dated April 7, 2006 relating to the financial statements of the National Variable Annuity Account II for the year ended December 31, 2005, both of which appear in such Statement of Additional Information. We also consent to the reference to us under the heading "Experts" in such Statement of Additional Information. PRICEWATERHOUSECOOPERS LLP Boston, Massachusetts April 28, 2006 EX-24.B.9 14 exh24-9.txt Exhibit 24 (b) 9 NATIONAL LIFE LOGO [OBJECT OMITTED][GRAPHIC OMITTED] National Life Insurance Company One National Life Drive o Montpelier, Vermont 05604 - -------------------------------------------------------------------------------- May 1, 2006 The Board of Directors National Life Insurance Company National Life Drive Montpelier, Vermont 05604 Re: Variable Annuity Registration Statement Post-Effective Amendment No. 19 Ladies and Gentlemen: With reference to the Post-Effective Amendment No. 19 to the Registration Statement on Form N-4 ("Registration Statement")as amended, filed by National Life Insurance Company and National Variable Annuity Account II with the Securities and Exchange Commission covering individual variable annuity contracts, I have examined such documents and such laws as I considered necessary and appropriate and on the basis of such examination, it is my opinion that: 1. National Life Insurance Company is duly organized and validly existing under the laws the State of Vermont, and has been duly authorized to issue individual variable annuity contracts by the Department of Insurance of the State of Vermont. 2. National Variable Annuity Account II is a duly authorized and existing separate account established pursuant to the provisions of Title 8, Vermont Statutes Annotated, sections 3855 to 3859. 3. The individual variable annuity contracts, when issued as contemplated by the Registration Statement, will constitute legal, validly issued and binding obligations of National Life Insurance Company. I hereby consent to the filing of this opinion as an Exhibit to said Post-Effective Amendment No. 19 to the Registration Statement and to the use of my name under the caption "Legal Matters" in the Registration Statement. Sincerely, Kerry A. Jung Senior Counsel -----END PRIVACY-ENHANCED MESSAGE-----